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How continously progressing concentration processes destruct the economy


Since Pareto it is known, that the creation of wealth in an economy is acompanied by concentration processes, which yield a highly unequal distribution of the wealth. Since Gibrat it is known that such concentration processes also affect firms and banks. Empirically they are proven over and over again. Just recently by a report of Credit Suisse and a study of  a research group at ETH Zurich (Global Wealth Report , Global Network of Corporate Control ). The massively harmful effects of such concentration processes on the quality of economic development are well known as well (2). However, all that is ignored, not understood or put aside, because it doesn't fit the concepts of neoliberal ideology and neoclassical economics. Even then, when major banks and world largest insurance companies collaps or are only saved from collaps by huge government bail out programs. Even the collaps of entire countries and their economies doesn't lead to a change in thinking or a careful reconsideration of harmful concentration processes as a possible cause of the crisis. In face of such stupid ignorance we may ask ourself, what needs to happen next to overcome this stuborn behaviour of mainstream economists, bankers and politicans?
But before we count on the next, probably even more severe wakeup call to open the eyes of the blind, I'll try to explain it once again with calm words and an hopefully illustrative, simple enough example.
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Let's assume we have a population of 1000 individuals or firms and one bank. Let's assume further that the bank will grant a loan of 1$ to each individual or firm at time zero, by opening two accounts for each individual or firm. One on the active side of the bank balance sheet with  the debt of 1$ and one on the passive side of the bank balance sheet with the credit of 1$. Let also assume the loan bears interest of 5% per year. So the total amount of balance is 1000$ plus the equity of the bank owners, which we may assume to be 10% or 100$. At time zero those individuals or firms start economic activity by using their credit of 1$ each. In average we assume the population gains exactly the 5% over one year, but the distribution of the success across the population is a normal distribution with sigma of 0.2. So the return on the 1$ at start is random for each individual or firm, but the distribution of the returns is a normal distribution with its average at 5% and sigma 0.2. This process is repeated every year. On the debt side the accounts are running up the normal compound interest scheme with a fixed rate of 5%. per year. After 75 years we stop and should look for answers to the following questions:

1.) How does the bright side of the economy = sum of the credit accounts look?
2.) What is the distribution of the values of credit accounts?
3.) How did the bank balance sum of credit accounts minus sum of debt accounts develop over time? (I know, a balance sheet of a bank needs to have this difference allways to be zero. However, I allow the difference and do not touch the equity to compensate, to illustrate the effect.)

The answers could not be more shocking!

1.) The growth rate of the sum of all credit accounts is barely above 3%.
2.) The most successful account on the credit side achievs a compound return rate of about 10% per year.
3.) The worst account achievs a compound return rate of -4% per year.
4.) The Theil Index is at 1.3. So 20% of the individuals or firms captured 80% of the credit sum.

x-Achse=Zeit in Jahre, y-Achse Theilindex


5.) Far beyond 50% of the individuals or firms are below the water line. Meaning that their accumulated debt is higher then their accumulated credit.
6.) The difference between the debt side and the credit side of the balance sheet becomes unpredictable after 20 to 25 years, which is a direct result of the progressing concentration of wealth on the credit side.

Beispielhafter Verlauf der Differenz Bank Passiva-Aktiva
x-Achse Zeit (t-20), y-Achse StdDev Passiva-Aktiva


7.) The std. deviation of the YoY growth rate for the entire economy (=sum of credit accounts) increases rapidly, which is an alarming sign to everyone familiar with quality insurance.
A process that shows unstable or climbing variation is a process running out of control, because repeatability of results  is lost.


x-Achse Zeit (t-20), y-Achse StdDev Growth %YoY


And all that in an economy where success = return on investment in average across the population is 5%. All that in an economy where success is random. No oligopoly, no monopoly, no lobbying, no corruption etc.. Just multplicative stochastik process that yields a progressive unequal wealth distribution. For those who have difficulties to believe all that, I have a create a gnumeric spread sheet, which enables you to take a closer look and to play around with it.
The model used within that spread sheet is based on an very elegant approach taken by a group of researches at the University of Minnesota ( 1 ).
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Now, we are not living in a random society, but in an economy blinded by neoliberal ideology and neoclassical economic thinking which not only ignores this but tend to exerbate these things by accelerating the concentration of wealth in the hands of few. The implications on society are dramatic. Not only becomes democracy a joke, but war becomes more propable as well. A society which is unable to understand or continues to ignore all this, is therefore not only stupid but on its way to destruct itself.

Sapere Aude! 

Georg Trappe

(1) Fargione JE, Lehman C, Polasky S (2011) Entrepreneurs, Chance, and the Deterministic Concentration of Wealth.
(2) Eichner, Stefan L. Wettbewerb, Industrieentwicklung und Industriepolitik
(*)
(**) An example of not understanding this, is german chanclor Merkel. Not only the exponential rise of debt is the problem, but the progressive concentration of wealth on the other side of the equation as well. With that the risks are increasing tremendously. In an economy close to the starting point failure of one firm would erase 1/1000th of the economy., but later on when the wealth is highly concentrated it makes a huge difference when one of the big players delivers only 4 vs. 5% return on that concentrated capital.
(***) The spread sheet is a gnumeric one. The windows version of gnumeric can be found here.
(****) The very basic assumptions behind the model are:
1 - Humans have the potential to produce surplus.
2 - Humans have the motivation to use the surplus to increase productivity/wealth and are willing to reinvest the surplus over and over for that purpose.
3 - Humans exhibit considerable differences in success when they do so.




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