Time for the annual spate of “gap between rich and poor increases” stories in the MSM. There are a number of problems with the judgmental assumptions implicit in these kinds of stories.

For example, there is a zero-sum view of wealth that pits individuals against each other. It’s essentially the “pie” view of money and wealth: if I take a piece, there’s that much less available for others. This is the distributivist economic model. This is a fundamentally flawed economic model that does not adequately account for the creation of wealth via free exchange.

But there’s an even more obvious phenomenon that makes such “news” stories so mundane. It’s been referred to as the “miracle of compounding interest.” Because of this, it should be no surprise that the gap between rich and poor continues to widen. In fact, assuming the laws of mathematics, we can say that it ought to continue to widen.

Let’s use an overly simple but instructive example. Say that person A has $1,000 in capital to invest while person B has $10,000. Relatively speaking, person A is poorer than person B, with a difference of $9,000.

If both persons invest their money, and get a return roughly equal to inflation, say 2% (compounded quarterly), in fifty years A will have $2,711.52, while person B will have $27,115.17. The gap between the two has exploded from a mere $9,000 to $24,403.65!

But is there anything fundamentally unfair about this? Change around the capital investments, the rate of return, and the time period, and you can quickly get into astronomical numbers. But why is this news? Just because there are big numbers with lots of zeroes?

Given this economic reality, it would really be news if the gap between rich and poor didn’t increase.

  • While long term macro economics is NOT a zero sum game, in each fiscal year the US budget, like every gov’t budget, IS a zero sum game. The more the gov’t spends, the more it must take as taxes (or inflation).

    This also holds locally — the more folk spend at Wal-Mart, the less they spend at the other local shops (like Sears or K-mart or mom & pop stores).

    What is crucially important on the compound interest example is that only Investment counts towards interest. The rich usually invest more. For a majority (or near?) of Americans, their only significant investment is their house — and they’ve been taking OUT the equity to consume it. That’s not the path towards more wealth in the future.