- Creating Capital
- The 80-20 Rule
- The Power of Productivity
This chapter is from the book
This chapter is from the book
This chapter is from the book
The 80-20 Rule
In any society, there will always be more followers than leaders, more losers than winners. An 80-20 rule seems to govern human affairs: Left to their own impulses, 80 percent of the work is done by 20 percent of the work force; 80 percent of property falls into the hands of 20 percent of the populace; 80 percent of the effort produces 20 percent of the value. Economists call it Pareto’s Law, after Vilifredo Pareto, a nineteenth-century Italian economist who noticed 20 percent of Italians were earning 80 percent of the national income.
Here are some other examples of the 80-20 rule:
- Twenty percent of the devices, tools, and people on an assembly line are responsible for 80 percent of the defects.
- Twenty percent of the customers account for 80 percent of the profits. Also, 20 percent of the products and 20 percent of the sales force generate 80 percent of the profits.
- Twenty percent of the customers—a different 20 percent—also make 80 percent of the complaints.
- Workers who can schedule themselves—such as artists, writers, or senior office workers—get about 80 percent of their work done by working intensely about 20 percent of the time.
- Twenty percent of hospital patients and 20 percent of health insurance clients account for 80 percent of the costs of care.
Much derided and denounced, “trickle-down economics” refers to the concept that if the 20 percent who create wealth are left unfettered and lightly taxed, they and their investments will create more wealth, so the benefits will trickle down to the rest of society in the form of wages and profits. This should not be controversial; it should be taken as a fundamental principle of capitalism.
That’s what it seemed like to Adam Smith, who noted that the wealthiest person cannot eat much more than anyone else. The rich man’s food may be more artfully prepared, better decorated, served by a waiter in a fine uniform, or composed of more courses. Still, a meal is just a meal, and one can eat only so much.
In Smith’s view, all the other trappings of wealth are conduits for trickle-down economics: If the wealthy diners were not wealthy, their chefs and sous-chefs might not be employed, their well-paid cake decorators might be baking cookies at home and selling them on the street, their waiters and the rest of their household staffs might be subsistence farmers. None of them could earn as much in such circumstances as they could on an eighteenth-century nobleman’s estate. (That does not stop the servants from resenting their stations in life or from looking down on those not so well employed.)
Far more important but less visible, wealthy individuals invest their wealth in productive enterprises, which also employ factory workers, salespeople, executives, and janitors. Wealth does not merely trickle down—it gushes in cataracts and nourishes the entire society.
As Smith said of the rich, “They divide with the poor the produce of all their improvements.”
In modern times, trickle-down economics burst upon the American political scene in the early days of the Reagan administration as a derogatory term for radical tax cuts, especially cuts in high progressive tax rates on high incomes. In 1981, the highest bracket of taxable income was taxed at 70 percent, although few people paid taxes at that rate because the tax code also offered many tax shelters.
Tax-cutters rarely dare to use the term trickle-down economics, although in one incident, President Reagan’s budget director, David Stockman, privately conceded that his “supply-side economics” was really trickle-down economics, and the concession made it into a book that was published while the tax-cut controversy was still lively.
The debate was in two parts: Was it true that Republican tax-cutters wanted to cut rates on the rich? And was it true that cutting high tax rates on the rich would stimulate investment, create new jobs, and bring benefits to lower income classes?
Both things were true, although the effects take time to work their way through the economy, and other factors also operate. Some Democrats, however, believed trickle-down economics was a cruel hoax and the benefits for the middle class and the poor were nonexistent.
Republicans rarely come out well when Democrats accuse them of favoring the rich, and thus they rarely defend trickle-down economics well. They ignore it or run away from it as much as they can.
They should be casting the alternative in terms people can understand. The point of high tax rates is to take wealth away from individuals who have a lot of it, never mind that most of it is invested in the productive economy, where the returns on the investment are trickling down to everyone. Most government spending, however, is just spending—pure consumption that does little to create new wealth.
Democratic government has this fundamental problem: In broad terms, 20 percent of the people do most of the productive work and create most of the nation’s wealth, but the other 80 percent command a heavy majority of votes. It’s a pleasant surprise that democracies foster much investment and productivity growth at all.