Inequality and Skin in the Game
(Chapter from Skin in the Game)
The Static and the Dynamic — How to go bankrupt and be loved by the many –Piketty’s equals
Inequality vs Inequality
There is inequality and inequality.
The first is the inequality people tolerate, such as one’s understanding compared to that of people deemed heroes, say Einstein, Michelangelo, or the recluse mathematician Grisha Perelman, in comparison to whom one has no difficulty acknowledging a large surplus. This applies to entrepreneurs, artists, soldiers, heroes, the singer Bob Dylan, Socrates, the current local celebrity chef, some Roman Emperor of good repute, say Marcus Aurelius; in short those for whom one can naturally be a “fan”. You may like to imitate them, you may aspire to be like them; but you don’t resent them.
The second is the inequality people find intolerable because the subject appears to be just a person like you, except that he has been playing the system, and getting himself into rent seeking, acquiring privileges that are not warranted –and although he has something you would not mind having (which may include his Russian girlfriend), he is exactly the type of whom you cannot possibly become a fan. The latter category includes bankers, bureaucrats who get rich, former senators shilling for the evil firm Monsanto, clean-shaven chief executives who wear ties, and talking heads on television making outsized bonuses. You don’t just envy them; you take umbrage at their fame, and the sight of their expensive or even semi-expensive car trigger some feeling of bitterness. They make you feel smaller.
There may be something dissonant in the spectacle of a rich slave.
The author Joan Williams, in an insightful article, explains that the working class is impressed by the rich, as role models. Michèle Lamont, the author of The Dignity of Working Men, whom she cites, did a systematic interview of blue collar Americans and found present a resentment of professionals but, unexpectedly, not of the rich.
It is safe to accept that the American public –actually all public –despise people who make a lot of money on a salary, or, rather, salarymen who make a lot of money. This is indeed noticeable in other countries: a few years ago one third of the Swiss, of all people, voted in favor of a law capping salaries of managers. But the same Swiss hold rich entrepreneurs, and people who have derived their celebrity by other means, in some respect.[ii]
Further, in countries where wealth comes from rent seeking, political patronage, or what is called regulatory capture (by which the powerful uses regulation to scam the public, or red tape to slow down competition), wealth is seen as zero-sum. What Peter gets is extracted from Paul. Someone getting rich is doing so at other people’s expense. In countries such as the U.S. where wealth can come from destruction, people can easily see that someone getting rich is not taking dollars from your pocket; perhaps even putting some in yours. On the other hand, inequality, by definition, is zero sum.
In this chapter I will propose that effectively what people resent –or should resent –is the person at the top who has no skin in the game, that is, because he doesn’t bear his allotted risk, is immune to the possibility of falling from his pedestal, exiting the income or wealth bracket, and getting to the soup kitchen. Again, on that account, the detractors of Donald Trump, when he was a candidate, failed to realize that, by advertising his episode of bankruptcy and his personal losses of close to a billion dollars, they removed the resentment (the second type of inequality) one may have towards him. There is something respectable in losing a billion dollars, provided it is your own money.
In addition, someone without skin in the game –say a corporate executive with upside and no financial downside (the type to speak clearly in meetings) –is paid according to some metrics that do not necessarily reflect the health of the company; these (as we saw in Chapter x) he can manipulate, hide risks, get the bonus, then retire (or go to another company) and blame his successor for the subsequent results.
We will also, in the process, redefine inequality and put the notion on more rigorous grounds. But we first need to introduce the difference between two types of approaches, the static and the dynamic, as skin in the game can transform one type of inequality into another.
Take also the two following remarks:
True equality is equality in probability
Skin in the game prevents systems from rotting
The Static and the Dynamic
Visibly, a problem with economists (particularly those who never really worked in the real world) is that they have mental difficulties with things that move and are unable to consider that things that move have different attributes from things that don’t –it may be trivial but reread Chapter  on IYIs if you are not convinced. That’s the reason complexity theory and fat tails are foreign to most of them; they also have (severe) difficulties with the mathematical and conceptual intuitions required for deeper probability theory. Blindness to ergodicity which we will define a few paragraphs down, is indeed in my opinion the best marker separating a genuine scholar who understands something about the world, from an academic hack who partakes of a ritualistic paper writing.
Let us make a few definitions:
Static inequality is a snapshot view of inequality; it does not reflect what will happen to you in the course of your life
Consider that about ten percent of Americans will spend at least a year in the top one percent and more than half of all Americans will spent a year in the top ten percent. This is visibly not the same for the more static –but nominally more equal –Europe. For instance, only ten percent of the wealthiest five hundred American people or dynasties were so thirty years ago; more than sixty percent of those on the French list were heirs and a third of the richest Europeans were the richest centuries ago. In Florence, it was just revealed that things are really even worse: the same handful of families have kept the wealth for five centuries.[iii]
Dynamic (ergodic) inequality takes into account the entire future and past life
You do not create dynamic equality just by raising the level of those at the bottom, but rather by making the rich rotate –or by forcing people to incur the possibility of creating an opening.
The way to make society more equal is by forcing (through skin in the game) the rich to be subjected to the risk of exiting from the one percent
Or, more mathematically
Dynamic equality assumes Markov chain with no absorbing states
Our condition here is stronger than mere income mobility. Mobility means that someone can become rich. The no absorbing barrier condition means that someone who is rich should never be certain to stay rich.
Now, even more mathematically
Dynamic equality is what restores ergodicity, making time and ensemble probabilities substitutable
Let me explain ergodicity –something that we said is foreign to the intelligentsia; we will devote an entire section as we will see it cancels most crucial psychological experiments related to probability and rationality. Take a cross sectional picture of the U.S. population. You have, say, a minority of millionaires in the one percent, some overweight, some tall, some humorous. You also have a high majority of people in the lower middle class, school yoga instructors, baking experts, gardening consultants, spreadsheet theoreticians, dancing advisors, and piano repairpersons. Take the percentages of each income or wealth bracket (note that income inequality is flatter than that of wealth). Perfect ergodicity means that each one of us, should he live forever, would spend the proportion of time in the economic conditions of segments of that entire cross-section: out of, say, a century, an average of sixty years in the lower middle class, ten years in the upper middle class, twenty years in the blue collar class, and perhaps one single year in the one percent. (Technical comment: what we can call here imperfect ergodicity means that each one of us has long term, ergodic probabilities that have some variation among individuals: your probability of ending in the one percent may be higher than mine; nevertheless no state will have a probability of zero for me and no state will have a transition probability of one for you).
The exact opposite of perfect ergodicity is an absorbing state. The term absorption is derived from particles that, when they hit an obstacle, get absorbed or stick to it. An absorbing barrier is like a trap, once in, you can’t get out, good or bad. A person gets rich by some process, then having arrived, as they say, he stays rich. And if someone enters the lower middle class (from above); he will never have the chance to exit from it and become rich should he want to, of course –hence will be justified to resent the rich. You will notice that where the state is large, people at the top tend to have little downward mobility –in such places as France, the state is chummy with large corporations and protects their executives and shareholders from experiencing such descent; it even encourages their ascent.
And no downside for some means no upside for the rest.
Take for now that an absorbing state –staying rich –causes path dependence, the topic of Part X.
Pikketism and the Revolt of the Mandarin Class
There is a class often called the Mandarins, after the fictional memoirs of the French author Simone de Beauvoir, named after the scholars of the Ming dynasty that gave their name to the high Chinese language. I have always been aware of its existence, but its salient –and pernicious –attribute came to me while observing the reactions to the works by the French economist Thomas Pikkety.
Pikkety followed Karl Marx by writing an ambitious book on Capital. I received the book as a gift when it was still in French (and unknown outside France) because I found it commendable that people publish their original, nonmathematical work in social science in book format. The book, Capital in the 21st Century, made aggressive claims about the alarming rise of inequality, added to a theory of why capital tended to command too much return in relation to labor and how absence of redistribution and dispossession would make the world collapse. The theory about the increase in the return of capital in relation to labor was patently wrong, as anyone who has witnessed the rise of what is called the “knowledge economy” (or anyone who has had investments in general) knows. But there was something far, far more severe than a scholar being wrong.
Soon, I discovered that the methods he used were flawed: Picketty’s tools did not show what he purported about the rise in inequality. I soon wrote two articles, one in collaboration with Raphael Douady that we published in Physica A: Statistical Mechanics and Applications, about the measure of inequality that consists in taking the ownership of, say the top 1% and monitoring its variations. The flaw is that if you take the inequality thus measured in Europe as a whole, you will find it is higher than the average inequality across component countries; the bias increases in severity with extreme processes. The same defect applied to the way inequality researchers used a measure called Gini coefficient, and I wrote another paper on that. All in all, the papers had enough theorems and proofs, to make them about as ironclad a piece of work one can have in science; I insisted on putting the results in theorem form because someone cannot contest a formally proved theorem without putting in question his own understanding of mathematics.
The reason these errors were not known was because economists who worked with inequality were not familiar with… inequality. Inequality is the disproportion of the role of the tail –rich people were in the tails of the distribution. The more inequality in the system, the more the winner-take-all effect, the more we depart from the methods of tin-tailed Mediocristan in which economists were trained. Recall that the wealth process is dominated by winner-take-all effects, the type described in The Black Swan. Any form of control of the wealth process –typically instigated by bureaucrats –tended to lock people with privileges in their state of entitlement. So the solution was to allow the system to destroy the strong, something that worked best in the United States.
The problem is never the problem; it is how people handle it. What was worse than the Piketty flaws was the discovery of how that Mandarin class operates. They got so excited by the rise of inequality that their actions were like fake news. Economists got so excited they praised Piketty for his “erudition” from his discussing Balzac and Jane Austen, the equivalent to hailing as a weightlifter someone seen carrying a briefcase. And they completely ignored my results –and when they didn’t, it was to declare that I was “arrogant” (recall that the strategy of using theorems is that they can’t say I was wrong, so they resorted to “arrogant” which is a form of scientific compliment). Even Paul Krugman who had written “if you think you’ve found an obvious hole, empirical or logical, in Piketty, you’re very probably wrong. He’s done his homework!”[iv], when I pointed out the flaw to him, when I met him in person, evaded it –not necessarily by meanness but most likely because probability and combinatorics eluded him, by his own admission.
Now consider that the likes of Krugman and Piketty have no downside in their existence –lowering inequality brings them up in the ladder of life. Unless the university system or the French state go bust, they will continue receiving their paycheck. Donald Trump is exposed to the risk of ending having his meals in a soup kitchen; not them.
Cobbler Envies Cobbler
Envy does not travel long distance, or across so many social classes. The envy-driven feelings that usually –as we saw in the works of Williams and Lamont –do not originate from the impoverished classes, concerned with the betterment of their condition, but with that of the clerical class. Simply, it looks like it is the university professors (who have arrived) and people who have permanent stability of income, in the form of tenure, governmental or academic, who bought heavily in the argument. From the conversations, I became convinced that these people who counterfactual upwards (i.e. compare themselves to those richer) wanted to actively dispossess the rich. As will all communist movements, it is often the bourgeois or clerical classes that buy first into the argument.
Aristotle, in his Rhetoric postulated that envy is something you are more likely to encounter in your own kin: lower classes are more likely to experience envy towards their cousins or the middle class than towards the very rich. The expression Nobody is a prophet in his own land making envy a geographical thing (mistakenly thought to originate with Jesus, ουδείς προφήτης στον τόπο του in Luke and a similar expression in Mark) originates with that passage in the Rhetoric. Aristotle himself was building on Hesiod’s: cobbler envies cobbler, carpenter envies carpenter. Later, La Bruyere wrote jealousy is found within the same art, talent and condition.
So I doubt Piketty bothered to ask blue-collar Frenchmen what they want, as Lamont did. I am certain that they would ask for a new dishwasher, or faster train for their commute, not to bring down some rich businessman invisible to them. But, again, people can frame questions and portray enrichment as theft, as it was before the French Revolution, in which case the blue-collar class would ask, once again, for heads to roll.
 “τὸ συγγενὲς γὰρ καὶ φθονεῖν ἐπίσταται.”, Rhetoric 1388a, citing originally from Aeschylus, frag. 304.
 La Bruyere: L’émulation et la jalousie ne se rencontrent guère que dans les personnes du même art, de même talent et de même condition.
Another lesson from Piketty’s ambitious volume: it was loaded with charts and tables. But what we learn from professionals in the real world is that data is not necessarily rigor. One reason I –as a probability professional –left data out of The Black Swan (except for illustrative purposes) is that it seems to me that people flood their story with numbers and graphs in the absence of logical argument. Further, people mistake empiricism with flood of data. Just a little bit of significant data is needed when one is right, particularly when it is disconfirmatory empiricism, or counterexamples for rules: only one point is sufficient to show that Black Swans exist.
Probability, statistics, and data science are principally logic fed by observations –and absence of observations. For many environments, the relevant data points are those in the extremes; these are rare by definition; and it suffices to focus on those few but big to get an idea of the story. If you want to show that a person is richer than, say $10 million, all you need is show the $50 mil in his brokerage account, not, in addition, list every piece of furniture in his house, including the $500 painting he has in his study and a count of the silver spoons in his pantry. So I’ve discovered, with experience, that when you buy a thick book with tons of graphs and tables used to prove a point, something is alarmingly suspicious. It means something didn’t distil right! But for the general public and those untrained in statistics, such tables appear convincing –another way to substitute the true with the complicated. For instance, the science journalist Steven Pinker did that with his book, The Better Angels of Our Nature, concerning the decline of violence in modern human history. My collaborator Pasquale Cirillo and I, when we put his “data” under scrutiny, found out that that either he didn’t understand his own numbers (actually, he didn’t), or he had a story in mind and kept adding charts not realizing that statistics isn’t about data but distillation, rigor and avoiding being fooled by randomness –but no matter, the general public of IYI colleagues found it impressive for a while.
Ethics of Civil Service
People who like bureaucracies and the state have trouble understanding that having rich people in a public office is very different from having public people become rich –again it is the dynamics, the sequence that matters. Rich people in public office have shown some evidence of lack of total incompetence –success may come from randomness, of course, but we at least have a hint of some skill in the real world, some evidence that the person has dealt with reality. This is of course conditional of the person having had skin in the game –and it is better if the person felt a blowup, has experienced at least once the loss part of his or her fortune and the angst associated with it.
A good rule for society is to oblige those who start in public office to pledge never subsequently to earn from the private sector more than a set amount; the rest should go to the taxpayer. This will ensure sincerity in, literally, “service” — where employees are supposedly underpaid because of their emotional reward from serving society. It would prove that they are not in the public sector as an investment strategy: you do not become a Jesuit priest because it may help you get hired by Goldman Sachs later, after your eventual defrocking –given the erudition and the masterly control of casuistry generally associated with the Society of Jesus.
Currently, most civil servants tend to stay in civil service –except for those in delicate areas that industry controls: the agro-alimentary segment, finance, aerospace, anything related to Saudi Arabia…
Currently, a civil servant can make rules that are friendly to an industry such as banking — and then go off to J.P. Morgan and recoup a multiple of the difference between his or her current salary and the market rate. (Regulators, you may recall, have an incentive to make rules as complex as possible so their expertise can later be hired at a higher price.)
So there is an implicit bribe in civil service: you act as a servant to industry, say Monsanto, and they take care of you later on. They do not do it out of a sense of honor: simply, it is necessary to keep such a system going and encourage the next guy to play by the rules. The IYI cum scumbag Tim Geithner–with whom I share a Calabrese barber –was overtly rewarded by the industry he helped bail out.
Watch former heads of state such as Bill Clinton or Tony Blair use the fame that the general public gave them to make hundreds of million in speaking fees –indeed for these two sleek fellows, public service was the most effective step towards enrichment. The difference between a salesman and a charlatan is that the latter doesn’t deliver what he claims to be selling. Ironically the pair Clinton-Blair appeared less greedy than the typical ego-driven businessman who seeks elections.
[CONTINUED LATER. THIS IS EXCERPTED FROM SKIN IN THE GAME]
 39% of Americans will spend a year in the top 5 % of the income distribution, 56 % will find themselves in the top 10%, and 73% percent will spend a year in the top 20 %.
 The type of distributions –called fat tails –associated with it made the analyses more delicate, far more delicate and it had become my mathematical specialty. In Mediocristan changes over time are the result of the collective contributions of the center, the middle. In Extremistan these changes come from the tails. Sorry, if you don’t like it but that is purely mathematical.
[ii] HBR article by Joan williams https://hbr.org/2016/11/what-so-many-people-dont-get-about-the-u-s-working-class