Understanding Growing Inequality Part 4: How the Market makes it Cheaper to be Rich and more Expensive to be Poor

Better Interest rates, for one. And businesses compete to get rich customers, and avoid poor ones. That's 80/20 marketing.

Above: In 1933, this is where my father and his family were living. A grain shed converted to makeshift living quarters. A veranda (now removed) had been built around it, and this was the “inside room” on a plot of land near Headingley, Manitoba/

How I got interested in inequality

My grandfather, John S. “Bud” Lamont was a lawyer and First World War veteran. Born in PEI in 1885, his father was a cobbler. He left home at the age of 15, became a teacher and a lumberjack and came to Winnipeg in 1906, working on the railroad. He went to the U of M and won the gold medal in mathematics, and won a scholarship to Princeton. He became a lawyer, and married May Bastin - who had been second in the same mathematics class. They had five children together, and the youngest, my father Frank, was born in March 1933, the worst month of the Depression in Canada.

Despite all that education, after the stock market crash of 1929 my grandparents and their five children were living in a grain shed on a plot of land in Headingley. The depression hit Western Canada harder than almost any other place in the world.

Back row, left to right: my grandmother, May Lamont, my Aunt Mary, Uncle John, and grandfather John S “Bud” Lamont. Front row: my father, Frank Lamont, Aunt Jean, and family friend, Blanche Hunter

It wasn’t just stock prices that collapsed, so did the price of wheat, which had generated incredible wealth across Western Canada - from grain barons to farmers and farm workers. The economic impact was devastating: a 92 percent drop.

“The Great Depression wrought great economic hardship throughout the world, but few places suffered so sharp a decline in income or required so much government assistance to survive as the Canadian prairie provinces. From 1928 to 1932 Canada's agricultural economy declined 68 per cent while the Prairies’ declined 92 per cent. In Alberta the average per capita income in 1928-29 was $548 ; in 1933 it decreased by 61 per cent to$ 212. The Canadian average per capita decrease during the same period was 48 per cent.”

My dad and his brothers and sisters would sit around and talk about those times. Yet, Manitoba and Canada emerged from the Depression, and my father went from growing up in a shed to a successful career in finance and law. Like his parents, he was also gifted academically and earned a Rhodes Scholarship in economics and philosophy. I recently learned that he was considered one of the foremost experts on monetary policy in Canada. I grew up with him explaining the economy, finance and the law to me.

As a Gen X-er, around 1989 I heard that for some reason it was predicted that we would be the first generation in history to be poorer than our parents. As this happened, we were entering a massive recession across North America, that drove a decade of austerity - and I have watched and things have gotten worse for generations after me.

First of all, we’re not the first generation, or the last. There have been times of widespread shared prosperity followed by economic collapse where people are worse off. It has happened many times, especially with really serious and prolonged economic depressions.

But I asked if this happening, why is it considered inevitable and something we can’t do anything about? It made no sense to me. After all, my father was born into the Depression, but became very successful - and it wasn’t just him. It wasn’t just him: the entire Canadian and North American economy had a massive recovery - “the Golden Age of Capitalism” and the post-war boom.

As it happened, many close friends worked in finance - as reporters, investment bankers, financial managers and executives. My wife and I were living in Toronto in the 1990s and a friend who worked at a bank was telling stories about how his bank’s customer satisfaction scores were so high - too high, because they were spending too much money on helping clients who didn’t have any.

His example was a customer who lived in Barrie, Ontario, who had lost his client card. So client support got in a taxi in Toronto to hand-deliver the new card to them, 100 km away. It was a $400 taxi ride all for a client whose total worth to the bank was $15,000. (He couldn’t stop laughing.)

That’s when he explained that customer service had been ignoring the 80/20 rule: that 80% of your revenue will come from 20% of your customers. That means you focus more of your efforts on that 20%.

I was absolutely shocked when he told me that. I couldn’t believe that inequality could be that great. It seemed to me to be colossally unfair, in every way - especially given that our generation, Generation X, was supposed to be fated to be worse off. I worked in the private and public sector, as well as policy research and development for political campaigns. I started researching inequality, because I wanted to understand what changed in the economy from 1930 to 1975 that pulled Canada and the world out of the Depression, and what changed from 1976 until now.

I suspected that one of the reasons was the 80/20 rule. It’s taught in marketing and business schools.

And to me, it shows that this is why democracy and the market are so fundamentally different, and why democracy and a government to deliver it are so important.

The 80/20 rules shows that customers and consumers are not equal. In the market, the more dollars you have, the more votes you get. The fundamental basis of democracy is that everyone gets one vote - and beyond that, that there are certain rules to ensure freedom, from both government and private violations of rights and dignity, and to recognize that we have to balance the needs of all.

80/20 as a Self-Fulfilling Prophecy

“If you’re going fishing, go where the fish are,” the saying goes.

If 80% of money is concentrated in the hands of the 20%, it makes business sense to “segment” your customers.

One way of doing it is in terms of income, or age, or some other demographic profile, density and geographic location. The data is readily available, and the impacts are profound. In the U.S. there is a single piece of data that can accurately predict your life expectancy: your postal code.

It’s also the reality of business. For a business with fixed costs in terms of overhead and labour, this is important. The more customer traffic, the better, because employees are kept busy all the time selling the product. The opposite is true in less densely populated areas, including rural areas and small towns. There is more “down time” where employees are being paid but not serving customers.

For rural and remote areas, it costs more to deliver the product or service due to transportation costs. This is also the case with extending infrastructure — like electric power, phone, or cell-phone networks — over great distances to a small number of customers.

A large company may be able to serve rural and remote customers, or customers in poor areas, and still be profitable overall. But if they analyze their numbers, they will see that certain branches or lines of business are less profitable, or that investments in new infrastructure in some areas will take much longer to pay back than others.

Though other parts of a network may be highly profitable (in densely populated urban centres, or in a wealthy suburb), the cost of providing the service to that small of a customer base may actually cost money — or not be profitable enough to warrant services at that particular location.

So, low-income areas and rural areas get even worse service, or get cut off. It’s not economical to provide services there, and, as businesses often say, they are not charities. It becomes a vicious circle — amenities are shut down and cut off. Banks branches are closed and replaced by payday loan companies or pawn shops.

Pursuing an 80/20 strategy makes business sense, but it also “amplifies” the difference between urban and rural, and rich and poor neighbourhoods and it makes the rich richer while making the poor poorer.

Businesses will actively avoid providing services to rural and low-income areas, and compete to provide services in urban and wealthy areas. It’s explains the phenomenon of urban “food deserts,” where major chain groceries close down or avoid neighbourhoods or even cities. Detroit no longer has a single major chain grocery store.

This creates a vicious circle in rural and poor areas, and a virtuous circle (some might say bubble) in urban areas. When banks, post offices, pharmacies and grocery stores close down in a given area, residents have travel to get them, which means their money leaves the community, impoverishing it further.

Why it’s cheaper to be rich and more expensive to be poor

For the wealthy or urban areas, businesses will compete for the 20% who have 80% of the income. “To those that have, it shall be given,” as the saying has it.

When 80% of revenue comes from the top 20%, it will create a glut of businesses competing for the 20%. Whether it’s an airline, a hotel, a restaurant or a car dealership, the well-to-do will get free offers, better service, better discounts, valet parking, better seats, upgrades, and so on. Their credit ratings mean they can borrow at lower rates of interest, their insurance policies will be cheaper because they live in low-crime areas. Banks have started to triage customers who call in by their phone number: if you are a low-income customer with few (or no) holdings you will wait longer on hold. Wealthier customers will get through right away.

The 80/20 rule is a power law that applies to itself, over and over. Not only does the top 20% own 80% - the top 1% of owners own 50% of all assets and property. Even within the top 1%, the concentration gets higher and higher:

So when it comes to “market segmentation” for business, when 50% of the wealth is owned by 1%, you can be very profitable focusing entirely on a small population - the high-end, luxury market. It also means that these large investors - both personal and institutional - have an outsize effect on the market as a whole.

In Canada, the concentration today is not 80/20 - about 67% of all property is owned by the top 20%.

But the result is that businesses will actively avoid poor areas, or areas that cost more to provide service to (rural and thinly populated areas).

For the businesses that do locate in those areas, they are usually the only game in town, and are in a stronger position to dictate terms and set prices for customers.

What is true of poor areas losing amenities and services also applies to the investment strategies of the wealthiest few in a community that is generally lower income. Rather than riskier, low-return investments in their own community, they will invest in something safer, higher-return investments outside of the community instead. So, money generated within the community leaves to spur growth elsewhere.

This, then, is one of the paradoxes of the free market economy: it’s expensive to be poor, and cheaper to be rich, and the more the gap grows between rich and poor, the more it makes sense to concentrate your business efforts on the few who hold most of the wealth and abandon everyone else.

The role of debt and interest rates is also important, because it also amplifies inequality in obvious ways, with higher interest rates for people who are low income and lower interest rates for people who are high income. This doesn’t just mean that people who are low income pay more for the same loan - people with higher incomes and lower interest rates can get far larger loans at the same cost that people with smaller incomes can afford. (This is the subject of the next chapter).

It also illustrates why it is hard to climb out of poverty, especially in rural areas: you are less likely to have access to some of the basic infrastructure others can take for granted in a city. By this I mean, quite literally, infrastructure — public utilities, transportation and communications infrastructure, as well as services like banking, food, health care. Even in a city, if you have to travel to get to these services on public transit, you are also paying with your time.

For companies who have to actually invest in the infrastructure (like cellphone towers), it may be impossible to justify spending a large capital outlay on a small number of people, (or a large number of poor people) when it could lose money, or, even if it does make money, be less profitable, or take too long to pay back.

When governments get involved in funding projects like these, and people ask why, the answer is because the private sector won’t. Business people may well say, “and for good reason, — because it is a money-loser.” That is not necessarily the case. Private companies and governments have different horizons for return on investment. Governments can borrow at lower cost than any private company, and while a company may no longer exist in 20 years, a government probably will.

Sometimes only once a government monopoly gets a service up and running does competition in the sector even become feasible. When radio, television and electrical power grids were established in Canada, it wasn’t economical for the private sector to do it without leaving large parts of the country unserviced. So governments, or government-owned corporations proceeded instead.

All of this is important from a couple of perspectives.

First, it shows that if every business follows the 80/20 rule, while it makes good business sense, is also a self-fulfilling prophecy. It takes current inequalities in social structure and makes society more stratified and unequal. It makes poor areas poorer (and riskier to invest in), and rich areas richer (and, temporarily, better bet for investment). Left to run on its own, it makes the few who are strong stronger, while leaving everyone else behind.

It is a “kiss up, kick down” economic strategy that entrenches social stratification, it impedes risk taking and growth and entrepreneurship.

It denies opportunities for people in rural areas or poor areas access to opportunities that would enable them to take risks or build more prosperous lives. For example, access to electrical power, internet, health care, phone service or transportation as well as services.

It is also conservative in the sense of avoiding risk-taking. It is anti-innovation, and anti-risk. It concentrates services in cities and pulls them away from rural areas, and within cities, away from poor areas and into rich ones. It effectively means withholding investments that would help make the poor or rural areas more competitive (or life better) and generate business activity once they were installed, like access to electricity, clean water, or the internet. The internet can create a level playing field in terms of communication, access to learning, or work.

But it is not good for the economy as a whole, because growing inequality means businesses have to chase an ever shrinking number of very wealthy customers. It is crushing entire markets - entire categories of customer - out of existence.

This reality is not what is predicted by free market economists, politicians, pundits or journalists. Considering the almost universal phenomenon of the 80/20 rule in business practice, it is appears to be rarely discussed or understood. There is an old saying that “An economist is someone who know a hundred different ways of making love, but has never actually done it.”

Arthur Okun wrote that “John Stuart Mill insisted that he would be a communist if he believed that economic misery and deprivation were inherent in a capitalistic economy. And Mill was right; they are not inherent and they can be eliminated. Indeed, in a democratic capitalism, they must be eliminated.”

If misery and deprivation are to be eliminated, the market alone is not going to do it, because if everyone pursuing 80/20 will not lead to equilibrium, or “downward” distribution of income.

One of the premises of business “restructuring” which is the current newspeak for layoffs, redundancies and cutbacks, is that you make the laid off workers someone else’s problem: it is assumed they will just find a good job elsewhere.

When people “run government like a business” this is also the premise they use, not just for public servants, but for people on social programs like employment insurance or welfare. They are moved off one government’s books and onto another’s, or charities and faith groups are supposed to pick up the slack. The reason social programs like welfare and employment insurance started in the first place is that charity was — and still is — inadequate to the need.

This is why, in most developed countries, we have progressive taxes. The market, left to its own devices, will tend to make the rich richer, and while innovation will improve efficiency and productivity and produce more cheap goods and services, it will also throw people out of work.

Without a mechanism to address the imbalances in the market - a government - the economy will grind to a halt for a lack of customers.

When viewed through the lens of risk, the market allows people who are already wealthy to build greater surplus against risk, while undermining people who are already at greater risk. With progressive taxation, transfer payments and a social safety net, governments can tax the highest income earners can be taxed without appreciably putting them at risk, while also introducing programs that effectively reduce poverty. It reduces risk that no private company will do.

People’s thinking about business are usually from one of three points of view:

• management dealing with employees

• labour, bargaining with management or dealing with bosses

• the customer picking and choosing a product.

80/20 is about how business looks at customers. Not Human Resources, but the real strategy behind marketing.

Following 80/20 as a rule shows how the practice of business, uninterrupted and unregulated, actually drives inequality: because business recognizes people as unequal (financially and in other ways), and treats them that way, by serving some and not others.

The 80/20 rule takes inequality as a given, and sets out to exploit it. This is not a moral comment: it’s how business works, and why business works: this is how business has to work. If you sell a product or service for less than it is worth, you will go bankrupt.

But societies do not have to be so unequal. Canada, the US and the UK were all more equal in the past in the 1950s through the 1970s. Yes, there were grave injustices, but generally speaking, people were paid better, the economy was more stable and governments were not in continual deficit.

In a more equal society - with greater competition, the market works better.

What about the 80% who provide 20% of the Revenue?

Sometimes people will say that incomes stalling doesn’t matter as much because some things are so much cheaper than they used to be. While it’s true that some things are cheaper, as this chart shows, they tend to be non-essentials, like toys. The things we need, like health care and housing, have gone up.

People will also point to places like Wal-Mart, and other retail giants, who serve enormous populations who are part of the 80%.

Part of the answer is that companies who serve the “80%” are often benefiting from government social safety nets.

In the case of Wal-Mart in the U.S., this is literally the case: its employees and customers alike receive government benefits. In Ohio alone, over 12,000 Wal-Mart employees received food stamp and medicare benefits in 2009.

Wal-Mart is also a place where people on food stamps and on social assistance programs spend their money to buy groceries. The number of people is so great that Wal-Mart and other stores had to change their hours and shelf-stocking procedures in order to adapt to the fact that food-stamp recipients cards were charged up at midnight, resulting in line-ups outside stores. 

Between 2007 and 2011, the amount spent on food stamps in the U.S. doubled to $75.7 billion.  The recipients get food, but the money is, of course, all spent at grocery stores. Tulsa World reporters studied food stamp data for Oklahoma and found that

“Much of the nearly $1.2 billion in food stamp expenditures went to Walmart stores, which brought in about $506 million between July 2009 and March 2011, according to data supplied by the Oklahoma Department of Human Services.” This is true far beyond Oklahoma: Leslie Dach, Executive VP of Corporate Affairs for Walmart said that “A very significant percentage of all SNAP dollars are spent in Walmart stores, in some states up to fifty percent.”

In Sept, 2012, the incoming CEO of Kraft told the Financial Times that “one-sixth of Kraft’s revenues comes from food stamp purchases and that the portion of sales through the programme was probably larger.”

On the one hand, a program like food stamps allows people who are out of work to feed their families. The financial benefit they receive will, literally, pass through their hands and be consumed — it’s impossible for them to save it, or build up any kind of a surplus that they can use to build wealth (which as people on assistance, no one expects them to do). But the company selling the product still makes a profit. In 2013, Kraft was #151 on the Fortune 500 list with $18.3 billion in revenue. Walmart, with $469.2 billion in revenue was #1.

While people talk about addressing inequality, we’re not holding steady, much less hoping to reverse it. As I wrote, inequality only ever got better once in history - during the Great Compression, from 1938-1945. It was not an accident - it was deliberately crafted policies and programs, including intensive programs for innovation and industrialization.

Past successful measures included trust-busting by Teddy Roosevelt, US anti-trust and Canadian anti-combine legislation to require break up companies in order to improve competition, and making investment available to entrepreneurs and existing companies to make capital investments in productivity.

Part of the economic crisis we are currently experiencing is that we have an economic ideology that actively advocates against the government intervening when the a systemic market problem causes a crisis.

To repeat Arthur Okun: “John Stuart Mill insisted that he would be a communist if he believed that economic misery and deprivation were inherent in a capitalistic economy. And Mill was right; they are not inherent and they can be eliminated. Indeed, in a democratic capitalism, they must be eliminated.”

Okun also wrote:

“The American economic system has at times developed knocks and required overhauls. The most serious knocks appeared in the Great Depression... Many of those who view capitalism as a rotten system blame John Maynard Keynes and Franklin Delano Roosevelt for saving it; but those who view it as a magnificent system rarely credit them with saving it.”

He also quoted Lindbeck:

“It may be possible to make a strong case against either markets or administrative systems, but if we are against both [as most radicals are] we are in trouble.”

That is the case today, where people are in distress and there are lots of complaints about what’s wrong, but very few practical, non-destructive solutions for reform.

In the last few years, the net worth of many high-income individuals has doubled - partly because freely available borrowed money is driving up the price of the assets they own, while also financing mergers and acquisitions.

Contrary to the claims of the right - who keep claiming “big government” is to blame, the solution to every problem for the past 40 years has been more debt and less government.

The argument made by “free market” fundamentalists is that inequality is the government’s fault, because it somehow interferes with the independent functioning of the market.

The current debate is dominated by right-wing extremists who treat a modern functioning democracy with the rule of law as communism or socialism, when it is a recognition that certain business practices, though profitable for a few, come at a real cost - a harmful loss for someone else.

In all of this there are two things to remember.

One is that we do need to understand what is happening and have a realistic explanation of the how business and government work. That is a huge challenge, because most of what we are presented with is “communications” or public relations crafted for propaganda. Clarity and accuracy is not the point: justification is.

The second challenge is greater - recognizing that even the best explanation is not the same thing as a solution.

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