TOPICS TO BE COVERED IN THIS CHAPTER: The Montroll-Shlesinger model: log-normal with powerlaw

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1 1 1 WHEN A SINGLE DISTRIBUTION IS NOT ENOUGH? A. Chatterjee and S. Sinha TOPICS TO BE COVERED IN THIS CHAPTER: The Montroll-Shlesinger model: log-normal with powerlaw tail Empirical data on Income and Wealth Distribution Are twodistributions better thanone? Fitting with a single distribution versus fitting different formstodifferent parts ofthe data Boxoncontributionsof: WSouma,YFujiwara,VMYakovenko et al Appropriate quotation here 1.1 The Montroll-Shlesinger model: log-normal with power-law tail 1.2 Empirical data on Income and Wealth Distribution The distribution of wealth among individuals in an economy has been an important areaof researchin economics, for more thanahundred years[1,2]. It was Wilfredo Pareto [3] who first quantified the high-end of the income distributioninasociety andfound it tofollow apower-law,quoted simply as P(m) m (1+ν), (1.1) Econophysics. Sinha, Chatterjee, Chakraborti and Chakrabarti Copyright c 2008 WILEY-VCH Verlag GmbH& Co. KGaA, Weinheim ISBN: XXXXX-X

2 2 1 WHEN A SINGLE DISTRIBUTION IS NOT ENOUGH? where P gives the normalized number of people with income m. The power law in income and wealth distribution is known after Pareto and the exponent ν is called the Pareto exponent. A historical account of Pareto s data and that from recent sources can be found in Ref. [5]. However, there are different forms of this law quoted in the literature. Mandelbrot [6] distinguished between different versions: (i)ifq(m) is thepercentageof individuals withanincome greaterthan m,the strong Pareto law states that { (m/m0 ) Q(m) = ν for m > m 0 (1.2) 1 for m < m 0 wherem 0 isascalefactor. InitsstrongestformoftheParetolaw, ν = 3/2,which is the average value of ν in Pareto s original data. (ii) However, the value of ν has a wider distribution, and referredto as the weak Pareto law which states thatthe law holds in theasymptotic limit, i.e, Q(m) (m/m 0 ) ν as m. (1.3) Inallcasesabove, Q(m) = m P(m)dm. Although Pareto[3] and Gini [4] had respectively identified the power-law tail and the log-normal bulk of the income distribution, the demonstration of both features in the same distribution was possibly first demonstrated by Montroll and Shlesinger [7] through an analysis of fine-scale income data obtained from the US Internal Revenue Service (IRS) for the year It was observed that while the top 2-3 % of the population (in terms of income) followed a power law with Paretoexponent ν 1.63,the rest followed a lognormal distribution. Later work on Japanese personal income data based on detailed records obtained from the Japanese National Tax Administration indicated that the tail of the distribution followed a power law with an exponent value that fluctuated from year to year around the mean value of 2 [8]. Furtherwork[9]showed thatthe powerlawregiondescribedthetop 10%orless of the population (in terms of income), while the remaining income distribution was well-described by the log-normal form. While the value of the Pareto index fluctuated significantly from year to year, it was observed that the parameter describing the log-normal bulk, the Gibrat index, remained relatively unchanged. The change of income from year to year, i.e., the growth rate as measuredby the log ratio of the income tax paid in successive years, was observed by Fujiwara et al [10] to be also a heavy tailed distribution, although skewed, and centered about zero. Later work on the US income distribution based on data from IRS for the years , while still indicating a powerlaw tail (with ν 1.7), have suggested that the lower 95% of the population have income whose distribution may be better described by an exponential form[11, 12]. The same observation has been made for income distribution in

3 1.2 Empirical data on Income and Wealth Distribution 3 the UK for the years , where the value was found to vary between 2.0and2.3,butthebulkseemedtobewell-describedbyanexponentialdecay. It is interesting to note that, when one shifts attention from the income of individuals to the income of companies, one still observes the power law tail. A study of the income distribution of Japanese firms [13] concluded that it follows a power law with ν 1, which is also often referred to as the Zipf s law. Similar observation has been reported for the income distribution of US companies [14]. Compared to the empirical work done on income distribution, relatively few studies have looked at the distribution of wealth, which consist of the net value of assets (financial holdings and/or tangible items) owned at a given point in time. The lack of an easily available data source for measuring wealth, analogous to income tax returns for measuring income, means that one has to resort to indirect methods. Levy and Solomon [18] used a published list of wealthiest people to generate a rank-order distribution, from which they inferred the Pareto exponent for wealth distribution in USA. Refs. [12] and [19] used an alternative technique based on adjusted data reported for the purpose of inheritance tax to obtain the Pareto exponent for UK. Another study used tangibleasset(namelyhousearea)asameasureofwealthtoobtainthewealth distribution exponent in ancient Egyptian society during the reign of Akhenaten (14th century BC) [20]. More recently, the wealth distribution in India at present was also observed to follow a power law tail with the exponent varying around 0.9[21]. The general feature observed in the limited empirical study of wealth distribution is that of a power law behavior for the wealthiest 5 10% of the population, and exponential or log-normal distribution for the rest of the population. The Pareto exponent as measured from the wealth distribution is found to be always lower than the exponent for the income distribution, which is consistent with the general observation that, in market economies, wealth is much more unequally distributed than income [22]. Arelatively recentstudy [23] on the list of richest people in the world from ForbesdatarevealedaParetolawwithanaverageexponent ν = Another study [24] reported a power-law tail for the wealth distribution of aristocratic families in medieval Hungary. The striking regularities(see Fig. 1.1) observed in the income distribution[15, 17, 16] for different countries, have led to several new attempts at explaining them on theoretical grounds. Much of the current impetus is from physicists modelling of economic behavior in analogy with large systems of interacting particles, as treated, e.g., in the kinetic theory of gases. According to physicists working on this problem, the regular patterns observed in the income (and wealth) distribution may be indicative of a natural law for the statistical properties of a many-body dynamical system representing the entire set of economic interactions in a society, analogous to those previously derived for

4 4 1 WHEN A SINGLE DISTRIBUTION IS NOT ENOUGH? Cumulative probability A Population with income > X Income in thousand USD B Income tax Super tax CDF of gross salary Income (X) in INR Cumulative probability C Income in thousand JPY Income in Euro Table 1.1 (A) Cumulative probability of US personal annual income for IRS data from 2001 (taken from [15]), Pareto exponent ν 1.5 (given by the slope of the solid line). (B) Cumulative Income distribution in India during , collected from Income Tax and Super Tax data [16]. The inset shows the cumulative distribution of the employment income for the top 422 salaried Indians (Business Standard survey, 2006) showing a power-law tail with ν = 1.75 ± (C) Cumulative probability distribution of Japanese personal income in the year The power law region approximately fits to ν = 1.96 (data from Ref. [17]). (D) Cumulative probability distribution of firm size (total-assets) in France in the year 2001 for firms. The power law region approximately fits to ν = 0.84 (data from Ref. [17]). Cumulative probability D gases and liquids. By viewing the economy as a thermodynamic system, one can identify the income distribution with the distribution of energy among the particles in a gas. In particular, a class of kinetic exchange models have provided a simple mechanism for understanding the unequal accumulation of assets. Many of these models, while simple from the perspective of economics, has the benefit of coming to grips with the key factor in socioeconomic interactions that results in very different societies converging to similar forms of

5 1.3 Are two distributions better than one? 5 unequal distribution of resources (see Refs. [1, 2], which consists of a collection of large number of technical papers in this field; see also [25, 26, 27] for some popular discussions and also criticisms). Considerable investigations with real data during the last ten years revealed that the tail of the income distribution indeed follows the above mentioned behavior and the value of the Pareto exponent ν is generally seen to vary between 1 and 3 [12, 18, 21, 28, 29, 30, 31]. It is also known that typically less than 10% of the population in any country possesses about 40% of the total wealth of that country and they follow the above law. The rest of the low income population, in fact the majority (90% or more), follow a different distribution which is debated to be either Gibbs [32, 33, 34, 35, 12, 18, 29, 36, 37] or log-normal [30, 31]. There have also been reports of fitting the low income population to Tsallis function[38] or κ-generalised statistics [39]. 1.3 Are two distributions better than one? Fitting with a single distribution versus fitting different forms to different parts of the data References A. Chatterjee, S. Yarlagadda, B. K. Chakrabarti (Eds.), Econophysics of Wealth Distributions, Springer Verlag, Milan (2005). 2 B. K. Chakrabarti, A. Chakraborti, A. Chatterjee(Eds.), Econophysics and Sociophysics, Wiley-VCH, Berlin(2006). 3 V. Pareto, Cours d economie Politique, F. Rouge, Lausanne(1897). 4 C.Gini, TheEconomic Journal 31 (1921) P. Richmond, S. Hutzler, R. Coelho, P. Repetowicz, in Ref.[2]. 6 B. B. Mandelbrot, International Economic Review 1 (1960) E.W.Montroll, M.F.Shlesinger,Proc. Natl. Acad. Sci. USA, 79 (1982) H. Aoyama,W.Souma,Y. Nagahara, M. P. Okazaki, H. Takayasu, M. Takayasu, Fractals 8 (2000) W.Souma, Fractals 9 (2000) Y.Fujiwara, W. Souma,H.Aoyama, T.Kaizoji, M.Aoki, PhysicaA321 (2003) A.A.Drăgulescu, V.M.Yakovenko,Eur. Phys. J.B,20 (2001) A. A. Drăgulescu, V. M. Yakovenko, Physica A299 (2001) K. Okuyama, M. Takayasu, H. Takayasu, Physica A 269 (1999) R.L.Axtell, Science293 (2001) A.C.Silva, V.M.Yakovenko,in Ref.[1]. 16 S.Sinha,in Ref.[1], p Y.Fujiwara, in Ref.[1]. 18 M.Levy,S.Solomon,Physica A242 (1997) R.Coelho, Z. Néda,J.J.Ramasco, M.A. Santos, Physica A 353 (2005) A.Y.Abul-Magd,Phys. Rev. E66 (2002)

6 6 References 21 S.Sinha,Physica A359 (2006) P. A. Samuelson, Economics, Mc-Graw Hill Int., Auckland(1980). 23 O.S. Klass, O.Biham,M.Levy,O.Malcai, S. Solomon, Economics Letters 90 (2006) 290; Eur. Phys. J.B55 (2007) Hegyi, G.,Z. Néda,M.A.Santos,Physica A 380 (2007) B. Hayes, American Scientist 90 (2002) J.Hogan, NewScientist (12 March 2005) P. Ball, Nature 441 (2006) 686; Editorial, Nature 441 (2006) S.Moss deoliveira, P. M.C.deOliveira, D. Stauffer, Evolution, Money, War and Computers, B. G. Tuebner, Stuttgart, Leipzig (1999). 29 H. Aoyama,W.Souma,Y. Fujiwara, Physica A324 (2003) T.Di Matteo,T.Aste,S.T.Hyde,in The Physics of Complex Systems(New Advances and Perspectives), F. Mallamace, H. E. Stanley (Eds.), Amsterdam(2004), p F. Clementi, M. Gallegati, Physica A 350 (2005) B.K.Chakrabarti, S.Marjit,Ind. J. Phys. B 69 (1995) A. B. Atkinso, F. Bourguignon, Eds. Handbook of Income Dtribution, Elsevier, Amsterdam, D. G.Champernowne,F.A.Cowell, Economic Inequality and Income Distribution, Cambridge University Press, Cambridge, N. Kakwani, Income Inequality and Poverty, Oxford University Press, Oxford, S. Ispolatov, P. L. Krapivsky, S. Redner, Eur. Phys. J.B2(1998) A.A.Drăgulescu, V.M.Yakovenko,Eur. Phys. J.B17 (2000) J.C. Ferrero,in[1],pg F. Clementi, M. Gallegati, M. Kaniadakis, Eur. Phys. JB57 (2007) 187.