Murphy's Law: Understanding income inequality

On Oct. 23, Ray Dalio, founder of Bridgewater Associates, the world’s largest hedge fund, posted an article to LinkedIn titled “Our Biggest Economic, Social and Political Issue The Two Economies: The Top 40% and the Bottom 60%.” In it, he breaks down the differing economic conditions of those across different wealth levels in the United States. While he offers no prescriptive fixes, his piece importantly identifies the root differences between the successful and the struggling, which can help us think critically about bolstering economic vitality, instead of simply shouting “tax the rich” and blaming corporate greed for everyone’s problems.

Dalio points out the danger of using average statistics to assess economic health, because of significant wealth and income skews. Instead, he breaks the economy down into two groups: the wealthiest 40 percent of Americans and the poorest 60 percent of Americans. By juxtaposing these two groups, we can understand what has enabled the living conditions of the top 40 percent to improve and what has held back the bottom 60 percent.

As in many similar analyses, several key differences emerge, the first of which is the propensity to save of the two economies. As wealth increases, the portion of additional income spent diminishes. The wealthier top 40 percent hold most of their wealth in financial assets, saving for retirement. Conversely, roughly two-thirds of the bottom 60 percent do not save any portion of their income. Research from the Federal Reserve showed that most of them would struggle to raise $400 when presented with an emergency. The first difference between the top and bottom economies is that the top can and does save more, making it more financially secure in the long run and in emergencies.

Another key difference is the asset-liability mix. Most of the wealth of the top economy is held in financial assets like stocks and bonds, which benefit from soaring asset prices, while the bottom has a much smaller percentage of their wealth in financial assets. Someone not invested in the stock market has missed huge gains in this current expansion. The liabilities held by the bottom 60 percent are more likely to have higher interest rates and be less serviceable, like student, credit card and auto debt. So, the top is concentrated in financial assets and holds reasonable debt, while the bottom holds less valuable assets and more difficult debt.

Finally, the bottom 60 percent spends one-quarter of what the top 40 percent does on education. As the American economy shifts further away from manufacturing and more toward tech and service-based jobs, a college education is increasingly important. The top 40 percent are obtaining the skills to succeed as the economy evolves, whereas the bottom 60 percent are not.

Without offering a prescription, Dalio lays out the economic fundamentals behind the rise of American populism. Understanding what the top 40 percent does, and what the bottom 60 percent does not or cannot do identifies the problems we should address to increase America’s economic well-being. To more healthily grow our economy, savings and education at the bottom need to increase, and wealth needs to reflect a stronger asset-liability mix. Given our government, I suspect these changes will likely have to come from philanthropy and the private sector.