Thursday, April 5, 2012

Leverage and Wealth Disparity

Lately I've been thinking about the role of leverage in wealth disparity. America is a land of amazing freedoms, allowing anyone to earn income with few boundaries, such as class or location. Meanwhile, I've seen repeated reports on the increased disparity between the wealthiest and the poorest in our nation over the past fifty years. I'm curious about three things: the role that leverage plays in increased wealth disparity, the minimum wealth that a society should deem as livable, and whether there is a need to limit the difference between the wealthiest and poorest individuals. Today I'll share some thoughts on the first of these. (Note - I'm using the term "wealth disparity" to talk about variance in wealth without passing judgment.)

Leverage is the ability to use resources to gain more resources. On a small scale, you leverage your savings by depositing it in a savings account. Your bank or credit union loans it out to others and pays you interest. You thereby leverage your savings into greater wealth. Greater leverage can come from borrowing money to invest (like using it to buy raw goods or inventory for sale, or to buy stocks on margin). Leverage is the basis of the adage "it takes money to make money."

I started thinking about the connection between leverage and wealth disparity on my last trip to the airport. I recently qualified for elite status with my airline. This means my employer and I spent a certain amount on travel for work and pleasure last year - approximately $3000. Now when I fly, I no longer have to pay a fee to check a bag, because I have elite status. The money I have spent is now earning me greater returns - leverage. I'm spending the same amount on the flights as other passengers, but I save a hundred dollars or so not paying those fees.

Flying is not a need in life. But I could argue that in today's economy, having a bank account for the safe-keeping of savings constitutes a minimum standard of protection. Leverage comes into play here as well. If you have a certain amount to deposit, you don't pay checking fees. (If you have a higher amount, you won't pay for checks. Higher still, and you get better interest rates on your savings.) If you don't have the minimum to deposit, you will see your balance eroded each month, meaning you have to earn more just to keep in place. Or you will avoid the banking system and use alternatives - like check cashing services - with their own fees.

There is a similar leverage effect from having health insurance generally provided by employers. I view low-cost access to preventive medicine as a minimum standard of health protection. With the current system, you need a certain set of skills to qualify for a job that offers affordable health insurance. Maybe you need additional skills to have health insurance that comes with preventive care fully covered.

As a side note, the perversity of these leverage effects is that they provide an obstacle to flexibility. If you want to try working for yourself, you have to contend with a lack of affordable health insurance along with the gap in income. Similarly, but less severely, if you want to fly a different airline with better routes, you have to build your frequent flyer status from zero.

What examples do you have of leverage that contributes to wealth disparity?

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