Tuesday, September 18, 2007

Pareto Principle

The Pareto Principle is a useful principle, often called the 80/20 principle. It can be used in quality control, 80% of faults are caused by 20% of the types of causes, sales (80% of your sales comes from 20% of your customers.)

It's roots lie in economics. Vilfredo Pareto studied the wealth of nations from the ancient Egyptians to modern day (at that time) Italy. He found that 80% of the wealth of a country is controlled by 20% of the population.

Looking at the Forbes list of 40 richest in Singapore, the breakdown of wealth even among the top 40 follows the Pareto Principle too. List of richest here.

The top 20% control 68% of the wealth, with the bottom 80% control 32%. (The principle is not exact, but it shows that asymmetry occurs.)

What are the other applications? I think equal wealth may not be a practical goal. Equilibrium is reached in asymmetric proportions. The New Economic Policy of Malaysia may be flawed to some degree. (The goal is for the Malays to control at least 30% of the wealth of the country.)

However, in the end, what happens is that there are very rich Malays and very poor Malays. There will be a top 20% of Malays who own 80% of the Malay wealth.

That being the case, the result will be that the top 20% of Malays will control 24% of the wealth of country. While the remaining 80% of Malays will control 6% of the wealth of the country.

It's an intuitive leap of logic, but I think that is why one of the observations as to why there are not more Malays being even more prosperous. The NEP benefits an asymmetric slice of the population.

Even worse, the average Malay voter on the street believes that the policy will actually benefit them. It only benefits the rich. Instead if the NEP is truly in the spirit of alleviating poverty, its benefits should be doled out based on economic boundaries rather than racial boundaries.

The key then, is not to hope for general external factors to push you into the top 20% but for you yourself to vault yourself there.

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