Economic Nonsense: 40. Too much wealth is owned by too few people

Underlying the claim is an assumed egalitarianism.  How much is "too much" and how few is "too few?"  Obviously those making the criticism have some concept in their minds of how they would like to see wealth distributed in society, and it seems they would prefer a more equal distribution than is currently the case.  The obvious question is "Why?"  The answer often given is that this would be 'fairer', but since they seem to define 'fairer' as 'more equal', this is not very helpful.

It does not help, either, that many of these measures of inequality only count certain forms of wealth.  Many people in the UK see equity in housing as their main source of wealth.  For some it is pensions.  Many assessments of wealth distribution, on the other hand, only count assets and investments, and thus miss much of the wealth owned by ordinary people.  Few if any seem to count entitlements to such things as health and education as part of measured wealth, even though they undoubtedly improve the living standards of the average citizen.

It could be argued that societies with an unequal distribution of wealth are able to increase wealth faster, and that poorer people in those societies become richer more rapidly than those living in more equal societies.  To poorer people it matters that they are able to command more resources.  It matters less to them that software multi-billionaires have widened the gap between them and made society less equal.  

Part of the reason this criticism persists is envy, the resentment that some have more, yet aspiration is often motivated by the observation that some have it better.  The success of others can inspire the desire to emulate instead of simply envying.

The false zero sum game probably plays a role in this criticism, the notion that because some own so much, the rest must make do with less.  In fact wealth in constantly being created, and creating wealth is a far surer route out of poverty than redistribution.  Instead of envying those richer than themselves, people would be better advised to try to copy them.

The amusement of Oxfam's wealth report

Oxfam is one of those groups jetting off to Davos this week to talk about how to set the world to rights. And they're doing so by going to sit among the plutocrats and telling everyone that it's the very plutocrats that are the problem. The top 80 people have more wealth than the bottom 50%, this is appalling and so on. You can see the report here.

Wealth: Having it all and wanting more, a research paper published today by Oxfam, shows that the richest 1 per cent have seen their share of global wealth increase from 44 per cent in 2009 to 48 per cent in 2014 and at this rate will be more than 50 per cent in 2016. Members of this global elite had an average wealth of $2.7m per adult in 2014.

Of the remaining 52 per cent of global wealth, almost all (46 per cent) is owned by the rest of the richest fifth of the world's population. The other 80 per cent share just 5.5 per cent and had an average wealth of $3,851 per adult - that's 1/700th of the average wealth of the 1 per cent.

Winnie Byanyima, Executive Director of Oxfam International, said: "Do we really want to live in a world where the one per cent own more than the rest of us combined? The scale of global inequality is quite simply staggering and despite the issues shooting up the global agenda, the gap between the richest and the rest is widening fast.

Winnie needs to get out more. As Saez, Zucman and Piketty have been explaining to us all this is just how wealth distributions work. The bottom 50% always have less than 10%.

Fraser Nelson is very good here. This global capitalism stuff has been reducing poverty like billyo these past few decades. And for a charity like Oxfam, nominally focused upon poverty, we might think that's a good thing. But they seem to have changed their minds a bit.

But for one elegant point about this brouhaha have a look at Figure 1 on page 2 of that very Oxfam report. Their actual complaint is that global wealth inequality is climbing back to, but is still under, the level reached in 2000 and 2001. This isn't unprecedented, it's not staggering and it's not even unusual. Wealth inequality is actually lower than it was 15 years ago.

Ideas can mean the difference between wealth and poverty

Adam Smith never said that “The real tragedy of the poor is the poverty of their aspirations”, as some people who have never read him think. It is hard to think of a less Smithian view – he was the opposite of that quote's patrician and patronising voice, and had a deep compassion for people who had been unlucky in life. But there is some evidence that disadvantaged people underinvest their savings at a huge cost to themselves. This seems to be true even when there are no social constraints or market failures that might cause this to happen.

One reason for this may simply be that poor people do not realise that the investment opportunities exist, or do not really consider that they might benefit from them. Consider those bright young students from deprived backgrounds who have never even considered applying to university, just because nobody in their families ever has either. Your experience of the world shapes how you react to various opportunities that you get.

To test this hypothesis, a group of researchers at Oxford performed a controlled trial in remote Ethiopian villages, where they showed one of several one-hour documentaries about poor Ethiopian farmers who had expanded a business, improved their farming practices or broken cultural norms by, say, marrying for love. “Individuals succeeded largely through their own efforts and by drawing on assistance from community members and available resources, not through outside government or NGO intervention.”

The trial involved a placebo group (shown a comedy movie) and a control group (shown nothing at all) and it seems to have been a success. Six months after the screenings, the documentary group’s savings rate had risen significantly above the control group’s and had also begun to access credit at a higher rate. (These are some of the poorest people in the world, so the absolute amounts – a few pounds – may seem very small to our eyes.)

School enrolment was up by 15 percent in the documentary group, although it was also up by 10 percent in the placebo group so the effect is unclear, and spending on school expenses was up by 17% (compared to no change in the placebo group).

Overall, the results seem to show that showing extremely poor people examples of people like them who had made something of themselves inspired them to invest in themselves and their families.

It’s just one study, but it hints at something bigger. Incentives matter, of course, but you have to be aware of the existence of an incentive for it to work on you. Even if you’re aware of it, you might discount (or exaggerate) its significance according to your experiences. In a complex world, each of us uses a different pair of glasses to focus on what matters and filter out what doesn't. And no pair is perfect.

There is no obvious public policy lesson from any of this, except perhaps that people don’t always react predictably to incentives. Incentives matter – but so do ideas.

The problem with wealth taxes is that they don't actually work very well

The bit of that recent Piketty magnum opus that had economists scratching their heads was his demand for a wealth tax. For it's a standard commonplace within the subject that you really don't want to tax capital. Doing so makes the future a great deal poorer than it could be. Just like that old windows tax made the future a lot darker than it needed to be. There's an opportunity to explain why in some numbers being attributed to the likely effect of Red Ed's mansion tax:

Mansion tax could wipe an average of 5pc off homes worth more than £2m should Labour win the next general election and make the proposals a reality.

The plans touted by the shadow chancellor, Ed Balls, could mean a 10pc drop for properties valued at £10m or more, and an 8pc fall for homes valued above £5m according to a new report from Savills.

The property group has also estimated a 6pc decline for those homes worth more than £3m.

People who own homes with a price tag above the £2m threshold could see their property value fall 4pc following Mr Balls' announcement that they will face a monthly levy of £250, a sum which gets progressively larger for more expensive properties.

£250 a month on a £2 million property is 0.15%. This drops the capital value of the asset under discussion by 5% or so. But the sort of wealth tax being demanded by Piketty is 1-2% annually, ten times larger than this tax. Now no, straight line predictions aren't all that good, there's changes in elasticity to consider, but it would be reasonable enough to think that a ten times the tax would have ten times the effect as a first stab at a guess.

So, in Piketty's desired world we'll be taxing wealth, or capital (they're rather the same thing) at 1.5% a year and thus the value of that capital, those bonds, stock and shares, that are being taxed will fall 50%. And that's why wealth taxes don't work very well. For consider the effect upon investment of a fall of 50% in the value of having made a successful investment.

It's still just as difficult to come up with a good business idea. It's still just as difficult to make that idea work, still just as expensive to make it do so. But the payoff from being one of the one in five that do manage to get something real going has just halved. Obviously, fewer people are going to make the effort and take the risks. Meaning that the future will be poorer by the lack of the effects of those new businesses that never were started.

Wealth taxes don't work very well for the simple reason that they make all our children poorer than they would have been even if they do make our children more equal. It's not a good bargain, not a good trade off.

Thomas Piketty ignores government capital

Thomas Piketty’s core argument in Capital in the Twenty-First Century is that the return on capital is (likely to be) greater than GDP growth and therefore those with capital will gain an ever greater share of wealth increasing inequality. This is not true in an individual sense or societally. Gilts returning 4% over an 80 year lifetime, paying 45% income tax, assuming RPI of ~3% and inheritance tax on two transfers would reduce a £100m fortune by 92% in real terms. There are almost no historic fortunes. Crassus was supposedly the wealthiest man to ever live. The de Medici fortune, assuming a zero real return, would be worth about $23bn today. But in practice individual great fortunes have struggled to earn even a zero real return, even without destruction, let alone Piketty's assumed 5% real return, which would have seen them dwarf Bill Gates' paltry billions.

Piketty argues income is increasingly taken by the productive: As he shows on page 200 of his book capital’s share of national income has fallen about 40% from 1850 to 2010 despite a substantial real savings ratio. Piketty argues the productive avoid taxes making inequality greater. According to the ONS the top 10% of income earners pay 39 times more income tax than the average of the other 90%.

Redistribution is materially greater than increased taxes and capital’s falling share of income would suggest. Capital and the entrepreneur have created almost all of the growth in income. The hairdresser has not changed his productivity but has seen his real income grow. The farm workers who produce vastly more than 200 years ago, only do so because of the inventions and innovations of capitalists and entrepreneurs. While he drives a combine harvester he has not improved his skills, capitalists and entrepreneurs taught him how to use their inventions and better processes. Workers work ever fewer less strenuous hours, retiring earlier and nevertheless receive an ever increasing real income.

Piketty argues that the private capital to income ratio has grown materially to about 6, that its distribution is very skewed and government’s capital is zero, all as evidence of the inexorability of ever greater inequality. However, government has vast wealth in the form of the net present value of the tax flows they receive (and expect to receive in the future) to which he ascribes no value. But these flows are worth about 40x national income.

Even if he is correct about private wealth, the overall wealth of society is quite evenly distributed—the government’s 40 is increasingly devoted to welfare (and might usefully be imagined as de facto belonging to those who expect to receive it in the form of welfare and state provision of goods), redistributing from those who earned it to the rest of society. The capital value of transfers to a hypothetical individual who chooses to never work and relies entirely on the state is likely to be in the region of £1.5m.