My wealth and the lives of others

I watched tonight a BBC-sponsored discussion on inequality held in Davos. It was a good discussion, and the crucial moment for me came when the moderator put down the two views of the top-one-percenters, creators or predators, and asked the audience and the discussants (which included private sector CEO’s, Governor of the Bank of England and the head of the IMF) whether one or the other category exemplified better the super-rich. The audience voted, unsurprisingly, 9 to 1, in favor of creators but I thought that the dichotomy, while real and very important, was not sufficiently developed.  

           No rational person can be against people who through their effort or brains, inventions, innovations or hard work, have become rich by improving also our lives. Without them we would be living without electricity, internet or washing machines. Even the person who invented pizza delivery deserves his wealth and our eternal gratitude. On a cold winter night, we would be freezing and hungry in our apartments without him.

            But I thought, there are at least six other ways that people might become billionaires without making lives of the rest of us any better. That is, their fortune could have been given to a random person and nobody (except perhaps their family) would be worse off for that. Let me list these six ways, in descending order of opprobrium.

(1) Inheritance. There is nothing that a person who got it did to make life better for anybody in this wide world. I think this is pretty clear.

(2) Political position. Presidents, kings, emirs who either got to their positions through “force and guile” or have inherited them have often (but not always) become rich without doing anything to improve other people’s lives. Here, think of the Saudi rulers, presidents  of the resource-rich countries (Obiang Nguema from the Equatorial Guinea) and others who simply stole billions of dollars.

(3) Political connections. These are people who made money by cozying up to the rulers, from billionaires in Indonesia who were Suharto’s best buddies to Abramovich and Khodorkovsky who were Yeltsin’s. These are people who have become rich just by being close to power and being given a license to steal or to “organize” business in the best possible way for themselves. Most of what is called Franϛafrique falls into this category: French businessmen cozying up to the African rulers. Many of today’s Russian and Chinese billionaires belong there too. State-financed activities, from road-building to military purchases, are the ideal forms for wealth made through political connections. (Read Helen Epstein’s excellent recent review of several books on Zambia if in doubt about what this category includes.)

(4) Political lobbying. These are people who made money through incessant political lobbying (“having politicians in their pocket”) aimed at changing the rules of the game, lowering taxation or handicapping competitors. Here think of pharmaceutical or insurance companies, oil and gas, and these hundreds  of multinationals that keep offices in Washington and Brussels and make their managers and shareholders rich. Financial sector belongs here too: how else would they have gotten the legislation they needed in Washington?  

(5) Monopoly. People who owe large share or all of their fortunes thanks to monopolies (which are  often acquired though political lobbying). Carlos Slim is often mentioning in this context; Bill Gates too. In every country where I travel I hear of one or two or three persons who have become rich by managing  to obtain a monopoly or a privileged position on TV channels, mobile phones or Internet. Berlusconi and Thaksin could be placed there before they moved to category 2.

(6) Tax evasion.  Although it may not be strictly illegal (but then lobbying is not illegal either) it surely often implies that wealth was acquired by cleverly exploiting the rules and without making anybody else better off. Bono of the U2 fame is often cited as an exemplar of this approach and of hypocrisy of arguing for higher taxes to help the poor while his companies are incorporated in the Caribbean islands and pay practically no taxes.

            So clearly, among the millionaires and billionaires there must be quite a few who have become rich, or who owe at least a part of their riches, to one of these six ways listed here. In other words, they have become very wealthy without any obvious contribution to anybody else’s welfare.  

            And thus I thought that we are unlikely make progress about finding out “who is who” among the top 1% (or rather 1% of 1%) until we do something that I suggested to a couple of my  Oxfam friends a year ago: we have to figure out who is mostly a creator and who is mostly a predator. As in many areas, we are unlikely to make a real progress until we quantify things. And we can quantify things by asking a simple, but powerful, question:

(1) How much of your wealth was acquired through activities that benefited other people in the world?

            Obviously, we cannot get to an exact assessment, but we can try to get to an approximation. I suggested to my friends to use the resources of Oxfam, information on the Internet, and people with specific  country knowledge, to look at the way the 1,500 billionaires on the Forbes list have acquired their wealth and then to make an approximate assessment of (1).  It is not an impossible, not even a difficult, task.  Most of the information is known. Very few large fortunes are made without people having an idea how somebody got rich. Not all of these ideas may be correct, but an impartial researcher can assess them, check them up against the known facts, and come to a preliminary judgment. We just need to create a  template where we would give negative points for acquisition of wealth under the six categories listed above (with  inheritance and political position being the worse and tax evasion being the least bad) and then make an assessment for each of the 1,500 billionaires.

            To give an example.  Start with the maximum of  10 points (all of your wealth was acquired through activities that benefited others), and then deduct points as you find out more about how wealth was really gotten.  Surely, Bill Gates might lose 2 to 3 points, but  his contribution to the betterment of the world through Microsoft (I am not talking here of the philanthropic activities; see the note on the bottom of the text) is real. Then, come to the owners of Walmart: they too have contributed to the world (through lower prices of the products in their stores) but have also made lives of many of their employees  miserable and used political lobbying to increase their wealth. They should lose points for the latter.  Then go to the Russian oligarchs:  it is difficult to see how anyone could have been made worse off if oligarch’s  wealth had gone into the hands of somebody else. Then, end with the heirs of large fortunes (Bettencourt in France, Forbes in the US) or Saudi princes where it is just impossible to see what their wealth has to do with the welfare of the world.

            The grades would at first be rough. But they can be gradually improved. If we can grade countries’ democracies, or how much governments’ policies help reduce world poverty, I cannot see why we cannot make estimates about how much of the wealth of each individual billionaire was made through activities that were innovative and helpful to others or not. The  objective is not to shame them into being better people. Many of them do not care about it. The objective is to put some value on that unending discussion about wealth acquisition, illustrated by the question posed at Davos: was wealth deserved or not. Until we know whether we are moving towards the world where most of the wealthy have become so by doing something useful, or the opposite of it, we shall remain stuck in the sterile discussion where one opinion can be equally right or wrong as another. We shall never know if we are getting closer to the socially-minded capitalism or to what Max Weber rightly called “political or exploitative” capitalism. In other words, whether we are moving forward or backward.

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Philanthropic activities. The objective of the exercise is to assess to what extent the acquisition of wealth serves some broader purposes of general human betterment, not whether a person, after perhaps acquiring wealth fraudulently or in a violent manner, is willing to share it. The latter may be good or desirable but is a separate issue from the key one here: is my wealth acquired through actions that have improved the lives of others.

Repeat after me: Wealth is not income and income is not consumption

            The recently published Oxfam report on the distribution of net wealth in the world, released  to coincide with the Davos meetings and showing that the global top 1% own almost one-half of world’s wealth, has generated lots of discussion. Some of it  reflects the misunderstanding of what distribution of wealth is, and it is on that specific critique that I would like to focus.

            The critique started by Felix Salmon (and continued by The Economist). Salmon in his piece entitled “Oxfam’s misleading wealth statistics” noticed in the Oxfam report (and in the report on which Oxfam study is based, Credit Suisse Global Wealth Report for 2014) that among the bottom decile  of adults, that is, among those with zero net wealth, there are about 40 million Americans and more than 50 million Europeans. That came as a shock: how can almost 100 million people from the rich world be among the poorest people on earth? (Other 80+% of the people in the bottom decile are from Africa, India, Latin America and Asia, as shown here in the graph from Credit Suisse report.)

            Salmon and others are perhaps not aware that, from the works published by Ed Wolff during the last 20 years and based on US Survey of Consumer Finances, we have known for years (see the graph below) that up to about one-fifth of American households have zero net wealth. When you exclude housing, the percentage of those with zero or negative net worth comes close to 30. How is net wealth defined? It is the sum of housing, cash, checking and savings deposits, financial assets such as stocks and bonds, and current cash value of life insurance and pension plans minus all liabilities (mortgages, loans). Most of the poor and the middle class have almost no financial assets, but their main assets is the homes they “own”.  “Own” here comes between the quotes because a large chunk, and at times (as when hosing prices go down) more than 100% of the value of one’s home may be owned by a bank. A person has then a negative housing wealth. Add to that car loans, school loans, credit card loans, and you can see how a large chunk of American households may have negative or zero wealth, and how in the wake of the recent recession that percentage increased by about 3 points (or about 10 million individuals). 

From Ed Wolff’s slides “Household Wealth Trends in the US, 1962-2013: What Happened over the Great Recession?” presented at CUNY Graduate center, October 7, 2014. 

            Among the advanced economies, wealth-poverty is not limited to the United States. In Germany  27% of households (as of 2013) have negative or zero net wealth (paper by Markus Grabka and Christian Westermeier). So these people would be also included among the wealth-poorest people in the world. 

            Is this an anomaly? Does it make the study of wealth inequality meaningless?  According to the critics of the Oxfam report it does, because the wealth-poor people from the rich countries do not necessarily lead a life of poverty. Thanks to deep financial systems that exist in rich countries they can borrow and keep their consumption relatively high all the while driving their net wealth down to zero. In effect, borrowing is simultaneously a way to keep consumption high (above your income which may be also high by global standards) and driving your net wealth down to zero. Thus, we have people who are absolutely poor by wealth standards while their income or consumption  may place them around the 60^th, 70^th or even higher global percentile.

            But the “anomaly” is solely in the minds of the critics. Distribution of net wealth is not the same thing as distribution of consumption or income. Each of these aggregates has its own uses. If one wants to look at people whose real consumption is minimal, who live at the edge of subsistence, one should look at the global distribution of consumption with its famous poverty line of $1 (now $1.25) international dollars per capita per day. This is what the World Bank has been doing since 1990. There are no people from the rich countries among the consumption-poor. Even the poorest people from the advanced economies have a much higher level of consumption (at least around $12-$15 international dollars per day).

            It is a wrong belief that there should be one and only one measure that would give us the answer who is poor and who is rich. The three welfare aggregates (wealth, income and consumption) are related but they are not the same. (And I leave out other “details” like the distinction between net income, that is, after-fisc income, and market income or income before any government transfers and taxes.) There are people who are poor or middle class according to one measure but rich according to another. Wealth is not income nor is income consumption. 

            Depending on what we want to study, we may focus on one or another aggregate. If standard of living is our concern, consumption is probably the best measure; it is also probably the best measure for long-term (lifetime) income. But if our interest is to look at the potential consumption that one can afford without reducing her assets, then income is a better measure. One may consider a decision to save out of a high income, and thus to choose to have a relatively low consumption, as not different from a decision to use one’s income to buy restaurant meals instead of a car. It is just a decision of what to do, or not to do, with your income that only the income-rich have the luxury to make. They can choose; others cannot. 

            But note also that there may be reverse cases, people with zero income whose consumption is relatively high (e.g., those who, after working for  several years and saving money, might take a couple of years off to go back go school). Or, as mentioned before, there may be people with reasonably high both income and consumption, and yet zero net wealth. You may even find people with very high net wealth and huge negative incomes, as happened in 2007 when the stock market crashed, and some billionaires lost millions of dollars. By the income metric, they were the poorest people on the planet that year. Is it wrong? Is it sully? Does it mean that we should not study income or consumption or wealth distributions? Not at all: we need them all but we need to know what the numbers we get mean.

            There are very good reasons to study distribution of net wealth, globally and within countries. Even for those people in the rich world who are “anomalously” placed among the wealth-poor and who may lead nice lives despite owning nothing, a shock in the form of a medical emergency (unless there is public health care), or loss of job may have catastrophic consequences. There is just no wealth to fall back on to tide you over the bad times. A decline in the value of the main asset (housing) had similar consequences for many people in the US during the recent crisis. Finally, wealth, especially when we look at the rich, is the source of both economic and political power. It is not people who are running huge, and hard to repay, credit card debts, who are likely to be "players" by contributing to the political campaigns, influencing policy and setting legislative agenda. It is the global top 1% who own half of world's wealth, or within the United States, the top 1% who own about 35% of net wealth, who wield political influence.

            To conclude: one has to be aware of what each measures does and what your objective is, before your decide that just because your think that the measure should show something it does not, you declare it a “silly” or “pointless exercise.”

NB. The Oxfam report is based on Credit Suisse 2014 report on global distribution of wealth. Credit Suisse reports in turn are based on the seminal work done by Jim Davies, Susanna Sandström, Tony Shorrocks and Ed Wolff on global distribution of wealth published in 2011. The global distribution data are pieced together from countries Household Balance sheets, wealth surveys, and finally, if data are  missing, through a regression-based relationship between income and wealth inequality. Luckily, however, actual data do exist for the main countries, US, China, most of Western Europe, India, Brazil and Russia. This, while global wealth data are even more difficult to put together than income or consumption data, and are subject to an even greater  margin of error, this work is the best estimate of global wealth inequality that we have.

Can Black Death explain the Industrial Revolution?

Every schoolchild knows that the Industrial revolution started in England. But the question no schoolchild knows the answer to is why did it start in England. One theory (Kenneth Pomerantz) sees it as a combination of serendipitous developments (invention of steam engine and presence of coal deposits), another (Daron Acemoglu and James Robinson) as the result of long-term institutional developments: limited franchise and protection of private property. David Landes thinks it was English culture. But to me the most persuasive explanation was offered in 2003 by Bob Allen’s “Poverty and progress in early modern Europe”: the Industrial revolution happened because capitalists had an incentive to substitute capital for labor since English labor was expensive. This led to the invention of labor-saving technology and technological revolution.

            The argument is relevant for the students of ancient economies too: to the famous question posed by Michael Rostovtzeff in 1926, why did not Roman economy directly transit to the commercial capitalism of the Renaissance if all the prerequisites were there? why a ten-century detour?, the answer, made already by Marx, is: because of the prevalence of cheap slave labor.

            (Allen’s 2005 paper also rejects two favorite shibboleths: that property was more secure in England than in pre-revolutionary France and that taxes were higher in France. Actually, the reverse is true for both.)  

            But Allen’s solution still needs to deal with an additional issue: why is it that labor in England was more expensive than elsewhere in Europe? In his 2001 paper, Allen has documented wage divergence between Northern and Southern European cities: while in the 14^th century real wages were about the same in the North as in the South,  by 1800s, real wage in London and Amsterdam was thrice as high as in Vienna and Valencia.  What led to this?

            At a recent conference organized by Santa Fe Institute and Sam Bowles, a young Italian researcher, Mattia Fochesato proposed an intriguing answer to that problem. The reason why European wages diverged between the North and the South was the difference in the response to the Black Death-driven increase in real wages. (Sevket Pamuk was, I think, the first to argue that the North-South wage divergence started with the Black Death.)  In the South, where feudal institutions  were stronger,  land-owners responded to the increase in wages, caused by the decline in population, by renegotiating share-cropping contracts, restraining movement of labor, and doing everything they could to reduce wages through extra-market mechanisms. In the North where feudal institutions were weaker, the ability to check wage increase was less. Feudal laws that limited the movement of labor was not always implemented. Fochesato constructs more or less annual  series of population and real wages for Northern and Southern countries (England and Netherlands are the “North”; France, Italy and Spain are the “South”) and shows that the response of  real wages to a given increase in population (i.e., population recovery after the decimation due to the plague)  was very different. In the North, population increase had negligible influence on wages; in the South, population increase reduced wages, eventually back to their pre-1350 levels.

            There are of course still the questions that the paper in its present version (it is just a draft)  does not answers satisfactorily: what exactly were the feudal institutions responsible for the “wage squeeze”?, how did they function?, was feudalism In the North really that much weaker? Also, there must have been some underlying economic reasons (like increase in productivity) that allowed population to increase in the North without producing negative effects on wages. Obviously, these are the questions that Fochesato’s paper (or perhaps another paper) might try to address. But for now we have here a set of very interesting hypotheses that link the events of 1350s with those some four centuries later, and that were crucial for worldwide economic development.

            Combining this hypothesis with Allen’s nicely eschews the mono-causal explanations that are all too current. It is both institutions (as reflected in the response to the population decrease)  and capitalist incentives (as reflected in the substitution of labor by machines) that led to economic development. Any single story is bound to provide only a partial explanation.

Stiglitz: Theories of just deserts and of exploitation

I am just back from the American Economic Association/Allied Social Sciences meetings in Boston. It was a hit-and-run affair for me: I could  go just for my session, and then back to New York. Nine hours in train in order to speak for 15 minutes (36 to 1 ratio for the lovers of inequality). The panel on “Inequality: challenge of the century?” was organized by Jamie Galbraith, the author (among other books) of “Inequality and Instability”. The panelists were Olivier Giovannoni (Bard College), Stephen Rose (Georgetown), Joe Stiglitz and I.

I would like  to share a few very fresh reflections on Stiglitz’s presentation. It followed very much the lines of the  presentation of his new very long paper (practically several papers) on inequality (see here, and which I discussed in a previous blog)--but there were some new points.

1) Economic theories, says Stiglitz, dealing with inequality fall into two groups. First,  those that are based on marginal productivity and neoclassical production function where the earnings of the factors of production are supposed to be determined impersonally by the market, or where returns to capital are explained by “abstinence” as in the case of Nassau Senior (explicitly mentioned by Stiglitz), or “waiting” (as in the case of Marshall).  The second group of theories regards incomes as determined largely by exploitation, political or economic power, rent-seeking, cronyism, imperfect information, monopolies. Stiglitz clearly saw himself as belonging to the latter group.

But, I thought, his work combines both. His original 1967 paper, on which Stiglitz is drawing in his new paper on the long-run wealth distribution is fully neoclassical, with an equilibrium wealth distribution, determined by the differences in saving rates and population growth. But in his other work (including in “Price of Inequality”) Stiglitz’s emphasis is on the second strand of literature. So, while his classification is useful, I thought that the real decision is whether one subscribes 100% to the marginal productivity theory (that is, all incomes are determined by the market) in which case there is little to say about distribution of income as such, or we accept that it is only, say 80% or 50% or 20% of all incomes that are thus determined. Perhaps one could argue that today in the US, only 50% of all incomes are determined by the market and that it used to be 80%.  

Only Marx’s theory of exploitation among those listed by Stiglitz would be different, because capital earnings do not appear there as unfair, or due to some departure from a “normal” functioning of capitalism, as in rent-seeking, but are indeed part of the normal functioning of capitalism, moreover its very definition.

2) Stiglitz proposed an interesting view of drivers of inequality in today’s US. The principal role belongs to finance (where he agrees with Galbraith) which made credits more easily available which in turn led to over-investment in housing, and to the increase in the wealth/GDP ratio, discussed by Piketty. But that increase while real was not conducive to greater productivity because what increased was value of land, not the physical quantity of productive  capital. Banks, instead of lending to companies to invest in new capital, lent to the public which spent the money on housing and unproductive assets. Stiglitz here rejoins, with some twists, Kumhoff and Rancière, and Rajan, and even (if I may say so) myself who wrote about that in March 2009. But Stiglitz presents it as a solution to the “Piketty puzzle”: how come that the wealth/income ratio went up but the marginal product of capital did not go down and, most importantly, wages did not increase.

3) An important implication, if you hold that a significant number of incomes are determined by the “second” theories (exploitation and market failure) is that there is no trade-off  between inequality and growth. Lower top incomes reduce inequality and increase growth.

4) Finally, Stiglitz thought that the sources of inequality in the United States today are so profound that small tinkering with the minimum wage, more affordable education etc. will not go to the root of the problem. He thought that more radical approaches, possibly cap on highest incomes, significantly increased tax rates etc. were necessary. But, to the best of my recollection, he was not very specific about the actual “more radical” measures.

This is all that I had to say about Stiglitz’s presentation. One aspect in the discussions on inequality that  I find strangely absent is broader ownership of capital.  If one of the drivers of inequality are capital incomes (and “allied” incomes like those of top management), this is because they are heavily concentrated. “Deconcentration” of capital incomes, that is much wider ownership, particularly of equities, is then a solution.  But it is seldom mentioned.