Thursday, July 17, 2014

Capital in the 21st Century: Global Inequality of Wealth in the Twenty-First Century (Chapter 12)

This chapter was about the structure of inequality. Despite being nearly the perfect chapter to attack the wealthiest 1%, he doesn’t do that. Thomas Piketty and I would get along really well. He uses real practical examples, including North Iowa Community College, as well as lots of numbers and often understates the impact of taking things to their logical conclusion. Something I have always felt too scared to even say is that if global inequality goes too far there will be “violent political reaction”. None of you read my book about unemployment, but I alluded to that fact several times. Piketty on the other hand says it more directly and delicately a number of times.

Basically this chapter was about the structure of inequality both within countries, and between countries. In short, while the media loves to cover China owning the US, or compare their GDP growth to our GDP growth, or compare trade surpluses and deficits for any one given quarter, inequality between countries is relatively minor, and in the future will likely be even less than it is today. The reason some countries are “growing” so fast is that they are simply catching up to where the rich countries are now. They don’t have to invent automobiles, computers, smart phones, light bulbs, or assembly lines, they just have to copy what already exists in our rich countries. That’s the short way of saying it. Obviously, “copying” is not the right word, as it must happen differently given different resources, and the catch up process takes decades, if not a century, or even more. So never fear China owning the entire US or all technical jobs being outsourced to Asia. Those poorer countries have a long way to go, and challenges of their own. No one even talks about the economic "threat" of Africa because it has so far to go to catch up. Chances are Africa will still be catching up in 2100.

The real “threat”, to use my own word, is inequality within countries, rather the likelihood of oligarchs taking over. One might already say that Bill Gates, the Koch brothers, or Warren Buffet have already approached the invincible status of oligarch. Within some market each one has some sort of monopoly, and each one has significant political influence, certainly more than I do. As the rate of return on capital is larger for larger fortunes, both family fortunes, and foundation fortunes, like universities, the rich really do get richer. Gates fortune (wealth) grew something like 10% over the last 25 years, compared with 6.8% for the richest 1 person per 100 million people and only 2.1% for the average person (which of course is above the median) (Piketty, Table 12.1, page 435). The reason being a person with $100 million can spend easily $500,000 a year on financial research and advice to discern investments, while a person with only $10,000 might as well spend that same percentage, which is only $50, on subscribing to the Wall Street Journal. For those of you with no wealth, roughly the poorest 50% of the rich countries, ummm I'm sorry I don't have much optimistic to say.

This is the last chapter before part 4, which is the part everyone, most of whom probably haven’t even read it, is raving about. The point being, the first 470 pages of Capital in the 21st Century are about wealth, income, who has it now, what defines “capital”, who has had it in the past, and who is likely to have it in the future. To sum up the book to this point, it would be best for you if you inherited money, especially if you are a young person today. The reason is capital, money, is necessary to eat, for transportation, to start a business, to buy a house, and continue paying expenses. With a certain amount of money, let’s say $1.2 million, and assuming an average rate of return of 4% (which is historically far more likely than the wonderful 8% predictions of the brokerage and financial “advice” websites) you could live on the median salary of a US family. Frankly, it is easiest to simply have that $1.2 million rather than learn a skill, have a trade, and spend most of the waking week working a job. Plus, that initial money may be a gateway to a more prestigious education, business networking, a cushion for unemployment, or simply a supplement to your income. In short, it’s going to make your life easier, or at least more luxurious, to have it rather than not have it.

For a time I admired Warren Buffet. However, as I have become more educated and traveled, my admiration has sunk. You see, he is enormously good at picking out undervalued companies, but let’s be honest, value investing is not even rocket science, it’s easier as long as you know what to look for, and that is beyond the scope of this article because I don’t totally understand it, except to say net-net companies and spinoffs are almost always a win. However, after seeing true poverty in Africa and Asia, my heart goes out to the real poor of the world. I feel guilty for even buying a $4 coffee. Yet the billionaires among us could feed, educate, provide clean water, etc. for the world and they don’t because they continue to build their fortunes. We can say “Bill Gates the philanthropist” but he was the highest paid person (to the tune of $59.7 million in dividends alone) last year by John Deere because he owns 8% of the company (not to mention he bought at $65 and the stock is now at $90). Maybe he is a philanthropist, and he is certainly doing a lot of good with his money, yet he was paid more than three times the CEO, who certainly works more than 40 hours a week and must frequently stress over the many problems of the company, has been with the company for well over 30 years. Yet Gates receives more than three times the CEO pay in dividends alone for doing nothing but owning 8% of the company. That is the world we live in.

To give some background on earlier chapters there is a capital/labor split when it comes to income. Roughly 30% of income goes to capital and 70% goes to labor, although in high capital environments capital's share of the income pile goes down because access to capital is easier. This means that investors who put up the $500,000 to build a new McDonalds are getting maybe a 20-30% cut of the income versus paying 70-80% of the income to employees. On a given yearly basis, income from wages always far outweighs income from capital interest, yet the capital is generally owned by a very small portion of the population and thus far more concentrated.

Another key point, when the rate of return on capital (known as r) is greater than the economic growth (known as g) it will always benefit the owners of capital. In other words, when r>g, which is historically the norm, but was not the norm during most of the 20th century due to explosive economic growth, the rich will become richer faster than economic growth, which is to say economic growth = average person becoming more wealthy. In concrete terms, if the average rate of return on capital (investment return) is 5% and economic growth (roughly or ideally salary growth) is 3%, people who own capital (investments) will be getting 2% farther ahead of people who work every year. 

Okay, mathematically that's one of the least accurate descriptions of the r>g idea in the book, but I feel it is the best way to make sense to most people who aren't reading a 600 page economics book for fun. The major inaccuracy is that 3% economic growth does not directly correspond to 3% salary growth at all, but inflation and the ever changing demand for different skills in the job market, as well as career development, is far to complex to describe in a paragraph.


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