Very Rough: Exploding Wealth Inequality and Its Rent-Seeking Society Consequences: (Early) Monday Focus for October 27, 2014
…less than 10% in the late 1970s but now exceeds 20%…. A large portion of this increase is due to an upsurge in the labor incomes earned by senior company executives and successful entrepreneurs. But… did wealth inequality rise as well?… The answer is a definitive yes…. We use comprehensive data on capital income—such as dividends, interest, rents, and business profits—that is reported on individual income tax returns since 1913. We then capitalize this income so that it matches the amount of wealth recorded in the Federal Reserve’s Flow of Funds…. In this way we obtain annual estimates of U.S. wealth inequality stretching back a century. Wealth inequality, it turns out, has followed a spectacular U-shape evolution over the past 100 years…. How can we explain the growing disparity in American wealth? The answer is that the combination of higher income inequality alongside a growing disparity in the ability to save for most Americans is fueling the explosion in wealth inequality. For the bottom 90 percent of families, real wage gains (after factoring in inflation) were very limited over the past three decades, but for their counterparts in the top 1 percent real wages grew fast. In addition, the saving rate of middle class and lower class families collapsed over the same period while it remained substantial at the top…. If income inequality stays high and if the saving rate of the bottom 90 percent of families remains low then wealth disparity will keep increasing. Ten or twenty years from now, all the gains in wealth democratization achieved during the New Deal and the post-war decades could be lost…. There are a number of specific policy reforms needed to rebuild middle class wealth…. Prudent financial regulation to rein in predatory lending, incentives to help people save… steps to boost the wages of the bottom 90 percent of workers are needed…. One final reform also needs to be on the policymaking agenda: the collection of better data on wealth…
Taking off from my Mr. Piketty and the Neoclassicists, once we had such guesses we could build a balanced-growth model…
The important quantities would be:
(1) The annual rate of population and labor force growth: n.
(2) The annual rate of labor productivity growth: g.
(3) The warranted annual rate of accumulation ra = n + g: the rate at which wealthholders’ assets need to grow if their wealth-to-national-income ratio to be constant.
(4) The wedge ω between the rates of accumulation and net profit: what share of their current assets the wealth spend, dissipate, lose to Wall Street sharks, consume, give away, and so forth.
(5) The resulting warranted annual rate of net profit rw= n + g + ω: The warranted annual rate of net profit at which wealthholders’ have a constant ratio of their wealth to national income. If the actual average rate of profit r > rw, the rich become richer in relative terms. If the actual average rate of profit r < rw, the rich lose ground in relative terms. If the actual average rate of profit r = rw, the wealth of the rich remains a stable multiple of national income.
From the warranted annual rate of net profit rw, we then need to know:
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How the annual rate of net profit r in the productive sector depends on the size of the stock of physical capital–which is rented out to workers at its marginal product–relative to annual income K/Y.
- To calculate this we need to know:
- What the physical net annual marginal product of capital is at some baseline physical capital-income ratio K/Y, say 3.
- What the elasticity of the net rate of annual profit r in the productive sector with respect to the productive capital-income ratio is.
- To calculate this we need to know:
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How the annual rate of net profit in the rent-seeking sector depends on the size of the stock of rent-seeking property relative to national income R/Y.
- To calculate this we need to know:
- What the rate of rent extraction ε is at some baseline rent-seeking property-income ratio, say 3.
- What the elasticity of the net rate of rent extraction ε in the rent-seeking sector is with respect to the rent-seeking property-income ration R/Y.
- To calculate this we need to know:
If we know all those, we can then calculate:
(6) The physical capital-annual income ratio at the warranted rate of net profit: (K/Y)*
(7) The rent-seeking capital-annual income ratio at the warranted rate of profit: (R/Y)*
(8) (W/Y)* = (K/Y): The total wealth-annual income ratio at the warranted rate of profit: (W/Y)
(9) The income-from-wealth share of total income: rw x (W/Y)*, given:
(10) The physical net annual marginal product of capital at K/Y = 3: ρK
(11) The annual net return on rent-seeking capital at R/Y = 3: ρR
(12) The elasticity of the rate of profit on physical capital: λK
(13) The elasticity of the rate of profit on rent-seeking capital: λR
Which I believe gets us to this spreadsheet. If you download it and edit it in interesting ways, please send me a copy…
For the particular parameters I have chosen, we have the wealthholders cumulatively investing 2.1 times a year’s GDP in productive capital that boosts the wage level, and 0.6 times in year’s GDP in rent-extraction property that subtracts from the wage level. And we have a Belle Epoque and a Future Second Gilded Age in which wealthholders do indeed hold a greater multiple of GDP’s worth of useful, productive, wage-boosting capital–3.4 times a year’s national income–but also hold vastly more rent-seeking property: 5.2 times a year’s national income.
In this interpretation of Piketty, thrift on the part of the rich is indeed beneficial to the working class–as long as it is channeled into productive investment. But if it is used to create, politically maintain, and profit from rent-extraction property… well, it is not so nice.