Good Times for Capital

Last week, the Wall Street Journal highlighted a Federal Reserve report on total household net worth. Surprise! Americans are richer than ever before, both in nominal and real terms.

At the same time, though, wealth inequality is increasing from its already Gilded Era levels. The main factor behind increasing household net worth over the past year was the rising stock market (followed far behind by rising housing prices). These obviously only help you if you own stocks—not if, say, you never had enough money to buy stocks, or you had to cash out your 401(k) in 2009 because you were laid off. Put another way, rising asset values help you if you are a supplier of capital more than a supplier of labor.

Is there anything we can do about this? The conventional wisdom from the political center all the way out to the right fringe is that we shouldn’t tinker too much with the wealth distribution—otherwise people won’t work as hard, which is bad for everyone. But perhaps it isn’t true.

In a new paper (Vox summary; hat tip Mark Thoma), three IMF economists look at the relationship between redistribution—measured by differences between the pre-tax-and-transfer income distribution and the post-tax-and-transfer income distribution—and overall economic growth over five-year periods, across countries and across time. They find (from the summary) “remarkably little evidence in the historical data used in our paper of adverse effects of fiscal redistribution on growth.” In general, that is, average levels of redistribution tend to be associated with higher levels of growth that are sustained for longer.

Why would this be? One reason is that inequality, in and of itself, seems to be associated with lower levels of growth. So if you redistribute income in order to reduce inequality, even if it is true that this hurts incentives to work hard, the reduced inequality has a countervailing (and, in most cases, stronger) effect.

Indeed, there’s a strong argument to be made that a capitalist society needs systematic redistribution to survive. Thomas Piketty’s new book—which I plan to read the next time I have time to read a 700-page economics book—free markets generally produce higher returns on capital than on labor, which means, to a first approximation, that people with capital will get richer faster than people with only labor. In a world where the political system is open to money, this means that the capitalists will also accumulate a disproportionate share of political power, leading to the type of extractive society described by Acemoglu and Robinson in Why Nations Fail. Which is not a world that most of us would want to live in.

This piece is cross-posted from The Baseline Scenario with permission.

One Response to "Good Times for Capital"

  1. benleet   March 11, 2014 at 1:37 pm

    Fed's Flow of Fund Report, Z1, shows total household wealth at $80.664 trillion, up from $57 trillion in 2008. That brings mean average savings to $690,000 per household. Half of households own 1.1% or maybe less. Liquid asset poverty rate is 44% of all households, and population, that have less than $5,763 in savings for a household of four.
    It should be quite obvious that fewer customers with means leads to a less vibrant economy. I'm reminded of a vegetable market in a public square in India, in comparison with Whole Foods market in San Francisco.
    Economic growth in the U.S. between 1934 and 1976 was pretty amazing, it had to do with redistribution. Look at the charts at Striking It Richer, Emmanuel Saez' ongoing essay on income distribution. I just wrote an essay that $22.81 per hour would be the minimum wage today if since 1968 the MW had tracked inflation and GDP/capita growth. — my blog