On the Causes of Inequality

So there is a new blog I have been following, dajeeps, and I saw the following post, on the causes of inequality.

The problem is not inequality of income or wealth, it is a symptom. It’s a symptom of inequality of opportunity that comes with the consolidation of investment channels to such a degree that more than 50% of the nation’s potentially productive capital is under the control of only a handful of firms.

Perhaps the proponents of wealth gap argument are too busy looking for ways government can solve the problem by sticking it to the rich to notice that government has caused the problem. In a capitalist society, no one gets wealthy by working as a wage slave.

As I see it, in so far as inequality has a cause, it is `capital accumulation’. Fundamentally, if I want to save, I need to find someone who has a productive opportunity to spend it on capital given the current interest rate. For a while, demand for capital was high, and this favored savers. Since savers are generally the better off in society, this has favored `the rich’. Now we have a situation which, potentially, favors the poor(er). Interest rates, and hence return on capital, could very well be very low (or negative) for the foreseeable future. All those owners of bonds might very well be `the rich’, and about to suffer hefty losses if interest rates `normalise’. This is why changes in inequality look pretty similar across all developed countries, even though they have wildly different tax policies.

This capital accumulation (saving) is a feature of the economy right now. Sooner or later a technology shock will come along and render a goodly proportion of the capital stock redundant, and since all that represents someone’s savings, a lot of savings will be destroyed, and many of the wealthy will lose a huge proportion of their money.

The best historical example of this kind of shock was the destruction of the aristocracy. At the turn of the 17th century in the UK, land was the capital of choice. If you wanted to be rich, you got rich by saving your money and buying land. Those who had land schemed through marriage, politics, and sometimes assassination, to acquire more land. They got a store of the profits from selling the food from that land, and that, more or less, was the economy.

Then came advances in agriculture, the seed drill was invented, and that was just the beginning. By 1850, only 22% of the UK population was engaged in agriculture. Think about what that means – in 1600 the aristocrats got a share of essentially all of the produce of the economy, by 1850 they were getting a share of one fifth of the economy. More than that, we could now produce more than enough food easily, and so food prices had fallen dramatically. The aristocracy were ruined and replaced by merchants. By 1900 this transition was complete, and merchants, ship owners and bankers were the new elite, because the economy was based around trade. Raw materials came in by sea, and finished products were shipped out. World trade volumes were growing rapidly.

In all of this, what is often forgotten, is that land was saving. If we had had a modern financial structure, agribuisness would have been the titans of the 1700’s, only to see its share price collapse and end in a messy default sometime in the 1800’s. Today, amazon is on course to destroy the entire retail sector. The internet, with its ability to organised information, might one day render all kinds of professions pointless. Already auditing has become e-auditing. How long before information technology makes accounting something that anyone can do? There is already plenty of evidence that computers do much better than most financial planners. Anyone invested in a buisness runs the risk that a new technology will render it pointless.

Anyway, the key lesson is that Technology Giveth, and Technology Taketh Away. We have lived through an age in which capital accumulation was the name of the game. The efficiencies of mass production and urbanization required large investments in fixed capital, and high demand for savings led to a healthy return on investment. If, in the future, technology means that we get buy with much lower investment in physical capital, then it will be impossible for the rich to save effectively. There will simply be no long term investments for them to buy. The investments they collectively own will fall in value, and inequality will fall.

Below, I have put a graph of investment in fixed capital as a percentage of GDP, alongside an appropriately transformed gini coefficient (just subtracted 0.35 to make them appear nicely in the same graph). This number is probably a decent proxy for the savings rate. It has been rising for decades, if it falls in the future then inequality will probably fall to (with some appropriate time lag). Just like rises in the investment in capital are associated with rises in the gini coefficient.

This shows `capital formation’ as a percentage of gdp in blue. In red is the gini coefficient, with 0.35 subtracted to make them appear nicely on the same graph. Notice how the large rises in inequality is associated with a rise in the investment in capital.



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About worldofinterest

I know I live in my own world, but I like it: they know me here.

One response to “On the Causes of Inequality”

  1. dajeeps says :

    Thanks for the ping and great blogging. I never considered the movement from aristocratic agribusiness to mercantilism in quite that way before. I was focused on the corporatism fueled by pension plans and other retirement plans in my post, just as a observation of what happens when investment channels are consolidated to just a handful of national firms – which I think has happened, thanks in no small part to Sarbanes-Oxley.

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