Friday, August 15, 2014

The absurdity of blaming capitalism for inequality - Part 4.

I want to look at this graph from Picketty, again.  Previously, I used the graph for the US.  This one is for the UK:

A driving force in our attitudes toward capital, incomes, volatility, and abundance, is the fundamental tendency toward risk averseness.  The steady state of pre-capitalist economies builds on this foundation.  An extreme current example of the power of this tendency is North Korea, which is a sort of hell-on-earth built on a foundation of risk averseness.  The most chilling part of this video of North Koreans' reaction to being cured of blindness, to me, is recognizing how similar they are to us.  We are confronted with Pascal's Wager continuously, and we, wisely, take the safe bet almost every time.  The problem is that the safe bet has its tradeoffs and, on rare occasions, the safe bet actually leads to hell.

The pre-capitalist, landed elite were mostly earning returns from practically risk-free capital, generally in the form of land.  Without the legal and cultural changes of capitalism, there weren't, in fact, many other options.  As human capital and at-risk physical capital have expanded, and as land values have declined (as a proportion of income), the demand for risk-free capital has expanded.  Homes help to fill this need for most middle-class households.  Developed world government debt also fills this need, in both the developed and developing world.


In fact, if we look at Picketty's estimate of the pre-tax return to capital over time, it is interesting how stable it is.  (I have separated historical data and future projections with red bars.)  The proportion of at-risk capital to low-risk capital must be much larger now than it was in 1700.  Three quarters of physical capital in the UK was land and housing in 1700.  But the total rate of return on capital is not much higher today.  To profit from capital today, we have to take on risk.  In fact, the lowest risk capital - short term inflation-protected Treasury notes have negative real returns.

This applies to human capital, too.  We are the 100%.  The unemployed 40 year old debating on returning to school, and wondering what vocation will still provide a decent income 20 years from now, is faced with the same problem as the private equity investor.  We are all capitalists now.

Old world: Capital: How do we earn additional returns? Choose a family can we join through our children so our descendants will have land income.
Labor:  What career should I choose?  Shovel horse shit like your grandfather did.

Current world: Capital: How do we earn additional returns?  Take risk, but diversify, because who knows what the future will hold.
Labor: What career should I choose? Well, you can either learn to program C++ or you could learn how to rehabilitate a broken hip.  Either skill could be obsolete in 10 years.  Good luck.

Progress is disruption.  This is why when the rubber hits the road, it is hard to find support for things like shutting down the Ex-Im bank.  People don't actually dislike rentiers.  Rentiers represent stability.*

In our own lives, given the opportunity to develop human capital, we take it.  It's too superior to the other options.  But, that leaves us feeling vulnerable.  Being capital isn't so easy, after all.  So, just as we pay a premium as laborers or fixed income investors to have more income stability, we are willing to pay a premium (less growth) for income stability through state policy, which usually creates rentiers (through subsidies, protectionism, regulatory apparatus, etc.).  This creates a sort of collective action problem, though, because in our personal lives, we bear enough of the cost from not specializing and optimizing that we tend to go ahead and take risks.  Those risks create many positive externalities, through our increased amount of innovation and productivity.  But, the cost of collective policies that reduce disruption at the expense of growth falls mostly on the future.  Thank goodness our ancestors chose risk.

Here we are discussing r > g and the permanence of wealth during a time when "r", whether in bond yields or stock returns, has been low for 15 years, when turnover of large firms is as high as ever, and when more than 90% of the Forbes 400 from 1982 didn't make the list in 2012, replaced with a growing list of entrepreneurs.

Revolutionary progress means that legacy capital is overtaken by new capital that arises from the superstars of human capital - in the current instance, this is the equity of Bill Gates, Sergey Brin, Larry Page, etc.  Their riches didn't come from rents on a pile of savings.  The 18th century land barons earned "r", but were simply passed up by the new physical capital.  The 20th century corporate barons earned "r", but were simply passed up by the new human capital.

So, there is inequality that could never have appeared without capitalism - the inequality that comes out of human capital.  Framing the current environment as a problem of "r > g" or of "the rich getting richer and the poor getting poorer" is confusion.

People like Tyler Cowen talk about a future where there is a larger divide between owners and workers and between high and low income workers.  I suspect that if this is correct, the divide won't come from physical capital.  It will come from human capital.  And the problem will be that human capital can't be diversified.  The problem we have is that there is too much economic mobility.  Some kid in his dorm can change the world, and the next thing he knows, he's worth $5 billion.  This is the farthest thing in the world from the inequality of the 18th century, but I suspect that it bothers us more.  The problem isn't that capital is out-earning labor.  The problem is that now we are all capital, and being capital ain't so easy.

I also wonder how foreign this idea of human capital would have been to the tycoons of the mechanical world - the Carnegies and the Rockefellers.  Would they have been able to conceive of a world where a few young adults could end up running the most powerful corporations on the planet without much need for physical capital?  They probably saw themselves as a sort of end of history.  They must have assumed that progress until the end of time would come from accumulated physical capital invested in marginal productivity improvements.  What will come after exponential human capital?  Could we even imagine it?  By the time we are able to judge Picketty's forecast of capital and income in 2100, the world will probably be so foreign to us that, as with the 18th century gentlemen confronted with our world, we won't even recognize their complaints as coherent.  As moralists, we end up fighting the last battle.  In the case of Picketty, we are actually fighting the previous battle that came before the last battle.

I started this series of posts with the title "the absurdity of blaming capitalism for inequality", but in the end, I think what I've found is that it is responsible for inequality.  It's an inequality between generations.  An inequality where one century's baron is the next century's anachronism.  We now live in a world where Kenyans making less than $2 per day send their kids to private schools, and pay the bill with their mobile phones.  I can barely imagine the world we have.  I hope to get a glimpse of what the next type of "inequality" brings.  I hope we choose risk.

* (Take the recent flair up about High Frequency Trading.  People who are not familiar with the institutions of trading come down overwhelmingly against HFT.  Trading costs have come down immensely, and HFT as a whole almost certainly has net positive externalities.  But, it's unpredictable and because HFT'ers aren't living off of limited access rents, they have to exploit tenuous circumstantial trading activities to try to capture profits.  People prefer the old market makers, who pocket a big profit day in and day out and promise to keep things calm.  We'd rather have a 20 cent spread and a rentier's protective hand than to have an anarchic 3 cent spread.)


  1. It's not that people like rentiers. They don't. It's that people like... well, how shall we put this. *Civil servants*.

    People want someone (else!) to be paid to keep things stable.

    If rentiers can do that (the feudal landlord who lives there and manages things himself) people are fine with rentiers.

    If rentiers fail to do that (the absentee landlord who does nothing to manage but merely comes by to extract rents intermittently), then people are mad at rentiers.

    It's really something more basic than money, and you get at that: it's stability. Most people will pay a lot for stability. "Anything for a quiet life", as the saying goes.

  2. " I hope we choose risk."

    We won't; we can't. This is a principle of psychology. We also shouldn't; this is a principle of complex systems.

    People who advocate for much greater risk for everyone are generally dangerous and should arguably be shot through the head... which they often are! If you force people to take greater risk by making everything risky, they will probably take revenge on you eventually. Examples of successful advocacy for greater risk include World War I.

    This doesn't mean suppressing change. Change is great. But change should take place in an essentially safe environment. So, we can allow for businesses and sectors to collapse *if* the people involved in them are guaranteed food, clothing, and shelter regardless -- the base of the Maslow hierarchy.

    This was essentially the New Deal bargain. Greater risk of losing elite status -- good for society. Greater risk of starving or freezing -- bad for society.

    1. Nathanael, I was neglectful in not responding to your comments when you originally posted them. I might take some issue with your second paragraph. First, for the violence, and second, for the binary thinking. I think it is clear to most readers that I am not advocating unsustainable or damaging risk, so I think you could share these thoughts in a way that builds on natural agreements instead of rhetorically creating wedges of disagreement. With these caveats in mind, these comments are thoughtful appendixes to the post.

  3. Change creates winners and losers. The losers are real existing people, usually current winners, often with associations and political clout. The future winners often haven't even been born, or if they have they are not yet organized.

    The current winners (and hence prospective losers) use their clout and existence and organization to suppress change. Because they can. Thus if change can be suppressed it will be.

    The key is institutions which undermine our ability to suppress change. In the 1800s this was the fragmented (yet somewhat integrated) political states of Europe and the US. Those states with what D North refers to as "open access" were less able to suppress change and protect incumbents. So economic progress wasn't killed off for the first time ever.

    Stability is the death of progress, and the short term friend of incumbents.

    1. Good point. Owners vs. managers, new money vs. old money, markets vs. businesses. So much public opinion is bound up with these confusions.