I was watching a youtube video in which Ray Dalio was saying the capitalism is broken and needs fixing. Ray Dalio is an American billionaire, investor and hedge fund manager. A few years back, a French economist Thomas Picketty wrote his best selling book,”Capital in The Twenty First Century”. Thomas Picketty highlights the concentration of wealth in a few individuals that has happened in the last few decades. In his view inequality in wealth distribution is the major problem in modern capitalism and if not addressed now will cause the system to break down in the future. Now I am reading the book, “Giants”, by Peter Phillips. I thought while reading the book I should review it and add more comments on what others are thinking. Did you read the post on Behavioral Finance and Technical Analysis?
Oxfam recently disclosed that 1% people in the world own more wealth than one half of the world population. There are around a few dozen individuals who own more wealth than the world’s 50% population. The argument of concentration of wealth in a few individual hands does has merit as pointed out by the above facts. Oxfam report got a lot of coverage in the global media when it was released with headlines like, “Oxfams warns of the growing and dangerous concentration of wealth.” Now this book, “Giants”. In 19th century Karl Marx warned of concentration of wealth and resources in the hands of the capitalist class. Has he been proven right? Read the post did UK shoot itself with Brexit.
With the talk of automation and AI taking over the workforce, it means laying off of millions of workers and the final triumph of capital over labor. The debate is raging. Autonomous trucks will of course make a few hundred thousand US truck drivers jobless in the start. But later on when autonomous trucks spread to the rest of the world this will translate into millions of truck drivers losing their jobs. In Econ 101 we are taught this standard model of circular flow. Our income translates into consumption which then translates into wages for the workers who produce the goods and services. When their will be no job for majority of the people there will be no income. Does this means the standard economic model of circular flow will break down? In the short run, it may by causing a disruption in the labor market. But in the long run, labor will find new markets and shift there. Bitcoin is a new form of wealth which is high volatile. Read the post when Bitcoin crashed 50% in one day.
Transnational Power Elites
As said above, Oxfam recently published a reported that said 8 individuals in the world hold half of the world wealth. Wealth concentration is taking place at a rapid pace and it is very much possible soon we can have one individual who will own half of the world wealth. There are around 2,047 billionaires in the world according to Forbes and these 2000 people hold almost all the wealth of the world. We need to understand the causes of this vast concentration of wealth and how we can reform the system to avoid it in the future. Societies have always been ruled by upper classes who wielded the levers of power in the society. In essence a minority has always ruled the majority in the human history. We have the case of Great Britain and France. French ruling elites refused to share power with the working class and as a result suffered a revolution and guillotine. British ruling elites were wise. They made political reforms every decade to keep the pressure off their backs while still holding the levers of power.
US also has a ruling class that comprises the corporate, government and military elites. Capitalist power elites exits in almost every society. Globalization of trade and capital is increasing interconnecting the global capitalist class. Transnational corporations are mechanism through which this global capitalist class is widening and spreading its influence on the states in the world. There is a shared belief in this class that profit driven consumerism is the solution to the global problems of poverty and environmental change. This global capitalist class always is in need of new opportunities that have high rates of return. Unfortunately high profit making opportunities are rapidly declining. Read the post on how behavior finance can help the investors.
There is a Superclass amongst this global wealthy class. This superclass comprises less than 10K people who are at the absolute peak of the global power pyramid. These people go to Davos in their private gulf stream jets. These are the people who set the agenda at G7, G20, NATO, WTO and World Bank. With the over accumulation of capital in the hands of a few thousand individuals, investment opportunities have become scare. The major challenge is how to invest the excess capital that can be billions of dollars to make a good return. Small scale investment opportunities don’t have the potential to absorb billions of dollars and hence get neglected. Global capitalist elites have excess billions of dollars and they need investment opportunities where that can reap high rates of return to grow their challenge. This is the challenge facing these power elites.
The total global wealth is estimated to be around $250 Trillion. US and Europe holds two third of this wealth meaning around $170 Trillion is being held by them. 80% of the global population lives on less than $10 per day. Around 800 million people suffer from hunger and starvation. Starvation is a problem caused by poor distribution of food as one third of all the food that is produced daily gets wasted. While global capital elite speculate on the rising cost of food and land. Corporate farming is a new hot area for investment. In the last decade around $100 billion got invested in corporate farming. Creating corporate farms means dispossessing local farmers. As you have seen above starvation is a major issue and around 1 billion people around the world suffer from it while the rich speculate on food and land prices in an effort to make high returns on their invested capital. Watch this interview of a billionaire mathematician hedge fund manager.
No one is interested in investing in startups that can solve the problem of food getting wasted instead of reaching the hungry people. One solution can be imposing 25% wealth tax on the 2000 billionaires and using that money to solve the starvation problem. Environmental degradation like climate challenge has become a major challenge even though there are still people in important powerful places who deny climate change.
Plastic was a great invention in 1930s. It created many new products that helped human population a lot. Plastics were cheap and were easy to mold and discard. Today plastic has become a major environmental hazard. Oceans are teaming will discarded plastic and aquatic life is being threatened by plastic. Urgent efforts are required to deal with this environmental menace. Solving environmental degradation can also be a profit making opportunity.
There are less than 20 firms that control more than $41 trillion. This list includes some big banks and big investment firms. Controlling $41 trillion gives them big power over the global financial system. Capital concentration is further taking place as these big firms use their excess capital to acquire new firms and consolidate their position further in the global financial system. Then there are more firms who also hold a lot of capital. Most of these firms have become too big to fail. This became evident during the financial meltdown of 2008 when one big firm after another big firm was facing liquidity problems. Federal Reserve came to their rescue singing the mantra,”Too Big to Fail” meaning if these firms are allowed to go bankrupt it will bring sown the whole financial system. Big banks have been fined for colliding in fixing things like LIBOR and global currency exchange rates. In economics we call too big to fail Moral Hazard.
Primary goal of these firms is to earn a return of 3-10% per annum on their investment. Investing and growing this $41 trillion is a challenge for these firms. Safe and risk free investment is their most important priority. Capitalism is a system that has contractions and expansions. These natural cycles of boom and bust ensure that inefficient firms go bankrupt and only the efficient firms survive which is a good thing in the long run as it ensures removal of inefficient slack from the system. But the mantra of too big to fail is being used to make inefficient firms who have made costly bad financial decisions to shift their risk to the shoulders of tax payers which is a moral hazard in economics. Moral hazard mean these firms can make reckless financial decisions in an effort to reap high return. In case things go wrong, these firms can use tax payers money to avoid bankruptcy. Global power elites now get the chance to attend the World Economic Forum and network there. Most of them are concerned about environmental issues and poverty in the world but don’t think that concentration of wealth in few hands is one of the reasons this is happening. All of them want projects that have high rates of return. According to many solving environmental problems can provide a profit making opportunity. There are around 200 people who are controlling the global financial system according to Peter Phillips in his book,”Giants.”
World Economic Forum does not make any policy. But it is important for networking and consensus building. In essence it is a socializing place where most of the global capital elite meet. Then there is the Bilderburg Group that is more exclusive and more discreet as compared to World Economic Forum. In 2017, world top 500 people saw their wealth increase by $1 trillion. Read the post will hedge funds bring down the global financial system.
Capital In 21st Century
Let’s now discuss what Thomas Piketty says in his book, “Capital in the Twenty First Century.” It was Thomas Piketty whom raised the issue of concentration of wealth in a few hands in his famous book that became a best seller. After that this theme of global wealth getting concentrated in few hands has been picked up by many other people. Thomas Piketty discuss the question of wealth concentration in a more philosophical manner by looking at the history of the past few centuries and figuring out what is happening now that did not happen in the past and how past can help us lead into the future.
Thomas Piketty compares capitalism in 21st century with the capitalism in the 19th century when industrial revolution created great wealth for a few but left the working class wretched. According to him, something like that might again happen in 21st century. He believes democracy can solve the problem of inequality while at the same time safeguarding private interests. In the past debate about the accumulation of wealth in the hands of few was based more on prejudice and less on data. But today as pointed out above we have abundance of data to support the thesis that wealth has indeed accumulated in a few hands and a handful of people are in fact controlling the global financial system.
The Prophets of Doom Ricardo Marx Malthus
There was a population explosion in France in the late eighteen century. French population increased from 20 million to 30 million. French Revolution came but there were many causes. 19th century saw Malthus predict global doom when growing population outstrips food supply. Ricardo came after Malthus and predicted land prices and landlord rents skyrocketing and then cam Karl Marx who predicted a global revolution the the workers against the capitalist class. But things didn’t happen as they had forewarned. In the middle of the nineteenth century industrial profits indeed went up while the worker wages stagnated. Karl Marx made one miscalculation. He misunderstood the role of technological innovation. Like other contemporaries of his time he totally ignored the role of technological progress that would transform the European societies in the coming decades. Technological progress and increase in productivity is a counter weight to the concentration of wealth in the society. This is one of the reasons why US economists focus on productivity in their economics textbooks and point out the role of productivity that has increased the standard of living in US many folds over the past century.
Karl Marx had not training in statistical data analysis and lacked basic statistical data. He had already made the conclusions before he started doing the research. Karl Marx totally failed to analysis or think how a society where private capital would be abolished work and functions and what types of institutions it should have to ensure that problems don’t arise. Later on when the experiment to practical carried out in the name of communism it just could not deliver.
But Karl Marx was not totally wrong. He made a point about the concentration of wealth that was taking place in the times of industrial revolution. Concentration of wealth has again become a major issue in the opening decades of 21st century. Then came Simon Kuznets who took a totally opposite viewpoint. He said we just need to be patient and income inequality will disappear in the advanced stages of capitalism. Kuznets used statistical data unlike his predecessors to prove his point in 1950s. Kuznets is considered to be a pioneer in developing the national income accounts. These economists commanded no armies, made no wars most died without renown but they did what no statesman could do. Change the world with their ideas. Kuznets used data to show that between 1910 and 1950 there was a sharp reduction in the income inequality in US. Talk about income inequality started with Malthus, Ricardo and Marx but none of them had any data to prove their point. They had the feeling that income inequality was increasing but lacked the data to prove their point. Kuznets used data to show that income inequality had indeed decreased in US between 1910 and 1950.
Kuznets Curve
But there was a caveat and Kuznets knew it. The sharp reduction in income inequality in US was not a natural occurrence. Rather it was the result of two external shocks that happened during this period. These external shocks were the Great Depression and the Second World War. So there was a need to avoid hasty conclusions from the data. But Kuznets went on to develop his Kuznets Curve that stipulated that in the initial phase of industrialization, income inequality increases until it reaches the peak and then starts decreasing. Kuznets later on admitted that his finding had more to do with keeping the developing countries on the side of the capitalist system.
Income Distribution Heart of Capitalism
In the first decade of 21st century income distribution question has again become very important just like it was in the times of Karl Marx. In US, income distribution has once again become concentrated in a few hands. The past few decades have shown that Kuznets and Solow theory of balanced growth is a bit shaky. It is obvious growth is not naturally balanced in a capitalist system in the long run. The economists of 19th century tried to study the income distributional question at that time and its effects on the societies in the long run. We should give them credit for attempting to do that despite lack of good data. Income can be from labor and income can be from capital. So we have two sources of income. Wealth distribution is more of a political as compared to economics issue.
Wealth distribution in a society is determined in large part by economic, political and social actors. Spread of knowledge is one way to spread the wealth. One cause of wealth concentration is slow growth in the society which means capital gets a large return as compared to labor. This is what the historical data shows. When the rate of return on the capital is greater than the economic growth rate as happened during the 19th century in the times of industrial revolution and as is happening now in the first decades of the 21st century, we will see the inherited wealth increase and few people getting more wealthy as compared to the rest as is happening now. Just keep this in mind, economics is a social science and we need a lot of knowledge of history, politics, psychology and other areas to properly analyze a situation. Wealth creating and wealth concentration requires delving into politics, history,psychology and many other areas that we are going to do.
Throughout human history, there has been a conflict between owners of land and their tenants how to distribute the farm produce. Land owners wants more while at the same time tenants also demand more share of the produce as they think it was their labor that is responsible for the produce. Whatever labor and capital are two fundamental factors of productions in the subject of economics. Industrial revolution has exacerbated this conflict between capital and labor. Labor wants higher wages while the factory owner wants wages to stay low so that he can keep more profit. So this basic question boils down to the division of income between capital and labor. Can a free market arrive at an optimal division of income between labor and capital? Over the past two centuries the nature of capital has changed drastically from land and real estate to industrial and financial capital.
What Is Capital?
Before we continue the discussion, we need to be clear what we mean by capital. Capital is all form of real property like real estate as well as professional capital like plants, infrastructure, machinery, patents and we should not forget to include financial capital like ownership of stocks, bonds, bank accounts and financial investments like insurance policies, pension funds, 401K retirement plans etc. Capital by be owned by private individuals as well as publicly held firms and government agencies and organization. Capital can be store of value as well factor of production. Capital and wealth are almost synonymous. National wealth or national capital is the total market value of all the capital held privately as well as publicly in a particular country in a given period of time. Stock and bond prices can go up and down violently increasing and decreasing the wealth of an individual as seen in the Tech Bubble Collapse as well as the 2007 stock market crash. This holds true for other forms of capital like real estate, plant and machinery. But the total national wealth has been observed to follow certain patterns that can be explored.
As defined above income is the sum of labor and capital. Income is a flow and is the total quantity of products and services produced in a given period of time. While capital is a stock which is just the total amount of wealth owned at a given point in time. Capital/Income ratio is a measure that is popular amongst economists. Rate of return on capital is important and is different from interest rates. In 1930s national accounts estimates started on annual basis unlike in the past where national accounts were not considered important but still individual economists attempted to estimate them on non regular basis. Data became very important during the time of Great Depression. US governments wanted national income accounting data on quarterly as well as monthly basis so as to steer the economy out of the great depression. At the start of 21st century wealth accounting again gained importance.
Rich countries are awash with surplus capital in 21st century. The challenge is to find investments which can give good returns on the capital. Most of the rich countries have exhausted the domestic investment opportunities. Free flow of capital is not that free in reality. When rich countries invest in poor countries, foreign share of property ownership increases that can lead to social pressures. Studies have shown that instead of free flow of capital, diffusion of knowledge is the principle mechanism for convergence between rich and poor countries. Diffusion of knowledge helps the poor countries to achieve the same level of education and technological know how as the rich countries. There is no solid evidence to suggest that investment by foreigners can help the poor countries in the catch process.
Global growth rates in the 21st century will be low. Low growth rates if sustained over a long period of time can result in substantial progress. 1% annual growth is not much if we look at it on a year to year basis. But a 1% growth rates sustained over a period of 30 years can bring substantial improvement in the society standard of living. A 1% growth rate is not much as compared to 2-3% growth rate but you can see even 1% can bring improvements if sustained over 30-50 years consistently. The only caveat is 1% of growth is reinvested at least a large portion instead of consumed.
In the past growth has been slow something less than 1%. In recent years we have seen growth rates higher than 4% in some countries that were doing catch up with developed countries. Higher growth rates comes to an end when the catch up is complete. In the long run we should expect annual growth something like 1-1.5%. Many people thin that we need high growth rates something 3-4% annually. An annual growth of 1% consistently can result into a major social change. Over a period of 30 years, an annual growth rate of 1% gives a cumulative growth of 35%. Economic growth does not means a just social order. Market forces cannot create a just social order which needs to be created by the society. US economy is a prime example of an economy that has grown at an annual rate of 1-2% but still enjoys the best standard of living in the world. US economy growth rate was slow as it did not need catch up. After second world war Europe experienced high growth rates till 1970s as it was catching up with US. After 1970s, the annual growth rate in Europe also came close to 1-2%. When we talk of growth rates we are talking real growth rates and not nominal growth rates.
Inflation And Growth Rates
We need to consider inflation. Inflation is a rise in the general price level over a period of time which can be monthly, quarterly and annually. In the 18th and the 19th century, there was very little inflation if we study the British Pound and the French Franc. This can be be attributed to the gold standard that has fixed currency price in terms of gold. Each currency was convertible into gold and hence convertible into each other. But in the 20th century this price stability came crashing down when first world war started. Countries like Great Britain, France, US and Germany had to pay to millions of soldiers and their weapons which they did by abandoning the gold standard and printing money. In 19th century wealth had generally two forms: land or government bonds. Rent was a major source of income for the wealthy classes. Land was a capital asset that produced reliable and stable income. A government bond is just a claim of one portion of the population that owns government bonds and receive interest on the rest of the population that pay taxes.
Public Wealth and National Capital
Financial intermediation has become so complex that it is difficult to identify who owns what. Capital is always risk oriented and entrepreneurial. In the 21st century agricultural land has been replaced by buildings, business capital and financial capital invested in stocks, bonds, firms and government organizations. Just keep in mind, national capital is the sum of private capital and public capital. Domestic capital measures the value of building and firms located within a country. Net foreign capital is the difference between the assets owned by a country residents in the outside world and the assets owned by the foreigners in the country. Building have got a larger share in national income as compared to farmland in the past. Buildings are now being used for housing, business purposes, offices, infrastructure, warehouses etc. Capital is now housing plus industrial and financial assets. In the long run, farmland has been replaced by real estate and working capital.
The division of national capital into private and public capital has important political, economic and social consequences. Capital is always the net worth meaning it is always the difference between assets and liabilities. Public buildings used for government offices and provision of public services are important public financial assets. In 19th century Great Britain and France were running huge debts. France in 1797 defaulted on two third of its public debt. Great Britain fought American Revolutionary War and the Napoleonic War by taking on huge debt. It took Great Britain almost a century to bring down the debt to less than 30% of national income.Most of the public debt in Great Britain was in the form of government bonds. There was a lot of private wealth in the British society at that time and land and government bonds were two main sources of income for the wealthy class. This was a far better than imposing taxes on the public for generating funds for the wars. The wealthy people lend funds to the government and received interest payments for decades. This was more advantageous as compared to paying taxes without getting anything back in return. Inflation was quite low in those days less than 1% while return on government bonds was something like 4-5% so it was a profitable proposition to lend to government and buy its bonds. After the debt default in 1797, France never defaulted on its public debt. Sovereign debt was a good investment in France and the private wealthy people profited from it throughout the 19th century.
In the 20th century, economist publicly advocated debt as an instrument of policy. This view of public debt is still popular amongst economists. Inflation helps in paying back debt. This is what happened in France and Britain when inflation went high and public debt went down to around 50% of the national income. Inflation is a powerful redistribution mechanism. Public debt gets helped paid fast when inflation is high. But when inflation becomes persistent, lenders can demand higher interest rates to compensate for high inflation rates. Whatever public debt is an important vehicle of internal redistribution of wealth when paid as well as when not paid. The crash of 1029 and the great depression were responsible for shaking public confidence in capitalism. The ideology of laissez faire meaning non interference by the government in the market economy was totally shattered. This ultimately led to mixed economies in the capitalist world. Privatization of the economy and the deregulation of financial markets around the world in 1980s and 1990s has had complex and multiple effects. Stagflation in 1970s had demonstrated limitations of Keynesian economics. German case is almost similar to France. Inflation ran high in Germany between 1930s and 1950s and helped it reduce its public debt.
Capital/Income Ratio
Between 1914 and 1945, capital/income ration fell sharply in Europe especially France, Germany, Britain, Italy. This was due to the massive destruction of building, factories and other infrastructure during the two world wars. Massive aerial bombing campaigns destroyed many cities like London, Dresden, Hamburg and others. But there were other factors also in the massive drop in the capital/income ratio in these advanced economies. During the Great Depression many stocks and bond holders got ruined when the firms issuing them went belly up. In 1950s and 1960s, real estate values and stock prices fell to historic lows. In 1970s and 1980s, a strong rebound took place and stock prices as well as real estate prices went up strongly. Capital/Income ratio was very low in US in the 18th and the 19th centuries. Land was abundant and very cheap as compared to Europe. The shock of two world wars was less severe in US as compared to Europe. Stock market crash of 1929 destroyed a lot of private capital and the Great Depression reduced capital/income ratio significantly. Savings went down considerably during the second world war.
Over the last two centuries capital transformed from agricultural land to urban real estate, financial and industrial capital. Total capital in an economy is measured in terms of the years of national income. Interestingly over these two centuries the capital/income ratio has not changed for UK and France. In the last few decades the capital/income ratio is on the rise and the loss in the wealth caused by the shocks of the two world wars and the great depression has been recovered by now. A country that saves a lot every year but has a low growth rate will over the coming years accumulate a lot of capital. Population growth has come down drastically in Europe and US and saving rates are high meaning capital stock has reached high levels. This means owners of capital control a lot of economic resources now. Accumulation of wealth takes decades. This explains why it took so many decades to recover from the shock of two world wars and the great depression. At the individual level, wealth can get accumulated pretty fast. But on the society level it can take many decades of consistent saving to accumulate wealth.
All rich countries are now growing approximately at the same rate. Chinese growth rate is also slowing down as it has done most of the catch up. In the short run, price dominates the capital/income ratio and in the long run volume dominates and the effect of price gets reduced. We should not forget to deduct depreciation of capital goods from the total savings in order to account for the wear tear and repair of capital goods. Durable goods purchased by households are not included in private wealth but considered as consumption. However durable goods purchased by private firms is included in private capital. You should also know the difference between disposable income and national income. If we use disposable income instead of national income then the capital/income ratio will become higher.
There are two methods by which governments can finance their expenditures. First is by increasing taxes and the second is by issuing debt in the form of government bonds. Over the decades increase in taxes have always been very unpopular. Issuing government bonds has been a popular method to raise finance for the government projects. Biggest form of privatization took place when USSR collapsed. All the property was owned by the government in the communist state. Within a few years of its collapse a fire sale of government assets took place in Russia. Real estate prices were at the lowest when World War II ended. There were various factors. The most important being rent control during the war. In 1950s, asset prices started rising and in the coming three decades this rise in asset price accelerated. Price of capital in the long term is always determined by the social and political forces in the society. Each society makes its own laws that can differ from the other societies as how to regulate the property in the society. In the beginning the book value and the market value of a firm is almost the same. But with passage of time the book value and the market value start diverging. Keep this in mind. Price of capital depends on national rules and institutions.
When countries have different growth rates or different saving rates it can result in different capital/income ratios. Countries having higher capital/income ratios will tend to invest in countries with lower capital/income ratio. In case of Japan, Japaneses had a higher preference for investing in the domestic real estate. This huge investment in domestic real estate inflated real estate prices to astronomical levels and when the bubble burst it was painful for the economy. Just a reminder in the long run, the capital/income ratio depends on the savings rate and the growth rate. Savings rate and the growth rate is the the cumulative sum of the millions of decisions made the individuals living in that society. From the share of the capital in the national income, we can easily get the share of the labor in the national income. The return on capital in the long term has been around 4-5%. Just keep this in mind, this is just an average. Individual capital return may show huge disparities.