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Some Thoughts on Income and Wealth Inequalities

November 15th, 2020

In a recently published book (sept 2020), When More is Not Better: Overcoming America’s Obsession with Economic Efficiency, Roger Martin argues that a short term focus on maximizing shareholder returns contributes is the cause of economic inequality and instability. A second, more comprehensive, work on the causes, extent, and consequences of wealth and income inequality is Thomas Piketty’s book, Capital in the Twenty-First Century. Inequality is contributing to geopolitical instability that we’re seeing around the world. There is good cause for concern.

There is an argument that although the rich are getting richer so are the poor. This is a matter of fact but the metric used to draw this conclusion is somewhat misleading. The share of a country’s annual growth in wealth is typically measured in terms of GDP per capita and is therefore an average metric which, in fact, has increased over the years.  

Supporters of unbridled capitalism point to this fact in their claim that although the gap between rich and poor has widened, the poor are still better off and that’s because the rich have been willing to take risks, work harder, and build economic value. That’s partially correct but it’s also partly bullshit of the highest order.

The more telling metric of economic welloffness (a new invented word) is the median share of GDP. This is the level where 50% of the population is above and 50% below. For the last 40 years gap between the median and average has widened and quite rapidly at times. This means that while the average has been rising slowly more than half the population is earning progressively less than the average because the share of GDP received by a very small number of super rich is so high.

To illustrate, if Jeff Bezos walked into a bar to join 100 other people the average wealth per person in the bar would be in the order of $1.6 billion! However, if another 100 very poor people walked into the bar the impact on the average wouldn’t even be significant at the 10th decimal place. This means that the richer the rich get, the richer the poor seem to be when averages rather than medians are used to reflect wealth or income shares.

The increasing gap between rich and poor (i.e. the decimation of the middle class) reflects, amongst other things, the shift in power from labour to capital which is caused in varying degrees by many things but important amongst them are technology (and especially its effect on the transition from industrial to information to knowledge industries), weakening of labour unions, the power of the management class, globalization, and political intervention e.g. tax reductions.

As a qualification to my above comments I am aware that the combined wealth of self-made billionaires such as the founders of the FAANG cohort of companies and others would have influenced the inequality gap. But these people are true innovators and it would be very dangerous indeed to argue that in order to close the gap we need to stop or dissuade people like these folk from innovating.

Of much greater concern is the effect inherited wealth, managerial power, and compliant political intervention has on wealth distribution.

Inherited wealth is hidden from general view to most people. Forbes lists the wealthiest people in the world every year but this is just the tip of the iceberg. Inherited wealth would not mean much if it were not for the fact that the average annual growth in it is about 4.5% while average global GDP growth is about 2.5%.

Part of this has been made possible by favorable tax treatment given by governments to wealthy people and corporations and, in particular, offshore tax havens but that is so serious it needs separate consideration except to say the power that money has on representation in government has resulted in a situation where a large proportion of citizens are effectively unrepresented in the halls of power. Take a look at this interview with Noam Chomsky.

This disparity between the growth rates, if it continues, is what inexorably leads to serious inequality and social unrest. For example, assuming inherited wealth and other wealth each now share 50% of their combined wealth (bear in mind, other wealth is shared by millions of people whereas inherited wealth might be shared by thousands but definitely not millions) over a 20 year period inherited wealth would have grown to 60% of the total, over 30 years it would have grown to 64%, and over 50 years it would have grown to 72%. If you extrapolate this for a long enough period of time all wealth gravitates to a very few people or families. Way before that time society will demand change.

Another hugely inequitable situation is the power of the managerial class which I think is even more dangerous as a source of social instability and dissatisfaction with the capitalist system’s ability to fairly allocate resources at least in the US.  In the US, the average income of CEOs of Fortune 500 companies is currently in the order of $11.9 million per year. Often a good part of their income is also tax efficient. In comparison the average wage of front line workers is about $35,500. The implication of this disparity is the assumption that these CEOs are 355 more valuable than an average employee.

Some of these CEOs are responsible for creating the circumstances for great value to be created and captured by the organization but we must not forget that execution of strategy is just as important as strategy, if not more so.  However, compared to the amount of inherited wealth and that which is attributed to the super rich founders of entrepreneurial companies the bigger problem is that the wealth being accumulated by the management class is more transparent which means employees are staring in the face of inequality the magnitude of which seems patently unfair. 

These people often have the power to determine their compensation (and that of their supportive C-Team and Board) and can even manipulate the metrics used as a basis to reward them. Add to that an incentive to focus on shareholder value growth rather than a broader and more inclusive social mandate.  It could be argued that at least some of these CEOs are not only grabbing an unreasonable share of national wealth they are also systematically destroying non-financial national wealth through the economic activities their companies engage in. The visibility of this is what brings the capitalist system into disrepute and exposes it to attack from socialists.

There is no doubt in my mind that capitalism is the only way to create wealth on a scale that has the potential for everyone benefit. What it’s not so good at is distributing the wealth while at the same time incentivising people to innovate, take risks, and accumulate great wealth but also be willing to share that wealth.

I suspect there will come a time when people will say enough is enough and something will need to change.

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