Should democratic societies be concerned about wealth concentration?
In market democracies, the assumed equality of rights of all citizens contrasts sharply with the real inequality of living conditions among people.
The normative justification of this inequality rests upon the assumption of merit.
Figure 11.11 illustrates why Piketty is concerned about inheritance.
This has a tendency to undermine merit. In 1893, Durkheim assumed that liberal democracies would abolish inheritance and property at death.
The graph shows that for those born around 1970-1980, 12-15 percent of individuals will inherit the equivalent of what the bottom 50 percent of the population earn in a lifetime.
Piketty suggests that inheritance and rent are problematic in a democracy but inevitable in a market economy. Why? Because in a context of R>G, inheritance will predominate over savings, and earned income.
When Mario Draghi took over as president of the European Central Bank (ECB) his proposal to resolve the Euro crisis was to “fight against rents” in Europe. What he meant by this was the fight against monopolies.
For economists, the term ‘rent’ is usually pejorative as it is assumed to equal the lack of competition in a market, particularly in the non-traded services sector: Construction, real estate, taxis, hairdressers, pharmacists.
But historically ‘rent’ was a term that was used to describe any income that was earned from owning a capital asset.
What is Piketty getting at here?
For Piketty ‘rent and inheritance’ are not an imperfection in the market. Rather they are the logical consequence of capital accumulation.
He is highlighting that market and economic rationality have nothing to do with democratic rationality. Democracy and social justice require specific institutions of their own, and these cannot be justified in terms of market competition.
When universal suffrage was instituted in the 19th century (and property voting abolished) it ended the legal domination of politics by the wealthy.
But it did not abolish the economic forces capable of producing a society of rentiers.
Let’s move on to examine why this matters at a global level.
Financial globalization and the inequality of R>G leads to a greater concentration of capital ownership. This automatically contributes to a structural divergence in the ownership of wealth, particularly at the very top of the income distribution.
One way to observe this (the impact of the R>G inequality among the top centile) is to examine global wealth rankings (ranking of billionaires) and global wealth reports.
Both of these rankings illustrate that the rate of return on the largest fortunes has grown significantly faster than average wealth. See the latest Crédit Suisse report here.
It suggests that there are two worlds at the top.
Global inequality of wealth in the early 2010’s is comparable in magnitude to that observed in Europe in 1900-1910.
The top 0.1 percent own 20 percent of global wealth, the top 1 percent own 50 percent of global wealth and the top 10 percent own between 80-90 percent of wealth.
If the top 0.1 percent (4.5 million people) enjoy a 6 percent return on their wealth, whilst average global wealth grows at 2 percent a year, then after 30 years, their share of global capital will increase to 60 percent.
Is this compatible with democracy?
Piketty suggests that this type of market regime is not compatible with democracy, and therefore it requires some sort of political intervention.
Hence his proposal for a global wealth tax.
Other mechanisms to redistribute include: inflation, expropriation, nationalisation.
The unequal returns to different types of capital assets (which is heavily dependent upon the initial portfolio size), and the fact that the highest fortunes grow significantly faster than average wealth, amplifies the inequality R>G.
All large fortunes, whether inherited or entrepreneurial in origin, tend to grow at extremely high rates.
Once a fortune is established, the capital grows according to a dynamic of its own.
Money reproduces itself.
But more importantly, inherited wealth accounts for more than half the total amount of the largest fortunes worldwide.
Hence, the entrepreneurial argument does not justify all inequalities of wealth. Fortunes can grow far beyond any rational justification in terms of social utility. This is Piketty’s justification for a progressive annual tax on capital-wealth.
To quote him directly:
Every fortune is partially justified yet potential excessive. Outright theft is rare, as is absolute merit. The advantage of a progressive tax on capital is that it exposes large fortunes to democratic control.
Another way to observe whether greater the endowment/size of capital, the greater the return, is to examine the capital endowment of US universities.
Table 12.2 reports the findings.
The average real rate of return for Ivy League US Universities was 8.2%. The higher rate of return is an outcome of very sophisticated investment strategies.
Most of these top universities invest in high yield assets such as private equity funds, foreign stocks, derivatives, real estate, natural resources and raw materials.
They tend not to invest in US government bonds.
These large returns on capital endowments largely account for the prosperity of the most prestigious US universities.
Should the US government tax these institutions higher and redistribute to poorer colleges? Or should they let billionaires build their own universities?
Sovereign wealth funds
Consider now the case of sovereign wealth funds and petroleum states. Unlike US universities we don’t know what the investment strategies of these funds are.
The Norwegian sovereign wealth fund is worth about 700 billion. 60 percent of money earned from Norwegian oil is reinvested into the fund, while 40 percent goes to government public services and expenses.
The financial reports of the next two biggest sovereign wealth funds: Abu Dhabi Investment Authority and Saudi Arabia, are more opaque.
Abu Dhabi boasts an average return of 7 percent, whilst Saudi Arabia is approximately 2-3 percent. This is because Saudi Arabia primarily invests in US Treasury bonds.
At a global level, sovereign wealth funds hold total investments that equal $5.3 trillion, of which $3.2 trillion belongs to petroleum exporting states.
This is the same as the fortune of all the worlds billionaires.
As oil becomes more scare and its price increases, the inequality R>G would imply that the share of global capital going to petro-states could reach 10-20 percent.
This would not bode well for democracy, as it implies growing economic dependence on oil-producing states.
Their populations are often tiny but their investments are huge.
Can we imagine a democracy blocking sovereign wealth funds from buying up real estate or other assets in a country?
A large portion of the global capital stock is accumulating in Asia, particularly China.
In borderless capital-markets, inward Chinese investment is causing some political tension. See figure 12.5.
The big difference between China and the small Arab oil-producing monarchies is that Asian populations are huge. Most of their future investment is likely to be spent on their own domestic populations.
The total real estate and financial assets, net of debt, owned by European households is 70 trillion whereas the sovereign wealth fund in China is less than 3 trillion.
Rich countries are being taken over by domestic oligarchs not China.
Wealth in most western democratic countries is private and cannot be mobilised by governments for public purposes.
For example, during the euro crisis, the Chinese recommended to the EU to mobilise private capital within its borders to solve the Greek debt crisis.
But the EU cannot regulate, tax or mobilise the capital and income it generates within it’s member-states. Small states are competing with each other to reduce capital taxation at the very moment when demand for public expenditure is increasing.
Cautious estimates suggest that unreported financial assets held in tax havens amount to nearly 10 percent of global GDP. Most of this belongs to residents of rich countries.
To overcome these contradictions Piketty proposes a global tax on capital wealth, particularly within the European Union.
Is this feasible?
Is Piketty (among many other scholars) right to be concerned that domestic wealthy oligarchs are in a position to distort democracy?