The publication of the Sunday Times Rich List comes at a time when the academic and policymaking world is becoming exercised again about inequality. The wealth management industry cannot afford to ignore this issue and must make the case for wealth creation and entrepreneurship.
As summer kicks in the wealth management business can expect its usual flurry of reports on how the high- and ultra-high net worths are faring. The Sunday Times newspaper weighed in yesterday: it announced that the 1,000 richest men and women in the UK saw their combined wealth rise 13 per cent last year to £519 billion ($872 billion). That wealth accounts for around a third of UK gross domestic product although the newspaper says official data shows no sign that the wealthy are increasing their total share of the economy.
If that last point holds true, it will be a counter to the assertion in a much-discussed new book, Capital in the 21st Century, by Thomas Piketty, a French academic. The central assertion of his book is that the wealth of capitalists grows faster than the economy as a whole so that, at one stage or so, this leads to an explosive social and political confrontation, and to be dealt with, Piketty recommends swingeing taxes on capital gains and incomes of the rich. Such a policy was tried in the UK in the 1970s with disastrous effect; the current President of France, Francois Hollande, is embarked on a similarly ruinous course, which explains why parts of London sound so French these days as affluent people flee the Fifth Republic.
There are several basic flaws in Piketty’s reasoning. Garett Jones, writing in the US magazine Reason (26 April), put his finger on the problem so well that I’ll quote him here: “Even capitalists consume, and they can consume quite a lot. The typical person might not be able to imagine what it's like to be worth a billion dollars and have about $40 million a year in interest and dividend income to spend, but among private jets, new cars, the latest medical treatments, and gifts for his rich friends, a billionaire can spend that much just trying to keep up with his neighbors. Saving is mostly just delayed consumption, as generations of economists have taught, and the only way for capital to grow exactly at the interest rate is for nobody to consume it. Every bit of consumption pushes down the growth rate of capital.”
He continues: “The entrepreneur who earns a few billion from innovation might be frugal enough to pass on a massively compounded pile of capital. But between the possibility of spendthrift descendants who fritter away her fortune and the possibility of multiple descendants who divide it into tiny slices, there's good reason to expect the long-run trend will be for the capital of billionaires to grow at about the same rate as the overall economy. Since capital helps the average worker do her job, we should hope that the world's billionaires will be frugal rather than reckless, lending their capital to fund innovation the world over, but we are unlikely to be so lucky. Billionaire wealth can turn into multimillionaire wealth with just a few ill-judged marriages.”
Jones goes onto argue that there is no logical reason for capitalists’ wealth to outpace growth of GDP in the long run: “The reason is simple. If the first machine is more productive than the second (i.e., diminishing returns), and if machines wear out and fall apart at a fairly predictable rate—a depreciation rate, in accounting-speak—then it's a safe bet that in the long run capital and the economy will grow at about the same rate. Double the machines mean double the machines wearing out, so at some point you have so many machines (and houses and outdated software and office buildings) wearing out each year that a nation spends an enormous economic effort just replacing them. And of course if interest rates are high, business owners look for alternatives to capital (such as workers); private demand for capital thus shrinks. So growing replacement costs and the quest for cheaper alternatives both make it hard to imagine capital growing as far as the eye can see. I'll spare you the math, but it's getting harder all the time to see a central contradiction.”
So why does such a flawed book – more than 700 pages long – get so much attention if its policy recommendations are so bad and if it can ignore issues such as diminishing returns, risk and volatility? This is partly because half a decade on from the worst financial crisis since arguably the Great Depression, capitalism – or at least our current version of it – has been called into question. Piketty gives a nice imprint of academic respectability to the idea that the rich deserve to be cut down.
A difficulty for any defender of capitalism and wealth creation – like yours truly – has is that there is a measure of justice in the claim that the wealthy have got richer in undeserved ways. The recent central bank policy of quantitative easing – printing money – has been to enrich further those who hold equities at the expense of those reliant on fixed incomes and low-return assets such as bonds. Parts of the middle class have been squeezed; certain business tycoons have prospered. For all the pain of redundancies and cutbacks (think of Barclays a couple of weeks ago) the world’s top banks are as dominant of their sector as before 2008. In capitals such as London, the skyrocketing prices of prime residential properties might suggest rude health – it is also frustrating for those on more modest earnings seeking to buy a home.
Away from such specific concerns, though, is another reason why such a book is being favourably received in certain quarters: hostility to the idea of inequality as such, and hostility to capitalism in a world where politicians have lost the ability to argue coherently for wealth creation. Due to the prevailing climate of opinion, particularly among the so-called chattering classes and academic world, it is taken as a fixed assumption that inequality must be wrong, and that the burden of proof rests on those who defend inequality, not the other way around. This rests on the notion that an economy is like a pie that has – mysteriously – been already created by a group of people who have a presumed claim on equal slices of it, rather than something that grows as the result of people choosing to dispose of their skills/property as they see fit via voluntary exchange. While there can be institutional and political reasons for inequality – such as the QE distortion I mentioned – or favours for this or that interest group (tariffs, subsidies, political favouritism, corruption, bribery, etc) that deserve censure, in certain cases it is hard to resist the conclusion that hatred of inequality can be a rationalisation for envy. Another reason for anger, which is more meritable, is that people are concerned if upward mobility, that great solvent of social conflict, appears to have hit a snag as might be the case today.
There is also more of a need for the wealth management industry to heed, or at least be aware of, the moral case that can be made for free market capitalism, and the importance of free exchange, property rights, entrepreneurial risk-taking and progress. Not enough thinkers have sought to make the moral case that such things are good (with the notable exception in the US of the author and philosopher Ayn Rand, who died in the 1980s but who left a strong intellectual legacy, especially among younger people.) In most cases, the argument for free enterprise is done on utilitarian grounds – that it makes better washing machines than centrally planned systems. While true, it is not very inspiring. And inspiration is important in winning an argument in the long run.
It might seem out of place for the wealth management sector to bother itself with such high-flown philosophical musings, and 99 per cent of the time, I would agree. But this industry cannot afford to ignore the general conversation that goes on in the background, nor can it spend life inside a bubble. Voters are – rightly or wrongly – upset at some of the conspicuous wealth they see and its contrast with poverty. And as we have seen in recent elections, the wealthy make convenient targets. The wealth management industry needs to make a better job at times of defending free enterprise capitalism, the ultimate cause for the industry’s very reason for existence.