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Good Times for Capital

This is a syndicated repost courtesy of The Baseline Scenario. To view original, click here. Reposted with permission.

Last week, the Wall Street Journal highlighted a Federal Reserve report on total household net worth. Surprise! Americans are richer than ever before, both in nominal and real terms.

At the same time, though, wealth inequality is increasing from its already Gilded Era levels.

The main factor behind increasing household net worth over the past year was the rising stock market (followed far behind by rising housing prices). These obviously only help you if you own stocks—not if, say, you never had enough money to buy stocks, or you had to cash out your 401(k) in 2009 because you were laid off. Put another way, rising asset values help you if you are a supplier of capital more than a supplier of labor.

Is there anything we can do about this? The conventional wisdom from the political center all the way out to the right fringe is that we shouldn’t tinker too much with the wealth distribution—otherwise people won’t work as hard, which is bad for everyone. But perhaps it isn’t true.

In a new paper (Vox summary; hat tip Mark Thoma), three IMF economists look at the relationship between redistribution—measured by differences between the pre-tax-and-transfer income distribution and the post-tax-and-transfer income distribution—and overall economic growth over five-year periods, across countries and across time. They find (from the summary) “remarkably little evidence in the historical data used in our paper of adverse effects of fiscal redistribution on growth.” In general, that is, average levels of redistribution tend to be associated with higher levels of growth that are sustained for longer.

Why would this be? One reason is that inequality, in and of itself, seems to be associated with lower levels of growth. So if you redistribute income in order to reduce inequality, even if it is true that this hurts incentives to work hard, the reduced inequality has a countervailing (and, in most cases, stronger) effect.

Indeed, there’s a strong argument to be made that a capitalist society needs systematic redistribution to survive. Thomas Piketty’s new book—which I plan to read the next time I have time to read a 700-page economics book—free markets generally produce higher returns on capital than on labor, which means, to a first approximation, that people with capital will get richer faster than people with only labor. In a world where the political system is open to money, this means that the capitalists will also accumulate a disproportionate share of political power, leading to the type of extractive society described by Acemoglu and Robinson in Why Nations Fail. Which is not a world that most of us would want to live in.

Wall Street Examiner Disclosure: Lee Adler, The Wall Street Examiner reposts third party content with the permission of the publisher. The opinions expressed in these reposts are not those of the Wall Street Examiner or Lee Adler, unless authored by me, under my byline. I curate posts here on the basis of whether they represent an interesting and logical point of view, that may or may not agree with my own views. Some of the content includes the original publisher's promotional messages. No endorsement of such content is either expressed or implied by posting the content. All items published here are matters of information and opinion, and are neither intended as, nor should you construe it as, individual investment advice. Do your own due diligence when considering the offerings of information providers, or considering any investment.

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