We were fortunate to get Harvard Professor Daniel Carpenter to write an important piece on wealth inequality in the new issue of the Washington Monthly. Despite the headline, What Piketty Missed: The Banks, the article should be seen more as a complement to the French economist’s work than a refutation.
Carpenter’s central insight is that financial regulation, if it is done correctly, can be a very important and effective component in reducing the difference between the rate of return on capital (r) and the rate of economic growth (g). Piketty argued that as long as r is greater than g, wealth disparities will grow over time, and the degree of difference determines how fast inequality will expand.
In the piece, Carpenter focuses on three main regulatory efforts that he believes would be useful in bringing r and g closer together: Glass-Steagall, regulation of stock buybacks, and core capital requirements.
All of these policies target organizations and institutions of capital—banks, investment firms, and, in many cases, regulatory agencies themselves. This approach differs from Piketty’s methodological individualism because the targets of policy are less individuals—or not exclusively individuals—and more organizations and institutions. And following Daniel Seligman’s classic Public Interest article in 1970 on the transformation of Wall Street to a world of more organizational investors, it is organizations and not just individual investors that need to be regulated in the world of finance.
Piketty’s call for a tax on global assets is more focused on clawing back wealth from individuals, but Carpenter is looking for structural reforms that can encourage organizations to behave differently and to use their capital in a way that is more beneficial to society.
Seven years ago, Mitt Romney was arguing that wealth inequality was a divisive issue that should only be discussed in “quiet rooms,” but lately we’ve seen Republicans show more interest in discussing the subject in the public square. If you want to be part of that conversation, you should definitely check out Professor Carpenter’s piece.
Krugman recently observed that it’s not capital that’s getting all the money, it’s corporations and their owners and managers. Interest rates are very low and real interest rates are actually negative in many countries, so you don’t make much by having capital per se. The real money is going to power – monopoly power (cable companies), monopsony power (Walmart), patent power (drug companies), information power (Google), and political power (Blackwater and Halliburton).
This also means the solutions are necessarily political. Tweaking tax rates won’t fix the problem.
In fact, it’s going to take political power in order to change the tax rates and the tax code.
And it’s going to take political power to put some social requirements on corporations in exchange for their many privileges.
What is happening is those granted the privilege of allocating labor costs are allocating more of those costs to their own salaries and benefits. That is clear indication that (1) the social relationships that allocate labor are not anywhere near being a market; (2) the process by which those costs are allocated is controllable by the party with asymmetric power.
But real estate is still capital too, right? What Piketty thinks, if I’m not mistaken, is that the very wealthy are sucking up rent from all these transactions between corporations and buying land to constitute themselves as a landed aristocracy.
Picketty has ID’d an increase in inequality but there’s still argument (amongst the sane, not counting the right-wing kooks) about the cause. After some thought, I’m leaning hard to the idea that what we’re seeing is companies exploiting flaws in the “free market”. As evidence, besides the fact that capital alone is not getting huge returns right now, income inequality is leading wealth inequality.
My favorite example of how market distortions are a source of wealth is Walmart. Walmart’s vaunted “efficiency” has been, for several decades, based on using their enormous bargaining power to squeeze better deals from their suppliers. (Their distributional efficiencies have been pretty much copied for a while.) This is monopoly power (monopsony to be technical); it doesn’t reflect just having more capital.
Their monopoly power is so extreme it’s caused two major shifts in American manufacturing. First there’s been a shift to low-cost sources like foreign production and entry-wage workers. Now that that’s not enough to meet Walmsrt’s incessant demand to cut prices, and manufacturers are starting to make specialized crap product to be sold at Walmart.
Tarheel points out another source, which is that the CEOs of all the various companies sit on each other’s corporate boards and vote each other soaring compensation. It’s kind of a conspiracy to embezzle that encompasses most publicly traded companies.
Wealth inequality is back at levels not since since the 1920s. What changed to cause wealth inequality to subside?
Of course it was dramatic increases in tax rates on the wealthy. Very high top marginal income tax rates (91% in the US until 1961 – over 90% in most other first world countries), plus various luxury and property taxes in different parts of the world. Although loopholes were available rich people couldn’t just reclassify all or almost all of their income to lower or zero tax rates like they can today. In effect, there was a maximum wage in place everywhere.
This had some interesting side effects. What do you do if you are the President of a company (“CEO” is a relatively recent term) and already earning the maximum wage? Well, instead of spending a lot of time working on ways to funnel legally large chunks of the company bank account to your own, as they do today, you either: 1) focus your energy on something else, possibly productive stuff like how to make your company more successful or charity work, or 2) focus on illegal embezzlement to get yourself richer. Now, some of (2) happened, but because EVERYONE ELSE at the country club was saddled with the same maximum wage, most of them competed in other ways to gain status, and often society benefited.
I can’t see any way to get back to the relative wage equality of the 40s and 50s without going back to those kinds of tax policies.
Moving to the political front, Ramesh Ponnuru tells us that voters don’t care about income inequality.
http://www.nytimes.com/2015/02/09/opinion/lets-not-mention-inequality.html
Or maybe they would care, but they don’t realize how extreme it is.
http://www.nytimes.com/2014/07/25/upshot/why-voters-arent-angrier-about-economic-inequality.html?abt
=0002&abg=1
http://www.salon.com/2014/10/05/why_voters_dont_care_more_about_income_inequality_partner/
But Mark Shields thinks income inequality could be “sleeper issue” of 2016.
Oops, I forgot the last link.
http://stablevalue.org/news/article/shields-says-income-inequality
I’ve long thought that this line of argument gets it backwards. Banks get run as casinos because that makes banksters obscenely rich. Claw back most of the ill-gotten gains via the tax code and it becomes a pointless exercise. If progressives ever attain enough power to seriously reform both the tax code and financial regulation, they should start with the tax code.
In simple terms of rates the growth of the economy (g) is money that changes hands while the return on capital (r) is money that leaves the economy for the pockets of the rich where it stays. Money that changes hands buys the things needed for life and becomes amplified. The money that stays in the economy is the fuel that makes the thing work for all but the rich. If r is more than g inequality grows. If g is more than r a middle class is formed. The question is how get g to be more than r so people other than the rich can get the things needed for life.
The tax rate you pay never limits the amount of money you can make, just the amount of money you can keep. With the top tax rates significantly high the game becomes how to get out of those top tax brackets. The idea is to dump the excess money into something where you avoid giving the money to the government but keep the value from the money you dumped. You could invest in plants and equipment avoiding the tax while making your company more valuable. A favorite of mine is to invest in research and development where you may make more money from innovation plus give me and my children a job that pays well. We must tax speculation so it costs more to play with more risk to lose. Spend that money on education and infrastructure to support the newly growing economy.
This is what a fighting chance is all about, getting the g above the r. It will take an on fire progressive political movement to make this happen.
Not quite right. The wealthy buy lots of luxury goods that does trickle down to employment for some. Those private jets and mansions aren’t built by the sweat of the 1%. And owning that stuff does require maintenance workers.
OTOH, there is the luxury sub-economy where they buy and sell used mansions, art, and jewels among themselves. Although that too employes a few people handling the sales.
You can’t really compare trickle down employment of the luxury economy with the destruction of the middle class due to growing inequality. Those luxury maintenance jobs are currently in the economy and inequality is already at a crisis level. The idea is to encourage individuals and organizations to use their capital in a way that is more beneficial to society. Making that change can only be forced by regulation and tax policy, things like make it expensive to ship jobs overseas and to participate in the Wall Street casino speculation. Currently we have rules that encourage or even require bad allocation of capital. This must change if we in the middle are to survive. Do the right thing or lose the money to a high tax bracket.
The system has been rigged to create our current state of inequality. We have to rig it back if we are ever to have any hope of a fighting chance. Understanding how to get that fighting chance is a result of work of people like Piketty, Carpenter and others. It will take a progressive movement and maybe another financial shock to get these changes. We must be ready with answers.
Didn’t disagree with your prior comment (tipped it). Was only pointing out that in the short run, the wealthy don’t hoard all their cash. And they do employ some workers (who tend to become very loyal to their employer). Their spending is neither productive nor beneficial to an economy as a whole. Many of their mansions become money pits that are later razed or deeded to governments to keep from falling down. (San Simeon is interesting, but a financial drain on the state of California.)
At this point Apple, Inc. is sitting on gobs of capital in the form of cash that isn’t necessary for their operations. It’s been shunted into a hedge fund because that avoids the taxation that would result from repatriating the cash. Makes a mockery of why corporate charters were extended and why corporate taxation is valuable for an economy and society.
Thank you for your nice post. Apple is a great example. You can’t find a more American company than Apple. Why is Apple allowed to ship their manufacturing jobs overseas, still having free ride access to our economy, get their money to a foreign hedge fund because that’s cheaper than paying American taxes. This is why I said the system is rigged to all but guarantee bad capital allocation. Find a way to make it cheaper for them to pay the taxes or better yet allocate their money to productive investment that lowers their r and raises our g.
Apple’s hedge fund operation is located in Reno, NV.
A couple of thoughts. Economies don’t work well when corporations hold excess capital or are under-capitalized. Same is true for individuals. The latter is more common than the former and more problematical, but the former does feed off the latter. When we had regulated capital requirements for banks and investment companies, they worked better. It worked better when Detroit was in the vehicle manufacturing business and not the vehicle financing business. Conglomerates are too difficult to regulate properly. There might be efficiencies gained by conglomerates that raise r, but also increase the risk of a large failure and their monopolistic and corrupt (criminal) activities. Look at what happened to ITT.
Noticed yesterday that the recent (2009-2014) AIG CEO, BenMosche, died. He was a libertarian that he and not the USG rescued AIG because the loans were repaid. Bollocks. AIG was bankrupt. Core insurance operations were viable in 2008 only if capital and cash flow was adequate. They weren’t. Those USG loans/investments allowed AIG not to liquidate assets at the 2008-09 valuations but several years later when the values were restored and continue earning operating profits for six years. AIG’s technical bankruptcy was the result of straying from its normal business — into credit default swaps and purchasing high risk mortgage CDOs with treasury funds. {The suit by the long-term prior CEO Greenberg correctly notes that AIG got a raw deal from the USG for its stupid actions because it was was required to make the banksters whole on those deals. OTOH, insurance companies, particularly AIG, have long been known to not to make their customers whole when they suffer a loss. So, they got some of their own medicine.)