Wealth Inequality is Here to Stay But Won’t Lead to Crisis

Unlike most new releases, there is a considerable hype surrounding Thomas Piketty’s, new book Capital in the Twenty-First Century.

Because the empirical evidence doesn’t lend itself to the Marxist’s capitalism being self-limiting prophecy, Piketty’s conclusion is the most likely outcome: growing inequality is permanent. We argue that inequality is optimal to economic growth, or a byproduct of an economy running optimally. Where we disagree is that policy makers should try to reverse inequality or that inequality causes crisis. There are studies such as by Jonathan D. Ostry, Andrew Berg that tries to show how inequality is possibly undesirable, but correlation between more economic growth and more inequality is a weak one. The conclude:

This implies that, rather than a trade-off, the average result across the sample is a win-win situation, in which redistribution has an overall pro-growth effect, counting both negative direct effects and positive effects of the resulting lower inequality

However, a generalization doesn’t necessarily prove that the US economy would be better off with less inequality.

Widening inequality is an inevitable consequence of neoclassical economic assumptions. Every and any advanced economy will have widening inequality over time.

Inequality is the result of the disproportionate amount of economic value the Creative Class bring through their creations. Is it wrong, for example, for Bill Gates or Carlos Slim to have million times the wealth of an average person if their companies and inventions create a million times the value – both directly and indirectly- as an ordinary person?

One explanation that has been proposed for rising inequality is that technical change allows highly talented individuals, or “superstars” to manage or perform on a larger scale, applying their talent to greater pools of resources and reaching larger numbers of people, thus becoming more productive and higher paid.

Kaplan, Steven N., and Joshua Rauh.

Some economists like Thomas Piketty argue that over the long run, rising inequality is unsustainable and will eventually terminate in a financial crisis or societal upheaval. They also ascribe past crisis like the Great Depression or Great Recession to inequality. Crisis can occur for many reasons, mainly due to high interest rates, external shock, overvaluation, over-leverage, and reckless lending standards – none of which are present today. Rising inequality can be concomitant with these factors, but not in and of itself, the cause of crisis. Societal upheaval occurs when the state cannot enforce the rule of law and individuals cannot enforce their property – or simply anarchy. Judging by the growing prison population and the proliferation of the national security complex, that isn’t a concern. The ownership society that Bush spoke about is thriving. Economic indicators don’t portend to a financial crisis either, or at least not for a long time. For policy makers to actively try to reduce inequality would be like trying interfere with evolution.

The part about “patrimonial capitalism,” is dubious

Paul Krugman:

the magnum opus of the French economist Thomas Piketty, will be the most important economics book of the year…. He… makes a powerful case that we’re on the way back to “patrimonial capitalism,” in which the commanding heights of the economy are dominated not just by wealth, but also by inherited wealth, in which birth matters more than effort and talent…. Six of the 10 wealthiest Americans are already heirs rather than self-made entrepreneurs…. America’s nascent oligarchy may not yet be fully formed — but one of our two main political parties already seems committed to defending the oligarchy’s interests….

That’s because the Walton family skew the list. most of the Forbes 500 consist of self-made billionaires. Mathematically, the wealth will still even out. If a billionaire has a kid he will inherit a billion. This can continue indefinitely, but there is still only one billionaire on the roster provided there are no costly divorces or multiple progeny per generation. If parents have multiple kids and divorces, the wealth will be diluted, which is the most likely outcome. Iterated over a couple centuries and there probably won’t be much left.

From Kaplan, Steven N., and Joshua Rauh. 2013. “It’s the Market: The Broad-Based Rise in the Return to Top Talent.”

we find that those in the Forbes 400 are less likely to have inherited their wealth or to have grown up wealthy.