Apologies, today I’m wandering off-topic and thinking through a subject that attracts a lot of attention, increasingly by the ESG brigade. Inequality. I have a pet theory that inequality is an obsession of left-wing, highly educated middle-class folk, especially in public sector roles and even more specifically in academia. We are constantly told that we are at peak inequality and in a crisis.

I don’t buy it.

My hunch is that when economists start getting angry about inequality, they are expressing a form of moral economy, prioritizing statements about what SHOULD be as opposed to what is. More to the point I think they are confusing some more practical concerns with outrage about say the Gini coefficient. These more practical concerns range widely and include some of the following:

  • A very valid concern about the squeezed middle classes, struggling with lower than expected wage growth and higher than expected cost inflation.
  • An equally valid concern that the super-rich are not paying their fair share in taxation.
  • A howl of rage against the abandonment of the social-democratic consensus post-war in favour of a supposedly ‘neo-liberal economic order. That social democratic settlement is indeed dead but I have my real doubts about the existence of the neoliberal order
  • An equally valid concern that excessive inequality might generate corporate cronyism and insipid corporate oligopolies that hurt our economies. There’s more debate about this argument – more in that shortly
  • What I call the Kulak argument. Localized anger that people you know or know of, are making much more money than you, are doing better on the housing ladder or getting their kids into better schools. This is impossible to address meaningfully in a policy sense except through pragmatic public policy changes or full-scale communism (thus eliminating the kulaks)
  • Billionaires making huge amounts of money and then wasting that good fortune on spurious stuff and not being public-minded and ‘giving back’
  • Equality of opportunity is felt to be in crisis although income and wealth inequality, as opposed to inequality of opportunity, are two very different challenges
  • Inter-generational inequalities
  • Last but by no means least many are concerned by the rise of poverty, both absolute and relative, with a particular focus on children.

I’d be willing to wager that when we talk to most ordinary people they are not in reality that concerned about tech billionaires or the rise of the Gini coefficient. In fact, I would go so far as to say that the ONLY people I have encountered who are that vexed by inequality of income and wealth in the systematic sense work in the public sector or are academics.

Absolutely everyone else I know is vexed by a few of the topics I mentioned above. For my part, I am extremely concerned by inequality of opportunity and the shocking challenges presented by childhood poverty and dysfunctional families. These for me are real first order, ‘get sorted’ issues.

As for the wider problems to do with excessive inequality, they register as an issue, varying in importance but frankly, I am not bothered tech entrepreneurs make billions or footballers make tens of millions – as long as they pay their taxes, and do their best to ‘give back’ to society.

As an aside, on a philosophical level, I think that some or even a fair bot of inequality is fine and a natural outcome of the capitalist process. I’m also with the moral philosopher Harry Frankfurt in his book On Inequality in suggesting that worrying about inequalities in outcome are a giant exercise in intellectual pointlessness.

As an outline summary of his book argues, rightly in my view, “Our focus should be on making sure everyone has a sufficient amount to live a decent life. To focus instead on inequality is distracting and alienating. At the same time, Frankfurt argues that the conjunction of vast wealth and poverty is offensive. If we dedicate ourselves to making sure everyone has enough, we may reduce inequality as a side effect. But it’s essential to see that the ultimate goal of justice is to end poverty, not inequality.”

More to the point I’ve also long suspected that there may not in fact be a crisis in systemic income and wealth inequality. Sure, it varies and, in some decades, it’s worse than in others, but overall I don’t sense we are in some of inequality dystopia imagined by feverish science fiction writers, where the wealthy live on a completely different planet! Unfortunately, in the age of Piketty – a socialist – it’s been hard to argue with the evidence, especially when presented in long very detailed books, replete with tables and statistical analysis.

But even on this front the façade is beginning to crack. I’ve long been worried that his ideas about constantly increasing returns to capital sound incredibly simplistic and overly mechanistic. Also, I’m not entirely convinced that once we exclude property wealth – which I concede can mechanistically increase year on year – we might find that inequality has simply varied over different decades with no predictable pattern.

My last concern is that how you measure inequality is also hugely dependent on varying welfare states and tax regimes – making a blanket assertion of rising system-wide, global inequality more problematic. The conservative economist John Cochrane has just put out a detailed blog looking at inequality that is well worth reading. You can see the blog here: https://johnhcochrane.blogspot.com/2021/04/inequality-mirage.html

I recommend reading it in great detail, and Cochrane’s own commentary is built on research by David Splinter and Gerald Auten. The key chart is the one below : it looks at income inequality in particular.

Cochrane’s summary is as follows: “In their careful redoing of the numbers, the top 1% share of income has barely budged since the 1970s. (And, by the way, if you think the mid 1970s economy was the great happy prosperity we should try to reestablish, you’re too young to remember the 1970s.)…… Piketty/Saez leave out many kinds of income. Auten Splinter attribute all national income to somebody.  Before 1986 many wealthy people were incorporated.  Leaving out corporate income biases the early shares down. Auten Splinter fix that. Pre-tax and transfer income! Who cares about pre-tax income! Auten Splinter calculate income after taxes at the top — lower — and including transfers at the bottom — higher. Demographics. Marriage rates have fallen, so Auten Splinter calculate income by individuals. Benefits! They include benefits like employer-provided health insurance.

In terms of wealth, I think the jury is probably out on property wealth though leaning towards more inequality but when it comes to business generated wealth, I think the evidence is that there may be more inequality but that that is a result of a more entrepreneurial culture, and not an embedded blue blood class system ossifying wealth.

The investor Paul Graham has a very interesting take on this – you can see it here http://paulgraham.com/richnow.html. I’ve quoted this at length:

Every year since 1982, Forbes magazine has published a list of the richest Americans. If we compare the 100 richest people in 1982 to the 100 richest in 2020, we notice some big differences. In 1982 the most common source of wealth was inheritance. Of the 100 richest people, 60 inherited from an ancestor. There were 10 du Pont heirs alone. By 2020 the number of heirs had been cut in half, accounting for only 27 of the biggest 100 fortunes. Why would the percentage of heirs decrease? Not because inheritance taxes increased. In fact, they decreased significantly during this period. The reason the percentage of heirs has decreased is not that fewer people are inheriting great fortunes, but that more people are making them. How are people making these new fortunes? Roughly 3/4 by starting companies and 1/4 by investing. Of the 73 new fortunes in 2020, 56 derive from founders’ or early employees’ equity (52 founders, 2 early employees, and 2 wives of founders), and 17 from managing investment funds. There were no fund managers among the 100 richest Americans in 1982. Hedge funds and private equity firms existed in 1982, but none of their founders were rich enough yet to make it into the top 100. Two things changed: fund managers discovered new ways to generate high returns, and more investors were willing to trust them with their money. [1] But the main source of new fortunes now is starting companies, and when you look at the data, you see big changes there too. People get richer from starting companies now than they did in 1982, because the companies do different things. In 1982, there were two dominant sources of new wealth: oil and real estate. Of the 40 new fortunes in 1982, at least 24 were due primarily to oil or real estate. Now only a small number are: of the 73 new fortunes in 2020, 4 were due to real estate and only 2 to oil. By 2020 the biggest source of new wealth was what are sometimes called “tech” companies. Of the 73 new fortunes, about 30 derive from such companies. These are particularly common among the richest of the rich: 8 of the top 10 fortunes in 2020 were new fortunes of this type.

I agree with Cochrane when he argues that “We should not think about more or less inequality, we should think about the right amount of inequality, or productive vs. rent-seeking sources of inequality. Or, better, whether inequality is a symptom of health or sickness in the economy.”

As a postscript, I would also cite the excellent economist Dietrich Vollrath in his brilliant book Fully Grown, where he examines whether ‘rising inequality’ has impacted the slow down in productivity across the developed world. In his final chapter – the future of growth – he tabulates the likely numerical impact of key trends on slowing growth and ascribes exactly zero percent to the increase n inequality.  It may or may not be a problem, but he thinks it has had very little to do with slowing growth.

Last but no means least I would make one last plea: if fund managers do start talking about inequality as the main fund objective, I think there’s a real challenge here. Unless its objectives are defined clearly and not based on moral economy, I think there is a real risk of mission failure!