‘Once constituted, capital reproduces itself faster than output increases. The past devours the future.’ Thomas Piketty, Capital in the Twenty-First Century. Released in 2013/14, this almost instant global blockbuster triggered a wave of soul-searching among social scientists. Had we somehow missed how our economic system had become unhinged?
Growing debt as a source of financial inequality
The economic argument for debt rests on productivity growth: borrowing from the future can work if it helps to increase future output and therefore enhances cross-generational wealth. In the last half-century however, it is largely residential borrowing which ballooned under the influence of deregulation and financial innovation. Vertical integration of mortgage lending, in which banks packaged up loans and sold them on rather than building long-term relationships, allowed them to offload risk onto third parties, distorting their incentives when issuing the loans.
While the greater availability of debt reduced inequality with more people owning property, over the longer term it reduced credit standards to the point of triggering the 2007-08 financial meltdown. To prevent the downward spiral turning into a depression, authorities stepped in with even more extensive borrowing, and global debt has continued to reach new highs. The winners of this more recent credit boom were those who could borrow the most and invest in real estate or financial markets; with little of central banks’ funds ending up in the real economy.
Data as of Q3 for each year. Source: Business Insider UK, based on IIF, BIS, IMF and Haver data, January 2018.
‘Propelled in part by the rising share of financial assets’, the growing gap between rich and poor, as measured by Credit Suisse’s flagship Global Wealth Report, has now reached a point where the world’s richest 1 per cent now own fully half the world’s household wealth. That’s up from 42.5 per cent at the height of the 2008 crisis. The young are clearly the ones losing the most, trailing their parents when it comes to home ownership, income and other wealth criteria, despite being better educated.
Assessing investment risk
When wealth increases are too concentrated, falling real incomes for the masses reduces their purchasing power, limiting companies’ pricing power while creating a safe space for populist movements as free market politics may no longer be seen as promoting democracy. What’s more, a system that creates high inequality through asset price inflation without fostering productivity growth may house a growing systemic financial risk, much in the way that a highly leveraged company can be brought down when the environment toughens.
Growth helps, and cycles aren’t dead
Inequality may yet rise a little further until asset prices run into obstacles, but the number and proportion of the global population that is lifted out of poverty continues to rise.
Percentage of people living on less than 1.25 US$ a day. Source: UN Millennium Development Goals Report 2015.
As a percentage of GDP, global debt is no longer rising now that economic growth has picked up substantially, showing that it is possible that current trends are to a large extent cyclical rather than structural. Another example is that companies are investing widely again in their own productive capital for the first time in years. It is early days yet to see any impact on productivity, but it is probable that improvements in machinery, technology and other assets will boost companies’ efficiency.
Applying the right tools
In the third wave of automation that we are currently experiencing, not only blue-collar workers but also white-collar ones will see their working lives changed beyond recognition, and this will act as a leveller in wealth terms. For example, artificial intelligence need not replace human workers altogether but could enhance their output, leading to shifts in economic rents: roles which require a high level of human physical and interpersonal skill seem particularly well-placed.
Companies are waking up to a reality in which customers can vote quickly with their feet, while regulators turn up the heat and investors force through changes. Enhancing shareholder returns at the cost of labour may well become more difficult. Companies that stop investing in their population through education, infrastructure, or health, for example, are hollowing out their workforce, which takes a toll not just on workers directly but also affects consumption. Companies, therefore, need to re-educate themselves on their role in the wider ecosystem, which is not sustainable if the fruits are not shared acceptably.
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