The enormous amount of money spent by governments after the global
financial crisis prevented the Great Recession from turning into the Great
Depression, but so far it has failed to revive global economic growth, which
baffles observers and analysts. Hardly a stone has been left unturned in search
for answers. And yet some dark recesses have not been looked into, or perhaps
they have, but what lurks there is too simplistic for economists to engage with
or too scary to articulate.
In the aftermath of the
global financial crisis (GFC), which started in 2007 and reached its climax in
September 2008 with the demise of the Lehman Brothers global financial service
firm, governments poured large amounts of money in stimulus programs to prevent
the financial industry from collapsing and spreading havoc throughout the world,
destabilising whole economies, causing social unrests and threatening a
break-down of law and order. The United States (US), where the crisis
originated and spread from, led the charge in saving and reanimating the global
economy.
The US administration and the
US central bank, the Fed, clinging to neoclassical economics and free-market
fundamentalism, were determined to ignore Keynes’s prescription and not to follow
in the footsteps of Roosevelt’s New Deal. And yet, despite the strong resolve, ideas
of the great British economist were applied on an unprecedented scale, which resulted
in a caricature of the New Deal. Instead of targeting its stimulus package at
segments of the economy deserving assistance, buckets of money were thrown
indiscriminately to save both illiquid and insolvent financial institutions. The
rescue efforts were also extended beyond finance to struggling non-financial
corporations, investors and consumers. While this prevented a global
catastrophe, it also weakened the US economy – with a flow-on effect on other
economies – by making its financial industry dependent on continuing stimulus
programs and increasing moral hazard.
As articulately explained
by Nouriel Roubini in his “Crisis Economics”, money was borrowed by governments
or created out of thin air by central banks to prop up private capital. This
substantially increased public debt, the magnitude of which approaches
unsustainable levels, threatening some economies with defaulting on their debts.
Inasmuch as the public debt problem is generally considered manageable, the
dilemma of capital being preserved in its already overblown form is not. Too
much wealth does not appear a mortal threat at first look. It is probably too
simplistic as a concept to most economists and abstract to others to consider
it a serious problem. This is probably why it is understated as the underlying
cause of the GFC and overlooked as a main reason for the lacklustre outcomes of
reviving global growth. And yet, when arguments of Mr Roubini and other
economics experts are reinforced by historical perspective, overabundance of
concentrated wealth takes on a more ominous appearance.
Historical data analysis by
Thomas Piketty in his famous “Capital in the Twenty-First Century” leads
to the conclusion that both the worst disasters and greatest social
achievements of the twentieth century were brought about by the collapse of the
European capital amassed prior to World War I. Mr Piketty’s advice to
record, trace and tax wealth with the same earnestness with which income is
being treated – in order to preserve the social gains and prevent calamitous
history repeating itself – is so far unheeded. Applying this simple
idea faces formidable challenges, as all of us are in the race of capital
accumulation, and nobody wants to be left behind in the Darwinian evolutionary
struggle. And yet it is not an outlandish notion for the rich to share a fraction of their fortunes to pay for the privilege of democracy looking after their accumulated wealth, and for the protection of society from public corporations and financial innovation that inevitably lead to crises and misery.
Theory of
evolution teaches that a similar altruistic gesture has been resorted to in the interest of survival in the distant past, of which the ants, bees, termites and mole
rats are examples. This also includes our own species, in whose societal
construction altruism plays an important role. Admittedly, ants and bees did not
decide on a more selfless behaviour of their own volition or accomplished it
in a short period of time. Mother nature must have helped their earlier forms,
for instance by throwing into their midst mutants whose more selfless behaviour
started bringing fruit of the species surviving at times of crises. Perhaps,
analogically, some human mutants with reduced levels of greed and egoism will help
our species to survive too.
For now, however, the
altruistic drive is definitely in decline. By the late 1970s, the determination
to support what had been achieved in the twentieth century – the strong state
with its democratic institutions, progressive taxation, welfare system and the robust
middle class – exhausted itself. By that stage the capital was largely rebuilt
after World War II, upon which it commenced regaining its lost self-accumulation
momentum it had gained by the end of the nineteenth century. Thanks to
diligence of mostly the Japanese, the Germans and then the Chinese, and owing
to the devilish cleverness of Wall Street bankers, this snowball of capital has
increased considerably during the last four decades.
Getting a reliable picture
of absolute global wealth is near impossible, and the next best thing is to
study its representative, available sample, which is what Mr Piketty did in his
remarkable empirical work. He analysed ups and downs of wealth and income in
the wealthy countries, such as the US, Britain, France, Germany, Italy, Japan,
Canada and Australia, historical data from which is readily available. Rather
than measuring absolute values of wealth in these countries, which poses challenges
due to different currencies, their varying purchasing powers and sizes of
economies, Mr Piketty measured wealth as percentage of national income for
these countries.
His study showed that
between 1970 and 2010 private wealth, relative to income, doubled in size,
increasing from 3.5 to 7 times the national income. A closer look at both
components of the ratio dispels doubts about its reliability in measuring
wealth. Between 1970 and 2010, national income per annum grew moderately from
1.9 per cent in Italy to 3.1 per cent in Australia. At the same time private savings
(after depreciation) grew annually more than three times faster, from 7.3 per
cent in Britain to 15 per cent in Italy, reaching 12.2 per cent in Germany and 14.6 per cent in Japan. Thus the increase of wealth is clearly driven by the rise in savings
in the ratio’s numerator, which is directly related to return on capital ploughed
back into wealth (invested) after consumption.
As fortunes became
inherited from the 1970s onwards – without so much effort and merit as when it
was first reconstructed following World War II – an ever smaller fraction of
returns generated by them was used for consumption by the wealthy owners. Increasing
economic efficiency and return maximization, including through using fewer
workers, further reduced the consumption of the wealthy and decreased
consumption of those left without work and cut their taxes, reducing growth and
hurting both the state and society. The increasing majority of the profits made
by these fortunes was reinvested to bring more returns. Wall Street banks
obligingly invented complicated and risky financial products by mixing, dicing
and slicking various types of debts and credits, so that this wealth could be
put to profitable, if futile from the society’s viewpoint, work.
These risky financial
products, after being purchased, became assets owned by investors around the
world. They were considered risky but lucrative investment and their value grew
like a bubble that finally burst between 2007 and 2008. Only a portion of
wealth locked up in these esoteric assets was eroded in the process, and
private fortunes amassed via sovereign, superannuation, hedge, private equity
and other managed funds remained largely unaffected. The fatal blow did not
happen because those who engineered this toxic asset bubble on Wall Street, and
who were responsible for its bursting, received a generous helping hand from
the US government and the Fed in the interest of restoring national and global stability.
This weakened the global financial system through making it dependent on
support and through related to it increase of moral hazard, promising even
greater global crashes in the future.
However, it is not
the increased possibility of future crashes through moral hazard that is
the biggest worry, as this risk may be reduced by adequate regulation. It is
not the current state of economic stagnation associated with post-GFC
uncertainty that is the direst problem – it may pass as people are inspired with
new confidence. Although serious, these problems could be described as
secondary in comparison with the primary dilemma of too much capital seeking
limited profit opportunities. In the post-GFC era wealth cannot be located in old
lucrative CDOs (collateralised debt obligations) or CDSs (credit default swaps)
any more, as investors and regulators learned their lessons. Big money has
become desperate looking for other destinations, in response to which new
tricks are being invented. High frequency trading, as a recent craze on Wall
Street, is one of them, whereby miniscule fractions of a second are taken advantage
of to arbitrage smaller and slower investors out of millions of dollars in
equity shares on stock exchanges.
As private capital has grown
and condensed, public wealth has declined and is now close to nil (meaning public
assets are about equal to public debt), which is due to the state propping up
private capital and getting rid of its assets and responsibilities. Fortune
owners are quite willing to replace the state in looking after the common good
– and own schools, hospitals, public offices, roads and prisons – provided it
brings guaranteed high returns. As
governments keen to address deficits and debts continue to privatize their possessions,
the strong state looking after its own (particularly those less privileged) is being
eroded. And contrary to assurances of the advocates of free market, more
government is needed, not less. In addition to providing monetary policy and
basic social security, its presence is urgently required to regulate the
financial markets to reduce the severity of future crises. More government is needed,
not less, to address growing inequality and create safety net for workforce struggling
in increasingly competitive job market.
Inasmuch as the current
economic stagnation hurts developed and developing economies, it will get worse
when the value of assets held by investors and return on these assets decline. It
has already started and evidence of it can be seen everywhere in the post-GFC
era marked by recession and price deflation, including in Australia which
enjoys the highest growth (2.5 per cent for 2015) among its wealthy peers.
Shops disappear from shopping precincts, offices are getting emptier or closed
down, factories and plants go silent. The continuing craze to banish coal does
not help either, as jobs disappear and whole communities suffer. The outcome is
decline in value of assets and return from them, including rental properties
and family homes, office blocks, shopping centres, factories and mines.
Hardly anybody would feel
sorry for big wealthy investors’ declining asset value, which is anticipated to
continue until stabilization later in this century. However, the current
decline also applies to mums and dads with mortgages on their family homes. It
also applies to their employers who, facing eroding asset value, and with loans
to be paid back, reduce their costs by letting workers go. It also causes
households to be careful with money and focus on paying off their debts while
consuming less, thus further dampening growth. Fewer workers and less
consumption mean less tax too, pushing governments deeper into debt and forcing
them to privatise. All of this feeds the spiral of the declining asset value
and economic slump
A quick glance at
the series of financial crises starting in the 1980s provides evidence of
damage done by capital seeking high returns. As Nourliel Roubini reminds in his
“Crisis Economics”, these cases – including Latin America in the early 1980s,
Asian countries in 1997, Russia in 1998, Ecuador in 1999 and Argentina in 2001
and 2001 – were related to soaring current account deficits due to foreign
capital investing in these countries’ public or private debt. The same capital
seeking greener pastures caused the Dot-com bubble crash in 1999-2001 and GFC
in 2007-2008. The start of this series coincided with the capital of wealthy
countries regaining momentum after the post-World War II reconstruction. Revealingly,
the crisis of 1973 – when wealth in the rich countries was still on a rebound –
was caused by wars in the Middle East and soaring oil prices, and not by
exuberance of capital causing account deficit imbalances.
Capital, meaning assets net
of debt, maintains its value as long as it remains relatively scarce. If there
is too much of it, assets value declines, as does the value of anything that
there is too much of. The reduction of its value due to oversize and the dampening
effect of it on economic growth are real and occur now. The current post-GFC
uncertainty may pass, and there are indeed signs from the US economy that
animal spirits are reviving. However, the oversized pile of private wealth will
keep growing, concentrating, eroding its own value and spreading economic stagnation.
As it ends up in fewer and fewer hands, it reduces jobs, consumption, taxes and
growth. It only increases the risk of future crises, public debt and government’s willingness to abandon society’s
social achievements.
Concentration of capital is
a derivative of its overall accumulation. As illustrated in Thomas Piketty’s
study by data from wealthy countries, wealth concentration has not reached the nineteenth
century levels, and, thanks to the emergence of the middle class, is not likely
to any time soon. But it is moving in that direction. Both capital and income
concentration, measured by proportion of what is earned and owned by top
percentage brackets – for example the top one and ten per cent – increased
between 1970 and 2010. The increase was sharper in the Anglo-Saxon countries,
which perhaps indicates that the beneficial effect of the middle class has been
more eroded there.
Another measure of wealth
concentration is provided by comparing historic rates of return on capital and
growth rates. Mr Piketty’s data shows that at the world level, the rate of
return has always been between 4 and 5 per cent, hovering slightly above 5 per
cent during most of the last three hundred years. Growth, on the other hand,
gradually increased from nil in antiquity to about 1.5 per cent at the
Industrial Revolution, reaching climax of almost 4 per cent before the GFC, and
is now declining. Facts seem to confirm Mr Piketty’s prediction that both the
rate of return and growth will decline in this century. As asset values drop, the
rate of return will go down too, anticipated to stabilize at about 4 per cent
later this century. The decline of growth, however, is not predicted to halt.
This is no surprise considering the relationship between growth and capital
concentration: the more capital is condensed, the smaller becomes consumption
and the less tax is generated due to fewer people at work.
If nothing is done to stop capital
from growing and compressing, there will be no stopping growth from declining
to between 1 and 2 per cent, where it was during the nineteenth century. Increasing
disparity between the rate of return on capital and economic growth, observed
now and expected to accelerate later in the twenty-first century, is an indicator
of where the world is going and what might happen as a result. This development
is set to increase tensions at various levels – economic, social and political
– until the breaking point. Environmental tensions, relevant as they may be, pale
in comparison with the more immediate global challenge.
There is no easy solution
to this structural problem of “too much capital”. Voluntary destruction of
assets, just to rebuild them to generate growth, is too ridiculous to seriously
contemplate. Prohibition of stimulus programs at the next crisis is another
unlikely option. An involuntary destruction of wealth, which would be the
natural consequence of the previous scenario, is yet another idea that comes to
mind. It would involve an even more destructive version of the two worst tragedies
of the twentieth century. While environmental disasters some worry about may
eventuate in hundreds of years, the calamities caused by the morbid growth of
capital will be at our door steps within a few decades, unless something is
done about it.
If capital is left to grow
and concentrate, it will be hard to prevent this last macabre scenario from
being played out, just as it is hard to modify the course of biological evolution. And
yet it has been done for survival in Earth’s history many times. Through a
combination of factors in the distant past, the previous forms of the ants,
bees, termites, mole rats and other societal biological organisms forfeited
part of their selfish ego to create sustainable societies. The strength of
human society depends on the same principle of sacrificing some its selfishness
for the benefit of the whole. We have come to take this necessary compromise for
granted, and the essential altruistic component of society is viewed as an
obstacle in achieving material gratification, and egoism and greed are treated
as high virtues.
Parting with some of the
attachment to accumulating wealth, through more scrupulous accounting for it
and taxing it, might be one of the evolutionary adjustments necessary to
avert the disaster. Addressing only symptoms of the problem of capital growth
and concentration – weakening middle class, inequality and growing public debt
with the risk of future crises – in separation from their underlying cause,
will only bring temporary relief without curing the sickness. Taxing wealth is not an unreasonable and crazy idea, considering that the state needs resources to guarantee inviolability of the accumulated fortunes and to protect the public from the risks involved in public corporations and financial innovation.
© Robert Panasiewicz, 2016
Essential further reading
and main sources for this essay:
Piketty, T 2014, Capital in the Twenty-First Century, The
Belknap Press of Harvard University Press, London (Translated from the original
2013 French edition by Arthur Goldhammer)
Roubini, N 2011, Crisis Economics,
Penguin Group, New York