Friday, September 19, 2014

Rich Nations: Private Wealth, Public Poverty

Traditionally, when a nation was in need of additional funds it had the option of either increasing taxes or borrowing the money.  Since those who possessed enough money to make the necessary contributions also possessed enough influence to shield themselves from onerous taxes, the only viable taxation option was to take the money from those who had little if any.  This was not very efficient and often led to public unrest.  A more efficient method of extracting money from the non-wealthy was to practice “austerity”—by which money was taken from the non-wealthy in the form of services no longer rendered.  Consequently, the general approach to deficit financing was to borrow money from the wealthy and limit services provided to the poor in order to pay the wealthy back.

Ownership of government bonds was a lucrative investment and provided a large and secure income for many wealthy European families in the era leading up to World War I.  The two wars and the Great Depression caused a great deal of economic havoc and private wealth fell during that period.  In recent decades, in spite of the changes in the nature of wealth, private wealth has been growing more or less steadily and seems headed back to prewar values.

Data on the evolution of wealth is one of Thomas Pinketty’s major contributions in Capital in the Twenty-First Century.  He provides this history of private wealth versus government wealth for Europe as a whole and for the United States.

Note that in Piketty’s terminology, capital is anything that can be bought or sold, including real property and financial instruments, and is therefore equivalent to wealth.  He chooses to express values as a percentage of national income, a quantity that is closely related to GDP, but not exactly equivalent.  Around 1970, private wealth began to increase steadily in both the United States and Europe.  The recent financial disaster put a dent in United States wealth, but by 2010 it had leveled off and begun to rise again.  Growth of private wealth in Europe continued throughout that same period.

Public wealth consists of government assets minus government debts.  Piketty’s data indicate that most nations have public assets about equivalent to national income.  As public debt has risen in all rich countries, the net public wealth has approached zero.

Piketty provides this assessment of the situation:

“….with public debt in the rich countries now averaging about one year of national income (or 90 percent of GDP), the developed world is currently indebted at a level not seen since 1945.  Although the emerging economies are poorer than the rich ones in both income and capital, their public debt is much lower (around 30 percent of GDP on average).  This shows that the question of public debt is a question of the distribution of wealth, between public and private actors in particular, and not a question of absolute wealth.  The rich world is rich, but the governments of the rich world are poor.  Europe is the most extreme case: it has both the highest level of private wealth in the world and the greatest difficulty in resolving its public debt crisis—a strange paradox.”

Piketty provides the following chart to support the notion that rich countries are getting richer in terms of private wealth.

This legend was provided for the chart:

“Private capital is worth between 2 and 3.5 years of national income in rich countries in 1970, and between 4 and 7 years of national income in 2010.”

It is interesting to note that Italy has the greatest private wealth of all even though it is considered one of the weakest economies in Europe.

“When we look at all the available data today, what is most striking is that national wealth in Europe has never been so high.  To be sure, net public wealth is virtually zero, but net private wealth is so high that the sum of the two is as great as it has been in a century.  Hence the idea that we are about to bequeath a shameful burden of debt to our children and grandchildren and that we ought to wear sackcloth and ashes and beg for forgiveness makes no sense.”

National debt has accumulated as a result of a persistent failure by those who have been accumulating wealth to pay their share of government expenses.  Piketty’s preferred solution, if debt must be retired, is a tax on wealth (in Europe, national debt is about 15 percent of private wealth).  A modest progressive tax on wealth that would only slow its accumulation a bit would quickly bring down debt levels.

His second best option is to encourage a bit of inflation.  Historically, this has been a very effective way to manage public debt, but it is not without negative consequences.

The least efficient and least just approach is the one that nations have actually been taking: austerity.  Austerity tends to protect the wealthy, damage the economy, and weigh most heavily on those with little or no wealth.

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