Wealth concentration, also known as wealth condensation, is a process by which, in some conditions, newly created wealth tends to become concentrated in the possession of already-wealthy individuals or entities, a form of preferential attachment. Those who already hold wealth have the means to invest in new sources and structure, thus creating more wealth, or to otherwise leverage the accumulation of wealth, thus are the beneficiaries of the new wealth.
The first condition is an unequal distribution in the first place. Without this there is nothing for the new wealth to 'condense' upward. J. P. Bouchaud & M. Mezard argue that:
It is a well known fact that the individual wealth is not broadly distributed quantity among the population. Even in developed countries, it is common that 90% of the total wealth is owned by only 5% of the population.
They say that the distribution of wealth throughout the population is closely described by a Pareto-tails function, which decay as a power-law in wealth. (See also: Distribution of wealth and Economic inequality).
The second condition is that a small initial inequality must, over time, widen into a larger inequality. This is an example of positive feedback in an economic system. A team from Jagiellonian University produced statistical model economies showing that wealth condensation can occur whether or not total wealth is growing (if it is not, this implies that the poor could become poorer).
Correlation between being rich and earning more
Given an initial condition in which wealth is unevenly distributed, several non-exclusive economic mechanisms for wealth condensation have been proposed:
- A correlation between being rich and being given high paid employment (oligarchy).
- A marginal propensity to consume low enough that high incomes are correlated with people who have already made themselves rich (meritocracy).
- The ability of the rich to influence government disproportionately to their favor thereby increasing their wealth (plutocracy).
In the first case, being wealthy gives one the opportunity to earn more through high paid employment (e.g., by going to elite schools). In the second case, having high paid employment gives one the opportunity to become rich (by saving your money).
In a capitalist society, with a marginal propensity to consume below one, these are 'automatic' causes of wealth condensation due to variable incomes. The following points relate to the concentration of wealth (capital) itself, even in the absence of variable wages.
In the case of plutocracy, the wealthy exert power over the legislative process, which enables them to increase the wealth disparity.
Because they are non-exclusive, it is possible for all three explanations to work together for a compounding effect, increasing wealth concentration even further.
Positive net real rate of return to capital
This condition would bring wealth condensation around more quickly than the two possibilities above (because there is so much net worth in the world). The general rate of return to capital investment is sometimes called the rental rate by economists, but here we consider the actual private income received, after taxation.
Very roughly, the
- net real rate of return = (nominal risk-free interest rate - Inflation) - (unearned income tax, dividend tax, and other capital-gains taxes).
If this rate is positive then owners of capital (George Orwell's "dividend-drawing class") will get richer if they neither produce or consume but simply "leave their money in the bank." It is under this condition (positive net return to capital) that widespread wealth condensation is most likely. (Wealth condensation would be inevitable in the long run in this case, unless the unearned income were consumed more rapidly than it was accumulated.)
Even if the rate of net return to capital is not positive on average, wealth condensation will also occur if the largest owners on average receive a higher return than smaller owners; this would constitute wealth condensation within the capitalist class rather than at the expense of the non-capitalist class.
Examples of Negative real returns:
- These were a long term Japanese phenomenon, despite and because of their high rates of private saving before deflation.
- Many countries in the 1970s experienced stagflation and surprise inflation which meant that the purchasing power of savings was substantially reduced even with the interest income, (which implies a negative real rate of return to capital).
- Since capital gains taxes apply on nominal earnings the net amount of wealth can decline even when the risk-free yield is above inflation. This is why inflation is sometimes said to be a "Wealth Tax", which prevents wealth condensation. Furthermore, the tax bands are not typically inflation-adjusted, so a higher share of nominal income must be paid in tax each year even as real incomes remain flat.
Hypothetically, leaving a small amount on deposit and then sleeping for several hundred years will lead to great wealth through the action of compound interest. However, historical real rates of return show that the effects of taxation and inflation would likely leave you worse off than when you started (with the money on risk-free deposit).
A common econometric phenomenon throughout developed nations since the beginning of the 1990s (and earlier) is that assets (such as housing, stocks, and bonds) are inflating faster than the consumer price index or the commodity price index.
For instance, the money price level of bread and milk has risen by 1-5% annually in most G7 countries since the mid-1980s, but real estate prices in those same countries have inflated at least twice as fast in money terms. At the same time, business assets are becoming more expensive (as measured through decaying PE ratios in the same time frame).
Marx promoted several explanations of the cause of wealth concentration. Some of the causes may include:
- Cost of living is typically the same for everyone. In a free market economy, factors contributing to the cost of living will adjust so that poorest members of the society are forced to spend all their income on bare necessities (food, housing, medicine), whereas richer members will have enough excess income that they can save and invest. Thus, in a free-market capitalist economy, both savings and the investment income (Marxian surplus value) are disproportionally accumulated in hands of wealthiest individuals.
- The process by which corporate officers are paid large salaries and bonuses: for example, average CEO pay is estimated to be between 200 and 300 times the pay of an average worker as of 2005. Critics of the corporate system have often charged that there is a substantial disconnect between a) officer performance and compensation, and b) officer compensation and worker compensation, and that officers are compensated at levels disproportionate to either performance or payroll because they are already part of the elite, and that this is a self-perpetuating methodology to maintain an elite class (see neofeudalism).
- If the economy of any country is organized in the interests of the super-rich, or is a plutocracy in which only the wealthy can hold government office, it should be expected that wealth condensation will follow. Critics contend a modern example of this is the current executive of the U.S. In the view of critics like Paul Krugman the tax policies of the Bush administration vastly favored the wealthy over the poor and the middle class. The argument underlying this was that progressive tax systems were being scrapped in favor of regressive tax systems, driving wealth condensation (by allowing the wealthy to retain more of their wealth as disposable and investable income.)
Marx believed that wealth concentration is common throughout democratic countries with free market economies, which is exemplified the old phrase "The rich get richer and the poor get poorer". (Although most would concede that the extent to which this is true varies from regime to regime, particularly in regard to "unearned income tax" policies.) For instance, the "law of the centralization of capital" was posited by Marx as applying to all capitalist societies.
Generally, supporters defending wealth concentration also support capitalism. They argue that, the principal assumption that wealth is neither created nor destroyed but rather shifted, is wrong. Wealth is not a zero sum game and thus wealth collected by the wealthy might not be distributable to the poor anyhow. They argue that over the course of human history, total global wealth has grown over the last several centuries, and therefore, investors may reap large economic benefits, and the side effect of investment is the creation of new jobs and industries that increase the overall standard of living for anyone participating in the market. Opponents argue that an increase in economic and social inequality, results in a reduction in the standard of living. In response, neoclassical economics dictates that if a business decreases the standard of living for people participating in the market, participants will exit the market until the business cannot function (that is, bad businesses go bankrupt). Even though there is a priority of whose standard of living is most worth increasing, they will all be increased overall, since none are actually "decreased." For defenses of economic inequality, see the article for Equality of outcome.
Proponents of neoclassical economics argue that this "leveraging of wealth" can be explained either by the legitimate creation of wealth by its owners or by specific instances of malfeasance. Therefore, by this line of argument, the results do not constitute a "process" or "effect", and to describe it as such could even be misleading because it would conflate two distinct sorts of behavior: one legitimate and positive, the other dishonest and harmful.
Rising tide argument
An argument in support of capitalism and the wealth disparity it creates is that even if the gap between rich and poor widens, the poor themselves are actually better off than they would have been in the more equal state using anything other than capitalism. This view is expressed in the saying, a rising tide lifts all boats.
Supporters of capitalism point out that wealth condensation theory applies less strongly to democratic countries. They argue that the United States is a counter-example of the theory, on the grounds that its middle class is materially the most prosperous in recorded human history, with America's poor being as economically well off as the middle class of other, less industrialized countries.
If returns to scale are positive, or if 'superstars' can earn vastly more than the average, some[who?] argue that it is natural and efficient to reward some vastly more than others. Again, it is argued that this will lead to benefits for all.
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- Economic inequality
- Capital accumulation
- Preferential attachment
- The rich get richer and the poor get poorer
- Matthew effect (sociology)
- Economic Growth and Tax Relief Reconciliation Act of 2001
- Gini coefficient
- Inequity aversion
- Pareto distribution
- Kinetic exchange models of markets
- Bouchaud, J.; Mezard, M. (2000). "Wealth condensation in a simple model of economy". Physica A: Statistical Mechanics and its Applications 282 (3–4): 536. Bibcode:2000PhyA..282..536B. doi:10.1016/S0378-4371(00)00205-3. (the article is also available on the arXiv preprint server: arXiv:cond-mat/0002374v1)
- Ravi Batra. The New Golden Age: The Coming Revolution against Political Corruption and Economic Chaos. Palgrave Macmillan, 2007, ISBN 1-4039-7579-5.
- Harold Hudson Channer (25 July 2011). "TV interview with Dr. Ravi Batra". Retrieved 21 October 2011.
- Economic Policy Institute
(Zdzislaw Burda and others at Jagiellonian University), 2002 "Wealth condensation in Pareto macroeconomies" model appears in Physical Review E, vol 65
- Winner-takes-all markets defined in the Economist magazine.
- CEO-to-worker pay imbalance grows
- Wages in America: The Rich Get Richer and the Rest Get Less
- 15 Mind-Blowing Facts About Wealth And Inequality In America - charts by The Business Insider
- Hogan, Jenny (March 2005). "Why it is hard to share the wealth". NewScientist (2490) (Reed Business Information). p. 6
- Yakovenko, Victor (November 2007). "Econophysics Research, Statistical Wealth Distribution". Retrieved 2007-12-17.