Returns on capital should not be cut

Investors who are eager to fund businesses that can’t make money worry people like New York magazine’s Kevin Roose.

At the same time, the hot new book in economics — Thomas Piketty’s Capital in the Twenty-First Century — argues that we need large wealth taxes to offset the tendency of investors to do better than workers. At least one of these people is wrong, and it’s probably Piketty.

Roose’s main argument is that many savers are subsidising unprofitable businesses, benefiting consumers and workers. What’s more, savers will never be able to recoup their investments. As Roose says: When these venture-backed price wars happen in dozens of high-end service sectors all at once, you have a strange cultural phenomenon in which Main Street dollars are being used to finance the lifestyles of cosmopolitan yuppies.

There’s a lot to be said for this view. Interest rates adjusted for inflation are much lower than 10, 20 or 30 years ago, which means that you need to sock away even more money to achieve a given standard of living in your golden years — or take a lot more risk with your investments. It wouldn’t be much of a stretch to say that the entire financial crisis was caused by savers’ inability to earn a decent return without having to take excessive risks.

After the dot-com bubble of the 1990s, the subprime bust and collapse in housing prices, and now the willingness of investors to plough money into unprofitable technology companies, it’s hard to buy Piketty’s thesis that capital is over-compensated. Inequality has certainly increased but even Paul Krugman, in an otherwise favourable review of Piketty’s book, notes that its findings don’t really apply to the US.

The income distribution in the US has changed mostly because pay for top executives and financiers has grown so much more than wages and salaries for other workers. Wealth inequality, in turn, has increased because people with high incomes tend to save and invest more of their money than those who live hand-to-mouth. That’s different from the notion that it’s got a lot easier to be a passive investor living off holdings acquired by your parents and grandparents.

In fact, a recent paper from Emmanuel Saez, a frequent collaborator of Piketty’s, and Gabriel Zucman shows that the bulk of the rise in the US wealth-to-income ratio since the 1970s can be attributed to the growth of pensions for the elderly. Wage inequality also increases as a society ages.

The polarisation of the income distribution creates serious macroeconomic costs, but that does not mean policymakers should try to lower the returns to capital. The markets have already done that and we’re living with the results.

- Bloomberg

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