The Investing Imperative

One of the world’s leading economists on the subject of inequality has written a new book that promises to change the frame of reference for this controversial topic. As evidence of the rightward shift over the last thirty years of the relevant political debate, Paris School of Economics Professor Thomas Piketty named his treatise on income and wealth inequality “Capital in the Twenty-First Century.” Reading the title, it occurred to me with some consternation that even established inequality experts may be under pressure to label their work in such a way to avoid its branding as fodder for left-wing liberals of a bygone era.

My cynical suspicions found anecdotal support when reports emerged that President Obama had begun, at the advice of his political strategists, to substitute the phrase “Opportunity Inequality” for “Income Inequality,” for fear that the right will, in a mid-term election year, brand democrats as the party of socialists. That the political strategists of the democratic machine were advising the President to alter his phrasing in order to project the image most beneficial to the slate of mid-term electoral candidates is not surprising. That the President heeded the advice highlights the contrast of the muted executive and legislative (as opposed to monetary) policy response to the Great Recession compared with the New Deal programs used to fight the pernicious societal effects of the Great Depression.

The truth is that income and wealth inequality are byproducts of an unbridled capitalist economy. Contrary to beliefs popular on the right (e.g., “trickle-down economics”) there is no equilibrium to which the purely market-driven economy will in the absence of government intervention gravitate and rain productivity-driven profits in the form of wealth-accumulating income on the working and middle classes. One of the roles of government is to guard against the market economy’s tendency to drive inequality to extremes. The founding fathers, whose names Tea Party darlings like Michele Bachmann and Ted Cruz are fond of invoking, understood this risk. In correspondence from the year 1787 regarding the First Amendment, Thomas Jefferson acknowledged (from “The Founders’ Constitution”):

“It seems to be the law of our general nature … that man is the only animal which devours his own kind, for I can apply no milder term to … the general prey of the rich on the poor.”

Until the recent tax increases put into place to help finance the Affordable Care Act, federal tax policy changes starting in the early 1980s compounded the impact of globalization and the technology revolution, driving income inequality in the U.S. to levels not seen since the 1920s. Ironically, the wealth disparities seen then derived from the same free-market ideology that dominated late 19th century American politics and ushered in the last Gilded Age.

The fascinating contribution of Piketty’s thesis is the breadth of his historical analysis relating the return on capital to global economic output and labor income. Having constructed a data set based on twenty or so countries and reaching back to Antiquity (how even the most astute economist credibly estimates data dating back that far in time is beyond me), Piketty illustrates that with the exception of one relatively brief period, the return on capital has exceeded the growth rate of global output. (Think of the growth rate of global output as the growth of the economy and therefore an indication of the growth of income, and think of capital as the investment in plants in which workers labor to earn income.) The relevant and rather urgent corollary here is that inequality was in decline only when the growth rate of output exceeded the return on capital. Keep in mind that Piketty’s data goes back more than two thousand years.

In other words, going back to year one, the level of inequality in a given era is more likely than not to have been increasing, as it is today. Piketty’s most sobering observation is that the sole period in which inequality was in decline, as the rate of economic output exceeded the return on capital, was the sixty or so years from the onset of World War I to the end of U.S. involvement in Vietnam. Put another way, the only period in which inequality declined was a blip in the history of western civilization since the reign of Emperor Augustus.

The English translation of Piketty’s book (the original is in French) is due out this April. If the prospect of curling up on the couch with a 700-page tome on the history of inequality is not your cup of tea, see Columbia Professor Thomas Edsall’s recent New York Times Op-Ed piece titled “Capitalism vs. Democracy.” Pay particular attention to Figure 1. Referencing Edsall’s article here might seem too political for a blog about personal financial planning and investing.

Then again, the upshot of the research by Piketty, Berkeley Professor Emmanuel Saez (with whom Piketty published previous noted work on inequality), and others, is as challenging to envision implementing as it is simple to state. In order to participate in the 21st century global economy, one must invest. As Piketty illustrates with his data, the return to the historical dominance of capital over labor, a trend that in the absence of progressive government intervention knows no constraint, necessitates this investing imperative. If you think I am spinning this theme for purely commercial purposes (financial advisors may often see it in the best interests of clients to invest as a means of working toward their goals), watch this video of Piketty discussing his book: Piketty Lecture on Capital in the Twenty-First Century. Pay particular attention at about 1 minute and 20 seconds into the lecture.

Unfortunately, the trend in corporate America is in opposition to this investing imperative. According to a recent article on (“Companies Squeeze 401K Plans from Facebook to JPMorgan,” by Carol Hymowitz and Margaret Collins):

“Employers are squeezing their workers’ retirement savings, holding back on both the amount and the timing of 401(k) matching funds and dragging out vesting schedules. Taken together, these measures are making it more difficult to save for old age.”

This confluence of trends is foreboding. Credible historical analysis illustrating fundamental forces driving high and rising inequality coupled with reductions in employer contributions to employee retirement savings leaves the reasonable person with legitimate concern for the financial future of working and middle class Americans. The tectonic rightward shift of the political debate has all but nullified the possibility of meaningful corrective fiscal action (e.g., closing the carried interest loophole to align tax rates of private equity investors with those imposed on ordinary taxpayers).

Professor Edsall’s positing unbridled capitalism and democracy as being at odds, as the title of his piece suggests, is a timeless notion. The Ancient Greek historian Plutarch put it succinctly (from

“An imbalance between rich and poor is the oldest and most fatal ailment of all republics.”

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