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The Moral Dimensions of Capital: Daryl Koehn on Broadening Piketty’s Conception of Social Goods


Editor’s Note: Today’s entry in our forum on Thomas Piketty’s Capital in the Twenty-First Century is by Daryl Koehn, a professor of ethics and business law at the University of St. Thomas, where her research focuses on the nature of good and evil in the business and professional arenas. This is the seventh post in our forum, which kicked off with an introductory post, where you’ll find an index of all the posts in the forum.

Piketty’s Capital in the Twenty-First Century sets up five key questions:

  1. Is wealth inequality increasing within the US and elsewhere?
  2. If so, what are the causes of the growing inequality?
  3. If inequality is increasing, is that an economically good thing?
  4. If inequality is increasing, is that a morally good thing?
  5. What, if anything, should be done about rising inequality?

1. Is wealth inequality increasing within the US and elsewhere?

In Capital, Piketty presents historical data, arguing that from World War I through the Great Depression and World War II, the wealth-to-income ratio fell rapidly. Income inequality shrank as well, especially during World War II. Piketty explains the data with a model, projects the model into the future, and proposes high taxes to correct for growing inequality. Piketty is primarily focused on wealth inequality, which he defines as concentrated wealth in the hands of a few families, not on income inequality.

I am not an economist and so am not sufficiently versed in statistics and econometrics to assess Piketty’s argument that wealth inequality is indeed increasing (and doing so at an accelerating rate). I would note that a number of other prominent economists and think tanks have recently published studies concurring with Piketty’s basic thesis. So for purposes of my contribution to today’s discussion, I will accept that wealth inequality is, in fact, increasing.

2. So assuming that there is growing inequality, what are its causes?

One cause of inequality or the lack thereof is war and the government’s response to war. The low inequality around WW1 and WW2 was due to the low savings rate during this period (Piketty 7) and European government’s devaluation of rich families’ assets (8).

Now, however, wealth inequality is once again increasing. Why? Piketty’s key argument, as I understand it, is that when r, the rate of return on capital, is greater than an economy’s growth rate—g—then high levels of wealth engender still higher levels of wealth because the investments of the rich are far more lucrative than any wage increases labor is getting via economic growth. Insofar as this wealth gets inherited, countries veer toward plutocracies or what Piketty calls “patrimonial capitalism” (154; passim).

There are, however, a number of points to make about this assertion. First, Piketty does not establish that r will necessarily remain greater than g. r might fall faster than g at some point. Second, this claim does not state the cause of growing inequality. It shows at best why those who start off with a stash of capital may be able to increase their wealth far faster than those who depend upon salaried labor. The claim that r has been greater than g by itself does not explain how certain parties obtained their initial stash of capital: “Piketty isn’t saying that r > g is why inequality has increased so far. It’s why he thinks inequality will keep increasing along hereditary lines in the future. Nor does the r greater than g equation tell us anything about how and why those who are becoming wealthy have been able to preserve ownership in their capital (e.g,, that they live in country that respects property rights).

So why, according to Piketty, is wealth inequality increasing? Piketty offers several theories. One answer is that governments’ taxation rates are not as confiscatory as they were during earlier eras. Second, rubber-stamping boards (staffed with interlocking CEOs) are paying executives astronomical salaries. This claim is crucial for Piketty’s argument because wealth cannot breed wealth unless and until individuals have money to invest in the first place. The claim then is that it has become easier during the prior decades for business executives to amass fortunes. And that fact fuels wealth inequality, which supposedly gets ever greater and becomes inheritable because of the r greater than g dynamic.

But it seems to me that other factors affecting individuals’ wealth level have been at work as well. On the one hand, many middle class Americans have started to save an ever-greater portion of their income because they fear that social security will not be around when they retire. Money that once was spent is now saved; such savings count as accumulated wealth. So fear-based savings presumably is creating some wealth. On the other hand, generous defined benefit pensions have traditionally supported the middle class, enabling them both to spend and save at reasonably high levels even after retirement. The poor do not work jobs that have defined benefit plans. So defined benefit pensions have historically been available only to certain groups of people and thus likely contributed to wealth inequality. These defined benefit plans have gone away as firms have replaced defined benefit plans with defined contribution plans. The latter are far less generous in their payouts so the rise of these plans is likely also leading to income and wealth disparity during recent years.

Labor unions have been weakened in part because workers saw during the 1980s that the union leaders took care of themselves and long-time employees while doing little for less tenured rank and file members. In other cases, firms (e.g., Walmart and Starbucks, and many universities) have fought tooth and nail to prevent unions from getting a toehold in their operations. The eviscerating of unions means that labor has lost bargaining power and, as a result, has not been as well positioned to demand the salary increases and benefits they had been able to secure in the past. That factor has tended to suppress wages and probably savings as well.

The lessening of taxes on dividends and on estates has allowed wealth that does exist to maintain itself. However, given that most fortunes are spent within three generations, we need to identify other factors that are at work in contributing to income inequality. Part of the answer surely is the shift from public sector to private sector jobs in the financial industry—a point I will return to shortly.

I suspect that another reason for the increase in wealth disparity is the increasing number of very successful, innovative entrepreneurs. Many of the wealthiest people in America made their wealth by inventing something new and very disruptive—think of the products offered by Apple, Google, Facebook, Uber, and eBay. This list of lucrative inventions goes on and on. These disrupters would have pursued these inventions regardless of the tax rate; America has a long history of nurturing innovation. The growing ability of innovators to gain easy access to capital (think of Kickstarter and the other crowd-sourcing funding mechanisms) and to draw upon the wisdom of crowds to perfect designs and to do marketing has made it possible for ever larger numbers of individuals to become entrepreneurs. Customers flock to these inventions and that dynamic has made those individuals hugely wealthy.

I doubt then whether astronomical CEO salaries has been the main driver of inequality.

3. Is Growing Inequality Necessarily Bad for Business?

Nobel prize winner Paul Krugman has made the point that New York City has done pretty well for years because very wealthy traders and bankers have spent heavily on fine dining, cars, services, etc. So it would seem that pockets of intense economic activity can occur even with extreme wealth and income inequality. We are not justified then in claiming that growing wealth inequality is always or necessarily bad for business. Piketty himself notes, “The history of income and wealth is always deeply political, chaotic, and unpredictable” (35).

Moreover, the prospect of being able to become very wealthy may motivate entrepreneurs. In some respects, we clearly are moving within the US toward an entrepreneurial economy. Of course, the prospect of others succeeding can fuel envy; but it may also inspire others to try their hand at offering new products and services. Crowd-sourced funding and inventions have exploded; small businesses are the primary engine for job growth so becoming a successful entrepreneur is not as impossible as it might have seemed even ten years ago. If we see more entrepreneurs who succeed in offering new services and products, then wealth inequality might be the result of business being very good.

Conversely, growing wealth and income inequality may be bad for business if we have a consumption economy rather than a production economy. When folks don’t have money to spend, consumption flattens or declines.

4. Is Increasing Wealth Inequality a Morally Bad Thing?

Whether growing wealth inequality is immoral depends, in part, upon its causes and effects. As Aristotle argued long ago, inequality per se is not unjust. Milo the wrestler may need to consume four times the amount of food you or I do because he needs more calories to sustain his level of activity. In times of great scarcity, Milo might not merit this larger share of calories. But if and when a society has the resources to distribute to according to his or her due, then perhaps inequalities should not merely be tolerated but even encouraged. It is right that Milo get the food that he needs.

Injustice arises when people do not receive returns commensurate with their contributions. To quote Plato, there must be justice even among thieves. For his part,

Piketty not only concedes, but documents himself, most . . . inequality arises from labor income, not capital income—from compensation earned by executives at big firms, entrepreneurs, and financial wizards. Almost none of these ultra-high income earners are the teachers, engineers, and academics that, according to data collected by Harvard economists, used to be the core of a modest-income social elite in the 1960s and 1970s . . . Economic research shows that the medical advances sparked by the research done by medical academics added $3.2 trillion to the value in the economy, in terms of improved health, each year, since 1970. Yet all academics in the United States—including all the researchers in other fields—were paid less than $100 billion. Financial workers earned five times that amount. A system that delivers rewards in such poor proportion to the benefits society derives will stifle economic growth as well as sharpen inequality. Thus, the fundamental problem facing American capitalism is not the high rate of return on capital relative to economic growth that Piketty highlights, but the radical deviation from the just rewards of the marketplace that have crept into our society and increasingly drives talented students out of innovation and into finance. (Eric A. Posner and Glen Weyl, “Thomas Piketty Is Wrong: America Will Never Look Like a Jane Austen Novel”)

This excessive financialization of the US economy and the accompanying loss of manufacturing jobs somehow needs to be addressed if justice is to be seen to be done. It is hard to see how that will occur, given that the wealthy are able to use their vast resources to lobby politicians to create and skew rules that favor their activities, many of which are rooted in the financial sector.

In the meantime, we seem to be witnessing some hollowing out of the middle class. To the extent that is so, we ought to be, if not alarmed, at least on guard. Some evidence suggests that we have evolved from being an industrial economy into a consumption economy. The middle class drives much of this consumption. In addition, the middle class has traditionally done a fine job of educating its children. These children become the innovators and educators needed to keep America strong. Seventy percent of America’s entrepreneurs have come from the middle class. So the loss of the middle class would be serious indeed. It would threaten the very ability of the economy to meet citizens’ needs. We collectively would not be able to render to each party his or her due. Other virtues cultivated by the middle class—thrift, charity—might disappear as well.

When we shift our attention from the middle class to the lower class, a related concern emerges. Inequality becomes unjust when all members of the body politic do not obtain what they need in order to survive because some citizens are taking too much for themselves. Piketty contends that we are returning to a kind of “patrimonial capitalism.” In such a system, class and especially inherited wealth matter far more than individual effort and talent. America has historically been relatively stable because individuals believed that they could—through hard work—share in the good life and give their children the skills needed for the children to be similarly successful. When a society ceases to be able to persuade its lower class citizens to believe in this kind of future, inequality can become very worrisome. The Arab Spring occurred in part because so many educated young people throughout the Middle East have few job prospects. The rise of European neo-Nazis who encourage citizens to attack others who supposedly leach off the body politic should give us pause; these extreme parties have realized gains primarily in those states with economies that have imploded since 2007, devastating the lower and middle classes.

Part of the reason for the increasing dominance of inherited wealth has been the changes in the tax law mentioned above. George W. Bush cut taxes not primarily on high salaries but upon interest, dividends, capital gains and estates. We are moving toward a state in which some people in theory will never have to pay federal income taxes because all of their money comes not from salaries but in the form of a non-taxed return on assets that are passed from generation to generation. The tax burden on the middle class, however, has steadily increased. Progressive taxation is arguably the most just system, but in the US we have moved away from such a system.

But taxation policy, as I noted above, does not tell the whole story. The hollowing out of the middle class is due (I suspect) in part to the loss of significant pensions, especially pensions in the public sector. Insofar as these pensions were not sustainable; and insofar as the current generation was paying itself generous retirement benefits that would have to be funded by future generations who are smaller than the baby boom generation, the loss of these pensions is perhaps not unjust. No one has a moral right to benefits that come at the expense of young people’s ability to make a life for themselves. In that sense, Piketty’s book can be read as providing a salutary warning to the American populace as a whole to think twice about pension promises that cannot and should not be kept. Some of the touted prosperity and strength of the middle class in America and in Europe may have been a mirage.

5. What, If Anything, Should Be Done about Rising Inequality?

Let us assume that rising wealth inequality is both bad for the economy and morally reprehensible. One response is to keep on doing what we already are doing—namely, reducing consumption inequality by redistributing monies through the various welfare state programs. In the 18th and 19th century, wealth inequality translated into huge consumption disparities. Such disparities are less apparent in the 21st century largely because of various state subsidies and programs (e.g., nationalized health in the UK; social security in the US). As Tim Worstall has noted, “Wealth inequality in Sweden is higher than it is in either the US or the UK. [But] [i]ncome inequality, after taxes and after benefits, is significantly lower in Sweden and consumption inequality even more so” (“Yet Another Reason Why Thomas Piketty Is Wrong”). The problem with this response is that welfare states all over Europe are in danger of collapsing, in part because the tax base of middle class people is shrinking and in part because the burden has proven to be too onerous.

Another argument in favor of the status quo is that, yes, we have a growing number of ultra-rich individuals but these folks are part of the solution, not the problem. In his review of Piketty’s book, Bill Gates has conceded that “capitalism does not self-correct toward greater equality”; like Piketty, Gates thinks government needs to “play a constructive role” in ameliorating the effects of wealth inequality. However, Gates goes on to make a case for the ability of philanthropy to help with social ills. Rich philanthropists, in Gates’s view, contribute to the social good in ways that, say, rich spendthrifts do not. Of course, that response by itself does not justify paying CEOs hundreds of times what the average worker in their firms make. Nor does it consider to whom the rich tend to make their donations—art museums, etc. It is the middle class and poor who give a far greater percentage of their income to the poor and favor donations to the social service agencies that are trying to deal directly with the debilitating consequences of poverty. This difference persisted during the Great Recession: “A 2012 study by the Chronicle showed that while middle income citizens gave 7.6 percent of their incomes to charity on average, the figure was just 2.8 percent for those earning more than $200,000 per year” (“Study: Rich give less to charity as low and middle income people give more”).

Piketty himself and many liberals reject the status quo, favoring a global wealth tax. The tax in theory would prevent or at least slow the accumulation of inheritable capital. However, much would depend on how easily the wealthy could evade such a tax. Moreover, I suspect that the real problem does not lie with wealth inequality per se but with a fundamental shift in how Americans and Europeans think about their working lives. Well-educated, ambitious and talented individuals now prefer to go into business and finance rather than to spend their lives working at less remunerative jobs in education, the public sector, etc. If so, then “the right solution . . . is not to shackle capitalism with a blunt wealth tax but to channel its energies into more productive, diverse activities. . . . But broad taxes, while useful absent better policy in other areas, are poorly targeted, because they do not distinguish clearly between people who are under-compensated for their social contributions (researchers, teachers, engineers) and those who receive excessive pay (financiers, lawyers)” (Posner and Weyl).

In the language of Michael Naughton and Ken Goodpaster, the real issue is that we as a society are failing collectively to focus on genuinely “good goods and useful services” (“Where Philosophy, Theology, and Ethical Leadership Intersect: Is Stakeholder Thinking Enough?” Unpublished). For example, high frequency trading churns the market, and there is nothing that traders like more (apart from astronomically large bonuses!) than market volatility, which creates the opportunity for great scores. However, such volatility is far less desirable in the eyes of consumers and businesses. These groups may suffer from wild swings in interest rates, commodity prices, etc. In this case, the real problem is not that HFT traders are getting rich but that the activity itself is suspect.

Distinguishing genuinely good goods and truly beneficial services from merely hedonic goods can be tricky. However, unless we begin to think about this distinction, our societies will likely continue not merely to tolerate but even to applaud activities that are very risky and that do not further the common good in the long run. Imposing draconian wealth taxes does not deal with this underlying problem of the goods we choose to pursue.

We should also encourage individuals to think about this crucial distinction between things and “good goods.” Although it seems that stagnant wages coupled with rising health and education costs have stressed the middle class, it is also true that many people now go into debt to acquire consumer goods that they do not need. We seem to be finding it harder and harder to defer gratification; the savings rate has been declining for generations. Yet saving money is key to being able to pay for truly good goods such as preventive care and a college education. I do wonder whether part of the rising income inequality is due to many folks saving less throughout their lives because they feel that they must have the latest phone, watch, car, etc. If so, then redistributing wealth will do little to prevent those who are able to save capital to start a business from earning far more than peers who spend every tax rebate or windfall on the latest hot item. Hedonic goods, although pleasant at the moment of consumption, tend to distract people from the task at hand and do not foster habits of concentration, persistence, etc. needed to build a business or to rise to the top of a profession.

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