Where’s the Golden Age for Investors?

(Originally published here.)

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 subsidizing 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. (University of California Berkeley economist Brad DeLong has some worthwhile thoughts on how to define the real rate of return on capital, for those interested in a deeper discussion of that issue.)

After the dot-com bubble of the 1990s; the subprime bust and collapse in housing prices; and now the willingness of investors to plow 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 anotherwise favorable review of Piketty’s book, notes that its findings don’t really apply to the U.S.

The income distribution in the U.S. 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 gotten 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 U.S. wealth-to-income ratio since the 1970s can be attributed to the growth of pensions for the elderly. Similarly, they find that the rising importance of capital income can be explained in part by the aging of U.S. society, which means a smaller share of the population is working and a larger share is living off of pension assets accumulated in the past. Wage inequality also increases as a society ages because there is greater variation among people at the peaks of their careers than among those just starting out.

The polarization of the income distribution creates serious macroeconomic costs, but that doesn’t mean policy makers should try to lower the returns to capital. The markets have already done that and we’re living with the results.

To contact the writer of this article: Matthew C. Klein at mklein62@bloomberg.net.

To contact the editor responsible for this article: James Greiff at jgreiff@bloomberg.net.

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About Matthew C. Klein

I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist on a fellowship provided by the Marjorie Deane Financial Journalism Foundation. I have worked at the world's largest hedge fund and read every FOMC transcript since May, 1987.
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