A theme of 19th century novels was inheritance, and especially protecting both it and daughters from fortune hunters. Marrying money was generally easier than working for it.
But this changed with the 20th century, for the American Dream not only promised riches and respectability to those who worked hard, but also the assurance that each succeeding generation would be better off than their father’s.
So is the dream still intact? Not according to Elizabeth Warren, former Harvard law professor and now senator for Massachusetts, who has examined why the financial fragility of middle class families has significantly increased since the 1970s.
Ms Warren is a leading expert on bankruptcy and described by the Boston Globe as “the plainspoken voice of people getting crushed by so many predatory lenders and under-regulated banks” through the financial tricks and traps hidden in mortgages, credit cards and many other financial products.
No surprise then, that Professor Thomas Piketty’s “Capital in the Twenty-First Century”, which caused little excitement on its publication in France, has become an unlikely best seller since its translation into English. As Gillian Tett wrote in the Financial Times, “I suspect that the real reason for Piketty’s rock star reception is not the quality of his numbers but the fact that he has forced Americans to confront a growing sense of cognitive dissonance.
“Nearly two and a half centuries ago, when the country’s founding fathers created the nation, they proudly believed they had rejected Europe’s tradition of inherited aristocracy and rentier wealth. Instead, it was presumed that people ought to become rich through hard work, merit and competition. Thus, inequalities of wealth were often tolerated because everyone hoped they could become rich. That was the American dream, which fostered admirable waves of entrepreneurial energy and – crucially – provided a social glue. Piketty’s book shows that this dream is increasingly a myth.”
Implications for investors
A key dynamic in Mr Piketty’s work is that if the return on capital is greater than the rate of economic growth, then the rich will continue to get richer. This is simply the formulation of a basic lesson in financial grammar – never spend capital, only the income from it, and that income has to cover the costs of the management of that capital. This is especially relevant now that the ‘new normal’ is a below-optimum rate of economic growth.
The book results from 15 years of empirical research into the tax returns of France, Britain and America, conducted in conjunction with other economic scholars. It is an enthralling social and political history, telling us about the development and distribution of income and wealth (which Mr Piketty calls ‘capital’) over the past three centuries in the leading high-income, fast developing countries of their time.
Its scale and sweep resembles that of the founders of political economy such as Adam Smith, for Mr Piketty considers economics not to be a mathematical study based on unreal assumptions but “as a sub-discipline of the social sciences, alongside history, sociology, anthropology, and political science”.
As such it is a work of historical scope, both grounded in exhaustive and fact-based research, but also incorporating literary references, like those 19th century novels. It is the first treatise since Edwardian times on where the wealth of nations comes from, how it is distributed within society, and how those that get it, keep it. As such it makes uncomfortable reading for the rich, who prefer anonymity.
Winner takes all capitalism
A key reason for that discomfort is that Mr Piketty sees no general tendency towards greater economic equality. According to him – and despite our own belief in the democratic dream – the high degree of equality seen after the second world war was unique; a combination of high and progressive taxation and the destruction of inherited European wealth between 1914 and 1945.
This suggests to him that we are naturally recreating the “patrimonial capitalism” – or a world dominated by inherited wealth – of the late 19th century. Piketty justifies this by a fact quoted by many analysts – namely that “the richest one per cent appropriated 60 percent of the increase in US national income between 1977 and 2007.” Additionally, the ratio of wealth to income in Europe has climbed back above US levels, while there has been a notably big rise in the share of national income taken by the top 1 per cent of the population in all English-speaking countries since 1980.
But this is simply the capitalist system unrestrained by the Soviet Union, and also one that has grown immeasurably wealthier: in 1970 Wimbledon prize money amounted to £40,000 but this year it is £27m. During the 1970s there was a long and detailed exchange of letters in The Times newspaper, commenting on what ought to be the correct ratio of pay between a CEO and the shop floor. It was generally agreed that 50:1 was not unreasonable but then a letter pointed out that the pay of a Marshall of the Red Army was some 1,000 times greater than that of the private soldier.
So CEO pay is now advised by salary consultants, dependent for their employment on the company but also aware of what footballers and other sports stars make, and regulated and agreed by committees of like-minded CEOs. So ‘winner takes all’ capitalism is currently unrestrained, but only until the “cognitive dissonance” to which Ms Tett refers brings about some political opposition.
The acquisition of wealth
Like many French intellectuals, Mr Piketty seems to have an instinctive distrust of the Anglo-Saxon belief in market mechanisms. While he accepts that this has brought about riches that neither kings nor emperors could have conceived of even a century ago, he ignores Smith’s equally valid remark that businessmen cannot meet on even the most innocent of occasions without some plot against the public interest – such as the gouging of consumers about which Ms Warren complains, or the sky-rocketing pay of the ‘super-manager’.
Mr Piketty insists that social scientists “must make choices and take stands in regard to specific institutions and policies, whether it be the social state, the tax system, or the public debt”. Great disparities of wealth may well be inimical to society, although Mr Piketty does not give his reasons and just assumes that they do.
Others may consider the rise of lobbyists – together with unrestrained funding of political parties – a sufficient reason for such disquiet. But as most commentaries have noted, few politicians are likely to take Mr Piketty’s tax proposals seriously.
The compound interest that has fuelled his patrimonial capitalism has ensured, through pension fund and property wealth, a reasonable inheritance for the present generation. But the coming generations will have to work harder for their comforts, and need to take note of Mr Piketty.
Wealth is best acquired not through working for a company but establishing a business of your own: the taxation of income and capital are different, and much in favour of the latter. Happily, though not mentioned in the book, the rate of technological change has become exponential and the internet gives even the one-man business a world market.
IFAs must not only appreciate the value of the cost-efficient investment but also the new and growing opportunities in business funding. Banking technology has changed, capital is available through alternative channels to those of bank branches, and a function of the IFA in Piketty’s world will be as the broker between money and ideas.
