Why the Rich Get Richer

Chris Douglas

 

It is no secret to practitioners that in systems of capital finance, opportunity and the wealth that comes with it have a natural propensity over time to clump, sometimes without regard to extraordinary human talent or ability. In what is otherwise probably the world’s most efficient system of resource allocation, this propensity of capital finance is an historically acknowledged systemic flaw.
Reportedly, the top 1 percent of the population in the United States has surpassed a greater net worth than the bottom 90 percent, and the top one percent earns more income than the bottom 50 percent. Because of the systemic flaw described below, this trend toward concentration could easily continue, if not accelerate, with potentially negative growth ramifications.

The Systemic Flaw

In a system of capital finance (when we speak of the capitalist system, we are speaking exclusively of a system of finance, though the word “capitalism” as a rival of “communism” has assumed ideological content as well), it takes money to make money. Those who have money have a systemic advantage in the acquisition of proven productive resources over those who do not, an advantage which compounds.

Ozzie & Harriet or Why Wealth Concentrates in Capital Finance

Imagine Ozzie and Harriet, each thinking of borrowing capital for the same business opportunity, a proven one. Ozzie is sitting on a few billion dollars of wealth in the form of land, art, stocks and bonds. Harriet has more talent and experience than Ozzie in the given business, but has no wealth.
The risk of the venture is relatively low, but that which exists is of the nature that Harriet through her superior talent and experience could offset more than Ozzie. Indeed, in Harriet’s hands, the opportunity would be better managed and a better product would emerge. Both for their own reasons seek to borrow money in order to acquire the opportunity, Ozzie because he prefers to and Harriet because she has to. Who would the bank finance on the most favorable terms?
The answer is easy.
Ozzie.
Even though Ozzie does not actually want to deploy his own wealth, he can pledge a small slice of it as collateral. Even though in Ozzie’s hands the opportunity is at greater innate risk than it would be in Harriet’s hands, the bank can eliminate that risk for itself entirely by securing it with other collateral from Ozzie. Consequently, its position guaranteed, the bank is willing to provide money to Ozzie at a low interest rate. Harriet has no collateral to pledge, and though hers is the superior talent, the bank would take on more risk by loaning to her than to Ozzie, for its loan would depend exclusively on the success of the venture, and not on other collateral. The bank will loan to Harriet only at a higher interest rate, if at all. While both propose to borrow the money, Ozzie can outbid the talented Harriet using cheaper money. ( Remember, though, it is not Ozzie’s money any more than it would have been Harriet’s money.)
So at first glance, Harriet is out entirely, unable to match Ozzie’s bid for the opportunity. She does have an option though. If Harriet wants to participate in the opportunity, she can bring Ozzie to the table as a guarantor or even go to work for Ozzie. Ozzie still comes out ahead, though, because the acquisition of the opportunity now depends on Ozzie who is able, in turn, to demand greater reward for it than Harriet. The greater reward for Harriet’s talent therefore accrues to Ozzie.

It Takes Money to Make Money
So it is no secret that it takes money to make money and those who already have it really are better positioned to get more of it than those who do not when it comes to many, perhaps most, proven business opportunities. Money in hand, the talent can be bought, unless the talent (Steve Jobs? Bill Gates?) is of truly unique genius, knows it, and can refuse to be bought. In a system of capital finance, only if talent is truly unique and of decisive importance in the success or failure of a venture, might talent have an advantage over money.
So it is in this context that the present crisis must be understood. With the top one percent of the population now owning more wealth than the bottom 90%, the acceleration of wealth to the top could easily intensify, not mitigate. Some might argue that the more natural state of mankind, unchecked by taxation, is not equality, but concentration, in which just a few families ultimately are able eventually to assume command of all wealth. So it was in the Gilded Age, when a few families came to control whole industries. Why has this concentration of wealth occurred only recently in the U.S. ? It’s hard not to suspect that the reduction of the estate, income, dividend and capital gains tax rates on the upper reaches of wealth, to the lowest level since those rates were raised at the outset of World War II, has had some influence.

Negative Ramifications for Economic Growth
The above flaw has negative ramifications for economic growth, for as economic assets and the income they produce have been concentrating at the very top, at the bottom they have been diminishing. But at the top, only so much can be spent in consumption: Families worth hundreds of millions, billions, and even tens of billions of dollars satisfy their personal needs and wants with but a fraction of their wealth. Their money instead, if they use it prudently, is directed towards acquiring additional productive assets (in which acquisition they have advantages over those with merely millions or tens of millions!), but not on consumption. As the lower reaches of society in America (whose consumption has for decades fueled global growth) have found themselves with less and less to spend , and therefore less they are able to buy, even investment in many types of productive assets lose their allure to those at the top, for who will buy those products? Hence, trillions of dollars, record amounts, accumulate on the sidelines, and economic growth becomes ever more a challenge.