How does wealth concentrate?
Alloporus has discussed whether or not it’s fair to give a 10% pay rise to every employee in a business.
It sounds dutiful and egalitarian, and it also suggests the company must be doing well to make such an intelligent investment in its workforce.
Breaking the numbers down, it is clear that 10% to the lowest-paid workers in the company and even those on the average salary in the company results in far fewer extra dollars in the paycheck received by the CEO; let’s call him Jerry, for his 10%.
The average worker gets, say, $200 extra a fortnight after tax. On his $750k a year, Jerry is looking at an additional $1,700 despite his heavier instalment to the tax office.
Justifications abound because the CEO is the boss and must make the decisions and wear the risk. He is worth the extra pay and has considerably more buying power in raw dollars from his 10% pay rise.
Jerry is an intelligent fellow — not a given — so he chose to put the money from his pay into a unit trust, nothing too fancy, just a rainy day option. He did this each month.
The shop floor worker, Tom, was in debt, and he decided to put the extra money into credit card repayments to bring his balance down. His kids wanted presents for Christmas, which took care of December’s extra pay. His eldest daughter was about to go to college, and Tom wanted to send her off with a small sum to get her through the first semester away from home and used January’s extra pay.
Tom consumed the extra money, and Jerry put it away in a modest investment.
After ten years, Jerry’s investment of $3,600 each month was worth $577,971, of which $132,328 was the result of compound interest at 5%.
He decided to cash out his units and made a hefty downpayment on a property south of Brisbane that he immediately rented to increase his net returns to 7.5% and convert his principle into a more stable asset class. The property doubled in value over the next decade, giving Jerry another $1.5 million property in his portfolio.
Now, you could say that Tom could have done the same thing and matured his salary increase by investing it. His $433 per month in the same unit trust would be worth $67,950 after a decade, including $15,500 of interest.
Making an investment choice might have been a clever play. Tom may have saved just enough through the investment to offer his daughter a deposit on a flat or maybe pay for her wedding that came ten years down the road.
But his material wealth would never reach the same levels as Jerry in his working lifetime.
As they say, money makes money.
But the point here is that wealth also concentrates.
The company has one CEO and a handful of executives with salaries large enough to easily invest their 10% but lots of workers, many struggling to make ends meet. The opportunity to make real money falls to a few.
Of course, the owners were happy too. The major shareholder in the business, Mr Hannah, also enjoyed a 5% share dividend each year. His 2.5 million shares were worth $5 million when the first instalment arrived, a handy $125,000.
Similar dividends were paid annually for a decade, with the money moved into various assets that yielded 5% interest. That initial $125,000 plus the annual instalments grew to $1.8 million in a decade, $400,000 of that in interest. Naturally, the shares rose on a buoyant market to be worth $10 million.
The owner’s wealth accumulated too.
Then there are the super owners. Here is one chosen at random. In June 2021, Bloomberg Billionaires Index listed Dieter Schwarz, a german businessman who built his fortune owning supermarket chains, as the 61st richest person globally with an estimated net worth of US$27.3 billion.
Should Mr Schwarz earn 5% interest on his assets, he receives $3.7 million a day before tax.
It is hard to figure out how to spend that kind of money.
Of course, most of the time, these people do not. They invest it after paying clever accountants to minimise their tax. Then, on occasion, they give some of it away.
The pattern is clear — capitalism creates wealth that concentrates into a few individuals or entities. Over time this opens a wide gap between those who have and those who do not.
None of this is new nor much of a revelation. Accumulation and concentration are how capitalism works. The reason for revisiting the basics is that there is a lot at stake should this pattern continue.
Poverty and excess make each other very uncomfortable, and history tells us that resolving such disparity is ugly for everyone.
Better not to let it get out of hand.
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I suspect that most people believe that the primary job of a bank is to look after their cash.
Deposit your money and, at any point in time, you can rock up at a branch or a hole in the wall and receive your cash up to the amount that you put in, minus a few fees.
The reality is that banks only provide a haven for our cash because it allows them to leverage the money held into investments. They borrow against their available capital and invest funds into a wide range of assets that they expect will yield more than what they’re giving you for the privilege of looking after your money.
It’s a fantastic financial model.
It’s the reason that having conquered the world of futures trading, capital gains, and hedge funds, Bobby Axelrod, the megalomaniac character in the Stan thriller Billions, played by Damian Lewis, decides he wants to become a bank.
Essentially it’s a license to print money.
Banks are always looking for assets that will yield investment returns in the shortest space of time. Their mantra, indeed their requirement under the law, is to profit, and they are ‘in the pound seats’ to do it, literally.
They have the scale and capacity to invest in projects that your average Joe couldn’t dream of, from skyscrapers to industrial plants, freeways, and airports. The kinds of investments that require tens to hundreds of millions of dollars to see them to fruition.
Banks have the advantage of using other people’s money and the advantage of scale. They make huge sums from investments that yield high returns for long periods, partly on the fact that no one else can invest in them.
And so it is and has been.
The banks make money, but the projects they fund often deliver utility.
It is not always good.
The pursuit of profit is relentless and ruthless.
Goldrush mentality attracts the most ardent and most skilled as well as the opportunist. Money gives banks the very best people with a sharp mind and a ruthless attitude. They quickly find the best ways to reduce costs and maximise returns.
No surprise that banking can support projects that have severe externalities and direct impacts on the environment. Recall an externality happens when the cost of an activity is not absorbed but shipped out. The commons are excellent dumping ground because no one person or entity gets hit with the liability.
Capitalism degrading the environment is profound. Development has to happen, but it becomes pointless if humanity has no safe place to live.
So who is to blame?
The reality is that we, the people, want roads, skyscrapers, and industrial plants that deliver raw materials for all of the stuff we want to buy.
We are the ones that live in large houses with more bedrooms than you could ever need, more luxury than you could ever really afford. And yet, everyone wants a better life, and it is forever the human condition to want betterment.
In other words, the consumer is ultimately responsible.
Instead of blaming the banks, what if we blame the consumer?
Maybe get consumers, us, to give up our desire for stuff, our emotional and mental drive to better ourselves and provide for our families. Quosh those innate biological feelings to make more that is in all of us.
Well, good luck with that one.
Perhaps there is a compromise position where both individuals and the finance community begin to work together to look long and prosper.
Currently, we do this through regulation.
Governments curtail the riskiest financial behaviours through legislation limiting the amounts of money banks can borrow, their financial ratios, and their ability to exploit customers, in itself a significant ongoing task.
Governments are in a difficult position. They see growth as a political necessity and are reluctant to curtail development activity or the banks that finance it. Yet, all the while, development activity is damaging the planet.
If we can’t blame ourselves or the banks for doing what we want them to do, humanity has a problem.
We do have a choice.
We can accept that consumption and more-making has an impact and try to do something about it. Even a little is better than doing nothing. Light bulbs, anyone?
But fiddling just puts off the inevitable. Instead, something dramatic is needed. The doughnut, perhaps?
Alternatives to historic capitalism exist, and many of the options are maturing nicely.
For example, ‘cooperative enterprises’ where workers make the major enterprise decisions rather than boards of directors selected by shareholders. This alternative is called economic democracy.
Only this is not a million miles away from what we already have. The people choose, but this will not guarantee decisions in favour of anything other than the people.
Robin Hahnel’s book Of the People, By the People: The Case for a Participatory Economy describes the participatory economy where all citizens, through the creation of worker councils and consumer councils, deal with large-scale production and consumption issues without the need for appointed representatives. The participatory economy is the origin of the Green New Deal, a package of policies that address climate change and financial crises.
A participatory economy is different. Imagine the circus of state and national politics banished to the bench.
Doughnut economics is an economic model proposed by Kate Raworth that combines planetary boundaries with the complementary concept of social boundaries. Look after everyone and the planet.
Doughnut economics is different too.
And these are just three of the many alternatives with potential.
What do the alternatives require of us?
Most of the alternative economic systems require a shift in responsibility.
It would be on us, not the banks or the government or the unscrupulous developers. We will all have to step up and understand the consequences of our choices.
The banks would continue to do their thing on our behalf; only we would be responsible for the consequences of what they do.
And so we get to the rub.
Capitalism has delivered growth and, on average, betterment for humanity. Only it comes at an uncomfortable cost. And the only way to pay back that cost is to take responsibility for it.
Are banks bad? No, they are a caricature of our abdication from personal responsibility.
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