One of the core principles of the free market is that those who work harder and smarter to produce ‘value’ for society are rewarded proportionately. It’s a strong reason why many individuals to seek education and entrepreneurs create new products and services, and in the process establishes a meritocracy wherein differing levels of financial wealth are accumulated. But what are the effects of that financial wealth becoming concentrated in the top 1% or .01% of society?
Uneven distributions can create the impression that the correlation between hard/smart work and its resultant payoff is broken, thus discouraging such effort. Concentrated financial wealth can also entrench itself, lessening the dynamism that is core to free markets. For instance, those with more financial wealth can pay for labor-intensive services, like housekeeping, that frees them up to pursue more financially lucrative opportunities, or purchase more efficient/productive goods which require higher capital outlays (e.g., hybrid cars, pre-school education, preventative healthcare). Those who are financially wealthy also tend to have a higher share of their income come from investments, which are often taxed at lower rates. Put simply, the wealthier one is the easier it is to generate new wealth.
Additionally, the difference in financial wealth enables those with more of it to pursue riskier and potentially more lucrative business opportunities as they can finance their own initiatives, lessening transaction costs and interest payments, as well as avoid severe downside risk as the cost of a venture not working out is for the most part lost time and money, rather than be burdened with long-term debt or face total bankruptcy. Finally, the concentration of financial wealth in a small percentage of society can negatively impact the economy as a whole as they tend to spend a smaller share of their disposable income, depressing aggregate consumer spending which upon which many businesses depend1. Research by the IMF also suggests that countries with greater income inequality experienced less robust growth spells2.
Before debating whether or not we have reached a financial wealth concentration that is detrimental to society, we must first examine our definition of “wealth.” The New Oxford American Dictionary defines wealth as: “a plentiful supply of a particular desirable thing,” and typically when discussing it in the media or conversationally we refer primarily to an individual or household’s net assets, less their liabilities. While this definition captures easily quantified and tangible inputs, it neglects many things. For instance, if you were to value a company by simply looking at its balance sheet (assets & liabilities) you might miss important factors such as its expected future cash flow, its intellectual property, and its brand equity. If company’s “value” is not limited in this way, why should we limit the scope of an individual’s “wealth”?
To better assess a person’s comprehensive wealth we must also consider intangible factors. To distinguish this new definition from the commonly used term wealth, which often alludes to just financial assets and liabilities, I will refer to this new measurement as holistic wealth. So, how should holistic wealth be measured?
One helpful framework, traditionally used in economics to analyze a nation or organization’s competitiveness, is the factors of production. In many ways a nation or organization’s competitiveness is similar to an individual’s holistic wealth, as both aim to measure both realized and yet-to-be-realized value. The framework traditionally uses three factors - land, labor, and capital - to categorize and measure one’s competitiveness, though many increasingly argue that there should be a fourth factor, human capital, which captures the ability to use the other three factors to produce value (other terms include: entrepreneurialism, intellectual capital, intellectual property, social capital). If using this framework to assess an individual’s holistic wealth this last factor, human capital, is extremely important because it is rarely, if ever, considered in the traditional definition of wealth, yet can have a significant impact on one’s future financial wealth potential. For example, an individual’s college education is comparable a company’s intellectual property - both have inherent value that is often not quantified due to its intangibility. In other words, information is increasingly capital.
It could also be argued that when talking about individuals a fifth factor should be included - wellbeing. This could include everything from one’s health, both physical and mental, to a sense of belonging and purpose. If the other four factors are difficult to quantify then this fifth factor is near-impossible (though Bhutan famously measures Gross National Happiness3). The value of including such inputs is to counter the commonly made assumption that there are ever-increasing returns to marginal wealth. One study from Princeton found that emotional wellbeing tended to peak at around $75K in income4. Several inferences can be made from this finding: 1) there is a set of ‘needs’ individuals have (e.g., sense of financial security, basic healthcare) that are fulfilled once they earn a certain level of income; 2) there are non-financial factors which influence wellbeing, such as leisure time, that may not correlate 1:1 with income and wealth, and 3) high levels of income and wealth may in fact have negative externalities, e.g., loss aversion, social pressures, etc. Regardless of which, if any, of these three inferences are true, the point remains that the perceived gains from marginal financial wealth are not necessarily linear.
What could be the effect of broadening the evaluation of wealth to include intangible factors? At the most basic level, it presents a more nuanced snapshot of society and the impact of time, expressed indirectly through human capital. For example, using this definition a 25 year old Engineering PhD student with $100k in student loans would not necessarily be considered “less wealthy” than a 65 year old retiree with $250k in the bank. Understanding the distribution of holistic wealth, beyond simply financial wealth, provides policy makers with a clearer picture of society and their constituents.
Furthermore, by understanding human capital’s contribution to holistic wealth we can prioritize related investments. A college education is commonly cited example of an intangible resource which has future value, thus justifying its inclusion in holistic wealth5,6. Even a preschool education has been found to lead to higher lifetime earnings7. Opening access to information through things like libraries and online portals (e.g., sba.gov for the Small Business Association) can also positively impact human capital by increasing one’s knowledge and lowering the cost to transform ideas into financial wealth. On the wellbeing front, access to public parks has a positive impact on mental and physical health, and quality mentorship programs have been found to reduce the rate of drug use and improve family relationships8,9. Even safety nets like health insurance and unemployment insurance can provide an individual with peace of mind. Individuals find value in all of these things and thus they should be included in holistic wealth.
It will take some time to construct an equation that accurately captures and quantifies all of these values for every individual. As a first step, however, policymakers should begin to use this concept to consider alternative means when addressing wealth disparities in society. Rather than solely focus on direct transfers from one group to another they should also consider the types of investments discussed above which improve one’s human capital and wellbeing, which together with financial wealth, constitute holistic wealth.
1https://www.aier.org/article/7696-stimulate-what 2http://www.imf.org/external/pubs/ft/sdn/2011/sdn1108.pdf 3http://www.gnhc.gov.bt/ 4http://wws.princeton.edu/news/Income_Happiness/Happiness_Money_Summary.pdf 5http://trends.collegeboard.org/education-pays/figures-tables/lifetime-earnings-education-level 6http://www.nationalaffairs.com/publications/detail/getting-ahead-in-america 7http://www.ericdigests.org/1994/lasting.htm 8http://www.library.ca.gov/crb/01/04/01-004.pdf 9http://www.worldparksday.com/files/FileUpload/files/resources/the-value-of-public-space.pdf