The 62 richest people in the world own as much wealth as half of humanity. Such extreme wealth conjures images of both fat cats and deserving entrepreneurs. So where did so much money come from?
It turns out, three-fourths of extreme wealth in the US falls on the fat cat side.
A key empirical question in the inequality debate is to what extent rich people derive their wealth from “rents”, which is windfall income they did not produce, as opposed to activities creating true economic benefit.
Economists define “rent” as the difference between what people are paid and what they would have to be paid to do the work anyway. The classical example is the farmer who owns particularly fertile land. With the same effort, she can produce more than other farmers working on land of average productivity. The extra income she gets is a rent. Monopolists also get rent by overcharging customers as compared to what they could charge in competitive markets. More generally, economists have identified a series of “market failures”, which are situations where full competition does not prevail and where someone can therefore overcharge – they would be ready to do the work for less, but lack of competition allows them to make a quick extra buck. Government can alleviate market failures through proper economic regulation; or it can make them worse. Political scientists define “rent-seeking” as influencing government to get special muh privileges, such as subsidies or exclusive production licenses, to capture income and wealth produced by others.
So how much of extreme wealth derives from rents? It’s a pretty divisive debate, but one that can be resolved with data.
On one hand, Lawrence Mishel and Josh Bivens argue that the income of the top one percent richest Americans comes mainly from executive pay and the financial industry, two sources of income notorious for the market failure of imperfect information between buyers and sellers. CEOs have more information about their company than shareholders and portfolio managers than investors, which allows them to dramatically overcharge.
On the other hand, Steven Kaplan and Joshua Rauh claim that the fast growth of income at the top is broad-based and is better explained by rising returns to talent induced by technological progress and globalization.
Both camps use largely the same data to support rather divergent narratives, and in truth extreme inequality is driven by more than one phenomenon.
Data limitations do not allow us to compute rents anywhere close to accurately. But if I had to give a single number to settle the debate, it is this: when it comes to the very richest Americans (Forbes’ billionaires), 74% of their wealth is derived from rents.
I recently explored this issue in my paper Extreme Wealth Is Not Merited, and found that American industries that produce more billionaire wealth than average relative to their size share one of three characteristics:
…They depend heavily on the state whether through government procurement, licenses, or subsidies, and are therefore prone to rent-seeking. This category includes for instance oil, gas and mining, gambling, or forestry.
…They are plagued by market failures such as imperfect information, like finance, or by the combination of intellectual property and so-called “network externalities”, which create monopolies like those that pervade the IT industry and industries prone to fads like fashion and music.
…The billionaire wealth they have generated is largely inherited.
Building on that finding, I calculate that the billionaire wealth generated by these industries in excess of what other industries (considered here as competitive industries) generate represents 74% of America’s billionaire wealth. The table below shows that the industries that are neither dependent on the state nor prone to market failures have a self-made “billionaire wealth intensity” (that is, non-inherited billionaire wealth divided by industry value added – a measure of industry size) of 3%. (So the self-made billionaire wealth we observe in the competitive industries equals 3% of annual production in those industries, or in other words you might say that it has taken 33 years-worth of production to generate today’s billionaire wealth in the competitive industries.) If the whole economy had produced billionaire wealth at that rate, the total American billionaire wealth would have been $427 billion in 2012 instead $1,626 billion, or just 26% as high.
evonomics.com
