Why are people like Bill Gates, Jeff Bezos and Mark Zuckerberg so incredibly rich? Sure, they’re great businesspeople, and they had the right ideas at the right time. But most importantly, when their businesses succeeded, they owned a large portion of the equity.
Equity, or stock, is the riskiest type of asset ownership. It’s the most volatile, and it’s the first to get wiped out when a company goes bankrupt. But it also has unlimited upside — the gains can, in theory, be infinite. It’s the entire upper tail. So of course the largest fortunes that we see — the richest individuals — were made through equity ownership.
But the big payouts to other stockholders are also responsible for much of the vast increase in wealth inequality. In 1980, the richest 5 percent of Americans owned half of the country’s wealth. In 2012, it was almost two-thirds.
Why has wealth become so concentrated at the top? One reason is certainly that income inequality has increased. People who make more money can also save more money, building wealth over time. Things like the estate tax, which work against the intergenerational transfer of wealth, have gone down, even as the chance of going from low-income to high-income has fallen; this means that the slow buildup of wealth by high earners can continue from generation to generation. Also, high earners tend to save more than the middle class, which increases the gap between the rate at which the two groups build wealth.
But this is only part of the story. There’s another important factor that’s often overlooked — the issue of who owns which type of financial assets. Wealthy people tend to own most of the equity in the economy. That means that when business does well, the rich reap disproportionate benefits.
At least two recent papers highlight this extremely important fact. The first is by Laurent Bach, Laurent Calvet and Paolo Sodini. Instead of looking at the U.S., they look at Sweden, because the Swedish government keeps much better data regarding the assets of the rich. Examining at the period from 2000 to 2007, they found that the middle class actually doesn’t do too badly — though it holds more bonds and fewer stocks, the rich tend to do a bit worse with stock investing, taking extra risks that aren’t matched by higher returns. This is evidence against the theory that the rich are more skilled investors.
But there’s one big reason why the rich still come out ahead — instead of stocks, the middle class puts a large share of its wealth into residential real estate. Houses tend to earn lower returns than stocks.
This is probably a fundamental law of the economy — as long as human beings continue to find more productive ways to use resources, companies will continue to gain value relative to land and other natural resources. By pouring so much of its wealth into houses, the Swedish middle class made a big bet on land, while the rich bet on human ingenuity. In the long run, the latter tends to win.
The second paper, by New York University economist Edward Wolff, found similar forces at work in the U.S. His data clearly shows that the wealthy have relatively less of their money in houses, and more in stocks and other financial assets.
Broadly speaking, rich people own the upside of the economy in the form of stock, while the middle class’s gains are limited by the slow growth of housing wealth. Wolff finds, unsurprisingly, that the collapse of the housing bubble exacerbated wealth inequality, because stocks recovered more strongly than real estate did.
So the concentration of stock ownership is a big reason for wealth inequality. How can policy help fight this trend?
One way is to encourage the middle class to put more of its money into the stock market and less into housing. Ending or capping the mortgage-interest tax deduction, as some are now proposing, would help encourage middle-class people to rent instead of own houses. Although losing this tax break would be a bit of a setback, spending less overall on housing would free up money for stock purchases. Making retirement savings plans opt-out instead of opt-in would nudge middle-class workers both to save more and to own more stock.
A more radical solution is for government to own stock directly, and distribute the proceeds to citizens. Japan’s central bank now does this through stock purchases as part of its program of quantitative easing, which was designed to stimulate the economy. A more permanent idea would be a U.S. sovereign wealth fund, as suggested by economist Miles Kimball. Such a fund would take minority equity stakes — not just in the U.S., but in foreign stocks as well — and distribute the proceeds as the government sees fit. The danger of programs like these is that they could distort corporate decisions or make industries less competitive. But if the government takes only a minority stake in each company, and doesn’t exercise voting rights, private investors will still hold the reins.
One thing is for sure — if the U.S. and other countries want to stop wealth distribution from growing ever more unequal, they’ll have to find a way to more broadly distribute the upside offered by owning stock.
Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.