Comment: Could federal management of wealth slow inequity?

By Aaron Brown / Bloomberg Opinion

A staff report from the Federal Reserve Bank of New York titled “Capital Management and Wealth Inequality” comes to some remarkable Marxist conclusions.

In James Best and Keshav Dogra’s model, an ever-smaller group of capitalists accumulate all wealth, while the ever-bigger proletariat survives on less and less. The optimal solution, reflecting the authors’ personal views and not necessarily the position of the Fed, is for central planners to control all capital with the profits distributed among workers.

The authors don’t claim these events will take place; they only posit a simple mathematical model that implies them. The assumptions are not realistic — all individuals are identical except for wealth; there is no uncertainty — but you judge models by predictions, not assumptions.

The driving assumption is that the more effort you put into managing capital, the higher the return. Wealthy people benefit more from higher returns so devote more time to managing capital, resulting in their greater wealth also growing faster. This lowers the average return on capital, preventing less-wealthy people from profiting through investment by saving or starting businesses. A continually growing working class has no choice but to work for a constantly shrinking investor class that owns everything.

To understand where the predictions might work, it’s easier and less ideological to consider human capital; a model where individuals are identical except for talent, defined as the potential for increasing human capital. People with small amounts of talent don’t find it worthwhile to spend much energy managing their human capital. They don’t work hard in school nor pursue advanced training, they don’t move around for the best opportunities, they don’t put in extra effort for promotions. Talented people find it profitable to increase their human capital, thinking hard about what fields have the highest rewards for study or starting businesses.

This leads to inequality. Small differences in talent can lead to big differences in human capital. But the model’s predictions are not useful for most fields because the inequality does not increase without limit. The best doctor cannot command all health-care resources, much less dominate other fields like engineering or business management. Moreover, top performers don’t impoverish lesser talents, they increase demand for them.

There are fields that the model seems to describe better. Conquerors and dictators, for example, sometimes seem to keep acquiring power, and their success takes power away from lesser claimants. But for some brave resistance and accidents of history, it’s possible to imagine one person ruling the world and everyone else enslaved.

The authors’ solution — putting all power in the hands of a small group to distribute income equally — fails dramatically for the problem of political power because the solution is the problem.

Small groups of celebrities dominate in fields like fiction writing, movies, professional athletics and popular music; and use their financial capital and star power to branch out to other fields. A more worrisome possibility is that advances in artificial intelligence or other technologies could allow a small group of people to run everything.

In these fields, the authors’ solution has more appeal. Instead of a socialist takeover of the entire economy, a few big studios dominating the movie business, a few literary gatekeepers selecting the books most people read or a few professional sports teams signing young people to long-term contracts arguably produce better outcomes than free-for-all markets dominated by a few superstars with most practitioners unable to make decent livings. And the potential for AI dominance of everything pushes even some capitalist-leaning people to support socialist intervention.

Getting back to the report’s concern with physical capital, I suspect the useful conclusions are similar to human capital. For most productive economic activity, the rich do get richer but hit ceilings. Their success brings up others — more jobs, higher wages, more opportunities, more profits for passive investors — rather than stripping everyone else of wealth.

The authors use the Alaska Permanent Fund as an example of central management of physical capital for egalitarian benefits. APF has $56.5 billion saved from state oil revenue — about $90,000 for each eligible Alaskan resident — and pays out annual dividends. In the authors’ model, if instead a one-time sum of $90,000 were distributed, it would increase wealth inequality. Poorer residents would spend the money or invest in relatively low-return opportunities. Richer investors could start businesses, invest in real estate or hedge funds or otherwise earn higher returns. In the future, poorer residents would have less to show for their windfall than richer residents, increasing the wealth gap.

That all seems reasonable, but the further prediction that the extra money would drive down returns on capital and continue to move toward a smaller and smaller group until the richest person in the state had it all seems contrary to experience. The investments by the wealthier people should help everyone with more jobs, higher wages, more tax revenue and more demand. Many poor people would use the money productively, to get out of debt, go back to school and start businesses. Many wealthy people would spend money or lose it in bad investments. The process of increasing concentration seems limited, not an irresistible impulse that can only lead to disaster. State management of the oil windfall does seem more egalitarian and may be a good idea, but I reject the suggestion that the alternative leads to oligarchic dystopia.

The stated goal of New York Fed research reports is, “to stimulate discussion and elicit comments.” This one should succeed spectacularly in that regard, but it isn’t a useful way to think about equality, financial markets or central planning.

Aaron Brown is a former managing director and head of financial market research at AQR Capital Management. He is author of “The Poker Face of Wall Street.” He is also an active crypto investor, and has venture capital investments and advisory relations with crypto companies.