Widening Wealth and Inequality Gaps Have Limits

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.