The Savings Glut And The 1%
Damon Linker does a fine job tearing into the absurdity of Jamie Dimon’s (of JP Morgan Chase) and Henrique De Castro’s (of Yahoo) stratospheric compensation in the wake of lackluster to poor performance of the public corporations in their respective charge. We’ve heard that news before, but so long as it doesn’t change, it’s still news.
But in passing, he makes a point that I think is worth another look. Apropos of why the 1% continues to get richer at a faster rate than other segments of the population, he says:
Part of it is undoubtedly a result of the greater opportunities for wealth generation enjoyed by rich people everywhere. Turning $1 million into $10 million is usually easier than acquiring the $1 million in the first place — and, all things being equal, turning $10 million into $100 million is even easier.
Why, though, should that be the rule? Why should returns to wealth “accelerate” in this fashion? It’s not a law of nature by any means.
With any enterprise, greater scale brings greater efficiencies in some areas, and worse efficiencies in others. Greater scale gives you greater bargaining leverage in contract negotiations, standardization can reduce the overhead associated with all sorts of decision making, etc. But, on the other hand, greater scale means that the process of moving information up the chain of command gets more difficult and expensive, the growth of vested interests within an organization that conflict with one another and are not aligned with the interests of the organization as a whole, and standardization can substantially reduce flexibility. At the very largest scales, it becomes impossible to grow because the market becomes saturated.
What all of the above should mean is that larger fortunes/businesses are more readily preserved, either growing or decaying slowly, while smaller ones have a greater chance of both growing rapidly and evaporating completely. It should not, in general, be the case that larger fortunes or businesses grow more rapidly more easily than smaller ones.
Moreover, right know we are purported to be in the middle of a long global savings glut (though that concept is, of course, disputed), where there is too much savings chasing too few legitimate investment opportunities. This is one explanation for low long-term rates and persistently recurrent asset bubbles. But if returns to capital are low in general, how does it become easier to grow a large fortune than a small one? Shouldn’t low returns to capital mean that big pools of money stagnate? Isn’t this precisely what Bill Gross was complaining about?
In an overall low-return environment, returns should scale inversely with the size of the investment opportunity. There should be no liquid asset classes that present attractive returns, and any large opportunities that are less-liquid but could attract large pools of capital should also show degraded returns because of the high degree of competition to invest. Whereas small, below-the-radar opportunities should still exist simply because they are too small to be worth the time of a large pool of capital to investigate. An environment of high real interest rates should be the one where capital holds the whip hand.
If it is indeed easier to make $100 million out of $10 million than to make $10 million out of $1 million, that suggests a process of cartelization in the investment world. In other words, the distinction between self-dealing in contracts for wages versus greater “opportunities” for the very wealthy to achieve high returns to capital may be specious. Both situations may involve a substantial element of self-dealing.
Alternatively or additionally, it’s yet more evidence that real interest rates are actually quite high.