A recent article “RG-bargy” in The Economist focuses on an argument surrounding the central tenet in Thomas Piketty’s economics bestseller, Capital in the Twenty-First Century.
Piketty maintains that a key reason why wealth inequality has worsened dramatically in recent decades is that the return on capital r has exceeded the growth rate of the economy g. As capital is concentrated in the hands of the wealthy, a long period in which there is a growing gap between the return to capital and growth (i.e., r > g) must lead to widening wealth inequality. Citing evidence from eight high-income economies—the United States, Japan, Germany, France, Britain, Italy, Canada and Australia—Piketty shows that, since 1970, long-run growth has slowed but the return on capital has not changed significantly. Thus, in developed economies and throughout the world, wealth has become increasingly concentrated in the hands of the rich. What is more, Piketty predicts that future growth rates are likely to slow down further. Thus, in the coming decades the gap between r and g will widen, and thus wealth inequality will increase.
However, as pointed out by The Economist, Piketty’s evidence concerning r > g has been challenged in a forthcoming article in the Cato Journal by Robert Arnott, William Bernstein and Lillian Wu. The authors do not dispute the slow-down in long run growth g. Instead, they maintain that the future return r to capital, principally bonds, stocks, equities and other financial wealth, will also fall. This is due to two principal reasons.
First, because yields in the developed world are so low, the future returns from bonds are likely to be reduced. Similarly, sustained periods of low interest rates—such as the current situation—are also associated with reduced equity returns over the long term.
Second, Arnott and colleagues argue that the net capital return to investors is even lower, once one accounts for taxes, fund-management costs, and other investment expenses. If based on the net return to capital, the future level of r will decline further.
However, this “RG-bargy” controversy has a major shortcoming, which is that it ignores an important source of economic wealth—natural capital.
As I argued in a previous post, “Natural Capital in the Twenty-First Century”, and a subsequent article “Account for the depreciation of natural capital” in Nature, economic indicators need also to take into account the depletion and degradation of natural resources. This is especially important when measuring either economic growth or the return to capital.
For example, in estimating the long-run economic growth rate g, Piketty uses the conventional economic measure of national income, which is net national income (NNI). Specifically,
Net National Income (NNI) = total goods and services produced domestically (GDP) + net income from abroad − the value of the consumption of domestic fixed capital
However, adjusting income for consumption of domestic fixed capital takes into account only depreciation of dwellings, factories, structures, road, and other built infrastructure, equipment, inventories, consumer durables, and other forms of human-made, or reproducible, capital. No allowance is made for the depletion or degradation of natural capital for production purposes. This is the value of net losses to natural resources, such as minerals, fossil fuels, forests, and similar sources of material and energy inputs into our economy. The resulting measure is adjusted net national income. That is,
Adjusted Net National Income (ANNI) = NNI − depreciation of natural capital
If we use up more natural capital to produce economic output today, then we have less for production tomorrow. Thus the true growth rate of an economy should be based on ANNI.
Future growth rates in the world economy are likely to be lower if natural capital depreciation is taken into account in measuring net income. As I indicate in my Nature article, two global trends are noticeable.
First, the decline in natural capital has been five times greater on average in developing economies than in the eight richest countries. Second, natural capital depreciation in all countries has risen significantly since the 1990s. There was a dip during the global recession of 2008-9, but as the world economy has recovered, so has the rate of resource use. Both trends suggest that the future growth in the production of goods and services in the world economy will require using up more natural resources rather than less, resulting in a lower growth rate in ANNI.
What about the future rate of return on capital r? Note that Arnott and colleagues consider only the rate of return to investors in financial capital, such as bonds, equities and similar investments. They do not consider the rate of return to investments in natural capital, in particular minerals, fossil fuels, forests, and similar sources of material and energy inputs into our economies. However, if natural capital depreciation is on the rise globally, then the rate of return r on future investments in remaining stocks of material and energy inputs might not fall significantly and could even increase. Moreover, equity holdings in companies that invest in natural capital will also see buoyant returns.
If the focus is on net rather than gross returns to investors in natural capital, then there is a worrying global trend: production and exploration of many sources of natural resources enjoy generous subsidies.
Take fossil fuels, for example. Subsidies to producers occur when suppliers of fossil fuels receive higher than market prices in domestic markets, and include tax breaks, allowances for accelerated depreciation, and reduced royalty payments to governments. A report for the Overseas Development Institute indicates that these subsidies may range from $80 billion and $285 billion annually in developing and emerging market economies. Estimates from the Global Subsidies Initiative suggest that oil and gas production subsidies in Russia are around $14.4 billion annually; in Norway, $4 billion; in Canada, $2.8 billion; and in Indonesia, $1.8 billion. According to the Oil Change Institute, in the United States, fossil fuel production subsidies have grown from $12.7 billion in 2009 to $18.5 billion in 2014. Thus, production subsidies artificially boost the returns to investment in the extraction and selling of fossil fuels.
Related to production subsidies is government-provided support for fossil fuel exploration, which aims to find new oil, natural gas, and coal resources and reserves. According to Elizabeth Bast and colleagues in another ODI report, between 2010 and 2013, the Group of 20 (G20) countries—the twenty largest and richest economies in the world—provided each year $49 billion for investment by state-owned enterprises in these activities, $23 billion in subsidies of direct spending and tax breaks, and $16 billion in other forms of public finance for exploration.
All this suggests that, once natural capital and its depreciation is taken into account, Piketty may be proven right. Future growth in the economy could be even lower because of natural capital depreciation, and the long-run return to capital—inclusive of holdings of natural resources—may not necessarily decline. If the gap between r and g does widen, then wealth inequality will continue to worsen in the world economy. Reducing excessive natural capital depreciation and policies that artificially inflate the returns to natural resource assets appear to an important counter to this growing global problem.
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