The Weird Political Economy of R < G

Piketty may have published at exactly the wrong time, since there is some question about his famous formulation “r > g”.  That stands for “the rate of return on capital is greater than the rate of growth”, meaning that capital tends to accumulate in fewer hands in capitalist systems.  The NYT reports on what has been going around in finance circles for some time – the general return on assets has been falling rapidly since its peak at the depths of the financial crisis.  It’s somewhat unclear how exactly this is possible, though many theories have to do with central banks buying up assets as part of quantitative easing.  There are other schools of thought – either that too much money is being saved or that there are too few investment opportunities, which are kind of the same idea phrased differently.  This might be a moment that passes quickly, but at least at this moment in time it appears that the returns to capital are falling quickly.  I think it’s worth stepping back for a moment and wondering about the changes to American political economy if in fact r < g.

Most big institutions – though not the federal government – are in big trouble.  Universities in particular will likely suffer, because they can no longer rely on healthy returns from endowment investment.  Pension funds are similarly in trouble, because they generally rely on fixed returns from their investment funds.  For both, there will likely be serious downsizing of future promises as the reality sinks in.  Businesses will likely also face issues as well, because they will have few opportunities to productively deploy their profits.  Leadership in the business world will become less stable, because profitable businesses won’t have as much of an opportunity to develop an economic moat.  In general, institutions will be less stable and competition amongst them more volatile.  The same will apply at the individual level – investments will either be low-return or pushed further out the risk curve, and wealth will be less durable.  We would expect a flattening of the income distribution and greater social mobility.

The political economy of this is moderately concerning – there will be a great deal of pressure for the government to do things to increase the rate of return on capital.  The currently powerful don’t like the institutional foundations of their power eroded away, and so juicing r will be a key political goal for institutions, the wealthy, and their representatives.  Some of this will take familiar forms – capital gains tax cuts, more anti-labor laws, and perhaps more implicit or explicit investment subsidies.  But this is pretty unusual – for the most part, a general glut of savings has not been a problem of the modern era, because there have been plenty of avenues for extensive and intensive growth via deploying capital.  I’d probably be prepared for things to get strange when it comes to policy.

More strangely, the elite political pressure for quantitative easing will probably only grow.  At this point, ending quantitative easing will deliver a massive hit to financial asset prices.  QE presents a novel form of a traditional finance problem, the tradeoff between upside and capital preservation.  Even if QE is eroding the realized return on asset prices, central banks’ purchasing actions are propping up the prices of assets and thus preserving capital for current capital holders.  Ending QE might make greater investment returns possible, but it’s unlikely those gains will accrue to those who are currently holding large amounts of financial assets, who will take large hits in the process.  This suggests that there’s a potential for a positive feedback loop here in QE and decreases in r: more QE decreases r, but generates more pressure to keep QE going.

In short – the political economy of r > g is well-understood, but the political economy of r < g is much less well-understood.  If this is a general feature of the future financial landscape, we can probably expect to see some novel political phenomena emerging.


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