Sunday, 1 June 2014

Capitalism, Consumerism & The Distribution of Wealth

How do you become a millionaire? In theory, it is quite easy. Just convince a million person to give you a dollar each. In practice, it can be quite difficult to do so, judging by the people who beg at MRT stations and hawker centres. The trick then is to give people something they want and ask for more in return. For example, if you have a product that costs $10 to produce and distribute, sell it for $11 and you will make $1 from those whom you sell to. If you can sell it to a million people, then you would have made $1 million dollars. However, this is not the end of the story. If consumers need to buy the same product from you a second time or you can produce a second version of your product, another $1 million goes into your pocket. This can be repeated countless times.

In practice, a company is set up to produce and sell products. It is not uncommon to have the top shareholder owning 40% or more of the company's shares while the next 19 shareholders own the other 40%. Thus, 20 shareholders own 80% of the profits of the company, a very concentrated form of the 80-20 rule. When consumers buy the company's products, money is collected fairly evenly from the consumers, but when the company distributes its profits, money is concentrated among the major shareholders. It is like an inverted funnel where money is collected fairly evenly from consumers and profits redistributed disproportionally to a small group of major shareholders.

Thus, capitalism ensures that money is collected from everybody and redistributed disproportionally to a small group of successful entrepreneurs while consumerism ensures that this exercise is repeated countless times. Eventually, we will have statistics that show the top 10% of the population owning 90% of the wealth.

Before you protest against capitalism, consider for a moment that the wealthy also exists in non-capitalist societies. How do the wealthy in these societies accumulate their wealth? Would you prefer the wealthy accumulate their wealth through innovation, foresight and hard work in capitalist societies or through other means in non-capitalist societies? Moreover, these entrepreneurs produce a product that satisfies our needs and wants. We should not begrudge the wealth that these entrepreneurs accumulate. Nevertheless, there are people who are struggling with their daily lives and as a society, we should look at what we can do to help them.

To address the inequality of income/wealth, we can look at the wealth distribution mechanism of capitalism, which is the concentration of shareholding in the hands of a small group of major shareholders. If the shareholding of companies could be distributed more broadly to more people, we would be able to share the fruits of capitalism among more people and reduce income/wealth inequality. However, this also depends on the willingness of the major shareholders to reduce their shareholding. If the top 20 shareholders continue to hold tightly to their 80% shareholding, the attempt to distribute the remaining 20% shares among more people would only result in more demand for the same number of shares, pushing up the wealth of the top 20 shareholders as well.

Governments can play a role in reducing income/wealth inequality. Through taxes, governments can collect a portion of corporate profits and personal income. These taxes could be rechannelled to fund social programmes to help those in need. Tax transfers have been shown to reduce the Gini coefficient, a measure of income inequality. However, in recent years, governments around the world have been reducing taxes to entice investors to set up operations in their countries. Nevertheless, we also have some wealthy entrepreneurs willing to stand out and speak up for more taxes for the rich.

The best method for reducing the income/wealth inequality is to reverse the flow of money from mass consumers to major shareholders through philanthropy. Like all goods and services, there is diminishing marginal utility with wealth. The more wealth a person has, the less marginal utility of that extra dollar. To a middle-income worker, a hundred dollar could mean a lot to him, but to a millionaire, the same amount could mean nothing to him. By transferring the hundred dollar from the millionaire to the middle-income worker, the millionaire essentially loses nothing while the middle-income worker gains a valuable hundred dollars.

Many wealthy individuals and families recognise this fact and are willing to donate a majority of their wealth to charitable causes. The names of these individuals and families can be found at The Giving Pledge. Unfortunately, in Asian societies, philanthropy is still not prevalent. Most wealthy individuals prefer to leave their wealth to their descendants.

We could perhaps encourage greater philanthropy by borrowing an idea from the patent system. The patent system encourages invention and innovation by allowing the inventor to benefit exclusively from his invention for a limited period of time. After the patent expires, others are free to copy his invention and sell it at a lower cost. Can the concept of patent expiry be used on wealth, i.e. can wealth expires after a period of time after which it can be redistributed to others who need it more? A suitable period of time would be the lifetime of the person, i.e. when a person dies, a part of his wealth automatically expires and is redistributed to others. This concept is consistent with the utility of wealth described earlier. To a person who has passed away, the utility of wealth to him is negligible. However, we recognise that there is utility of that wealth among his descendants and dependents and not all that wealth should expire. An acceptable percentage of the wealth that expires could be 5% above a certain threshold.

To effect the wealth expiration, an estate tax could be imposed. However, to encourage philanthropy, the estate tax could be waived if the descendants of the deceased donate an amount equivalent to the estate tax to a charitable organisation of their choice. The estate tax essentially becomes a philanthropy tax. In donating the wealth rather than paying the estate tax, the wealthy individual also leaves his name behind to legacy.

To conclude, capitalism has the ability to generate great fortunes for societies that embraces it. However, this wealth is concentrated on a small group of successful entrepreneurs. If we can transfer the excess wealth that these wealthy individuals do not need to the mass of people who struggle with their daily lives, society as a whole would benefit greatly from capitalism.

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  1. Hi The Boring Fisherman,

    Pondering about capitalism too, but in terms of output and workers.

    NGOs and civics activism can do some re-balancing of wealth too.

    But, we need to create wealth before we can redistribute wealth. That is the pragmatic doctrine our existing administration buy into.

    1. Yes, capitalism is a great tool for creating wealth. We just need to find better ways to distribute the wealth thus created to benefit society as a whole.