Rachel Reeves on “Wealth Creation”
I posted a thread on “X” about the commitment the new UK Chancellor, Rachel Reeves, continues to declare to “wealth creation”:
What puzzles me about this is that the UK doesn’t seem at all short of wealth. The UK’s total wealth was on the order of £11.8 trillion in 2021. You can complain about the distribution of wealth, or you can complain that wealth isn’t invested in the best ways. But it’s hard to see how you could think that what we need is to create more of it.
In fairness to Reeves, she does complain about those last two things. You can read a manifesto she wrote in 2018 about it here. Still, the headline policy is wealth creation, not distribution or investment. Thinking about this made me realise how much confusion there is around terms like “wealth” and “economic growth” in the speeches and writings of politicians and the popular press.
Wealth and Growth
Somebody suggested to me that when Reeves talks about wealth creation she actually means economic growth. That is certainly suggested in this article in the Financial Times, which says, for example:
Ultimately, there is only one way out of the bind the country is in: a return to strong and sustained economic growth. Wealth creation will be the defining mission of the next Labour government.
Juxtaposition suggests that “sustained economic growth” and “wealth creation” are treated as equivalent. This is highly confusing.
Economic growth is normally thought of as growth in Gross Domestic Product, which is, roughly, the total combined income of everyone in the country. If the distribution of income doesn’t change then growth in real GDP means growth in your real income. Don’t sneer at the protasis of that sentence; income inequality hasn’t actually moved all that much in the last few decades (wealth inequality is a very different story, but we’ll get to that). So growth in GDP sounds good for most people.
GDP hasn’t grown very fast in the UK lately. In 1996 GDP was around £1.4tn. In 2021, it was around £2.1tn. If that seems big, compare it to the growth of wealth. In 1996, the UK’s net worth or total wealth was £3tn. In 2021, as mentioned, it was £11.8tn. While GDP grew by a half, wealth nearly tripled.
Of course it’s possible that Reeves and Labour mean something else by “wealth”. At one point in her manifesto she quotes John Ruskin: “There is no wealth but life”. These words appear in all capitals in Unto This Last, where Ruskin goes on: “That country is the richest which nourishes the greatest number of noble and happy human beings”. But at other times Reeves uses “wealth” to mean the thing of which there is £11.8tn worth. That, I think, does not conduce to wealth in Ruskin’s sense.
If, like most people, you don’t start with much wealth, then your only way to acquire it is to earn income and save. For you, the massive growth of wealth relative to income is bad for your chances of becoming a noble and happy human being.
Suppose your real income is rising at 3% per year. Every year you can buy 3% more clothes, haircuts, fuel, food, etc. To that extent, you’re better off. But if wealth is rising six times as fast then you are commanding a smaller share of society’s wealth each year. And there is one important thing you can buy less of every year: housing. Rising wealth de facto means rising home values. If wealth is rising faster than income, then everyone who doesn’t own a home already becomes poorer each year in terms of housing.
Wealth is much, much, much more unequally distributed than income. As wealth grows relative to income, it comes to dominate the economy more and more, and so the whole situation becomes more unequal. This does not lead to a greater number of noble and happy human beings.
Return on Wealth
Something you don’t often see measured is the relation between wealth and GDP. This is odd because it’s common in business to compare revenue to value. If I tell you that one business makes £100 of sales per year while another one makes £10,000, which do you want to invest in? Hopefully you will answer that you don’t have enough information. What matters isn’t the amount of revenue as such. If the first business makes £100 revenue off £100 of assets (say its market cap is £100), while the second makes £10,000 off £1,000,000, the first is obviously the way to go.
Likewise, GDP just tells you what the economy is earning on its total wealth. GDP is measured in £ per year (in the UK). Wealth is measured in £. You can work out the UK’s price-to-sales ratio by taking wealth divided by GDP — this gives you a figure in the dimension years (£ divided by £/year)— and then dividing by 1 year to get an annual rate, which gives you a dimensionless number. In 1996, the UK’s price-to-sales ratio was 2.14. In 2021, it was 5.6. As a going concern, the UK is becoming more expensive and less productive.
This makes nonsense of another thing we might imagine Reeves to mean. She might mean that wealth creation is the way to boost economic growth. On the contrary, the marginal product of additional wealth seems to diminish: the more you add to wealth, the less revenue you get from it.
Investment
This is puzzling, on the face of it. Why wouldn’t rising wealth lead to more investment and spending, thus boosting GDP? The likely reason is that the increase in wealth is coming in rising asset prices, which don’t get counted in GDP. If you bought a house in East London in the 1990s (you bastard) then your wealth might have quadrupled, but this doesn’t get logged as income. Nor does it get logged as income when your children inherit the house, even if they pay some inheritance tax on it (though a good accountant should be able to get you out of that).
If the best way to grow your wealth is to just hold onto rising assets then growing wealth corresponds to less rather than more investment. The game of buying and holding assets crowds out the game of investing in new business ventures. The best way to grow your wealth is not to invest it, and there’s a big tax incentive to follow this path.
The logic behind “growth through wealth-creation” is something like this: more wealth means more capital to invest. Investment causes production, and more production leads to higher wages and more stuff to buy with them (hopefully without this leading to higher greenhouse gas emissions, but that’s another story).
However, the fact that wealth has grown so much faster than income in the UK suggests that wealth is being invested less and less productively. If the policy is to get wealth invested more productively then the name for this policy should be something like wealth intensification or increased wealth exploitation, not wealth creation.
Grey Capital and Income Suppression
In my thread I also mentioned Erixon and Weigel’s book, which shows that even when wealth is invested in assets that generate income, this is a long way from the textbook image of capitalism, where profit-seekers look to place their capital in the most productive ventures. Instead, the majority of financial wealth is held in giant pension funds, which invest in index funds, which spread investment over thousands of corporate conglomerates, which in turn own a huge portfolio of businesses. This “grey capital”, as Erixon and Weigel call it, doesn’t seek productivity; it just smears wealth across the whole market and benefits from a steady overall rise in the mark-to-market price of assets.
A good business idea is hardly likely to register any effect on “grey capital”, but anything seriously innovative would probably register a negative effect: showing up as a diversion from the ordinary pattern and leading the fund to divest and go for something more predictable.
Thus growing wealth, collecting into gigantic, blind index funds, works to smother and suppress the innovation and dynamism that generate income: the things that “capital” is meant to provide, at least in the story that Reeves sells. Wealth creation, in effect, is income suppression. It also suppresses productivity.
Income Creation?
The political goal should be to boost income, not wealth. Higher incomes might lead to growing wealth, but the reverse is certainly not true. Wealth has entirely divorced itself from income when the best way to get rich is to buy expensive things and wait for them to get even more expensive. Wealth doesn’t finance productive investment when it sits aloof in grey funds that bet on nothing much changing and rig the game in favour of that bet.
But you can see why politicians don’t talk about “income creation”. Commentators would reply that income must be earned, not “created”. The fact that the same reply doesn’t come up in the case of wealth tells you how wrong things have gone in the economic culture.
