Rethinking wealth

Wealth and income distribution have been in the social scientists’ focus since the dawn of modern economics. However, discussions on such topic often fail right at the definition of the invisible reference point of equal distribution. On the one hand, it is often interpreted as the equal distribution of goods between individuals; on the other hand, it can be also meant as equal number of people within certain income brackets. Even though these arguments would be worth a book, if not a small library, I would like to take the argument one step back to measuring wealth.

As easy as it is to observe capital-related wealth by using share or bond price indices, labour-related wealth remains hidden when we account for wealth distributions using classical models. No wonder that wealth numbers indicate a more unequal, highly dispersed scale compared to plain vanilla income figures.

In the case of a financial claim the market simply calculates a net-present value of it, and right away we know the immediate wealth of the individual(s). But what does this really mean? According to Benjamin Graham’s famous metaphor Mr. Market tells us a price where he is willing to buy our future cash-flow. There is no difference in the case of labour-related income either. The market or bank gives us a quote on which we can exchange our future earnings for a certain amount of money. Yet this kind of wealth is not accounted for, a missing element of household balance sheets which distorts overall numbers when compared to capital instruments.

In its nature this invisible wealth, or labour stock is very similar to share prices: its value is positively correlated with earnings growth, negatively with required returns. Let me express it with less econ-finance nerdy words. With increasing wages one could afford higher instalments, hence is eligible for a higher amount of principle. Given lower debt servicing costs our fixed income can finance a higher amount of debt.

Credit issuance makes this invisible element of household balance sheets observable through debt markets. Even though market creation always helps optimal allocation, each coin has two sides. On the one hand, we are able to exchange these future earnings for another asset (e.g. real estate), while we are also make changes on our liability side, converting invisible equity into visible liabilities. (See picture below) On the other hand, this conversion of the invisible part of the balance sheet might create false assumptions, as physical balance sheets expend, but in reality the economy does not necessarily follow as the potential were there all along.

After all this theoretical discussion lets see how much money are we considering. If the labour force of the US would exchange their future earnings to a fixed amount of money they would receive an eye-watering 338 230 billion US dollars… plus change. The number is derived by using the Gordon growth model on wages and salaries as they were dividends, data retrieved from the Fed. So let me put it into context: this is 19 folds the GDP, or 14 times the S&P market capitalisation (all at the end of 2015). The growth rate of this stock is also remarkable. In the last half of a century the value growth of labour stock outpaced S&P 500 returns by an annualised 48 basis points.

My point here is not to support one or the other perspectives when it comes to considerations of what is just. My aim is rather to say that before we get ourselves into such discussion get the right numbers and use apples-to-apples figures, so we don’t make false claims or assumptions. Because of this invisible part of the economy, I would certainly prefer income numbers over wealth.


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