Wealth condensation is a theoretical process by which, in certain conditions, newly-created wealth tends to become concentrated in the possession of already-wealthy individuals or entities. According to this theory, those who already hold wealth have the means to invest in new sources of creating wealth or to otherwise leverage the accumulation of wealth, thus are the beneficiaries of the new wealth.

Political objections to wealth condensation

Two processes that some critics claim are driving wealth condensation are:

1. The process by which corporate officers are paid large salaries and bonuses, the total compensation sometimes being as much as thirty thousand times as much as that of their lower-paid employees. Critics of the corporate system have often charged that there is a substantial disconnect between a) officer performance and compensation, and b) officer compensation and worker compensation, and that officers are compensated at levels disproportionate to either performance or payroll because they are already part of the elite, and that this is a self-perpetuating methodology to maintain an elite class (see neofeudalism).
2. If the economy of any country is organized in the interests of the super-rich, or is a plutocracy in which only the wealthy can hold government office, it should be expected that wealth condensation will follow. Some critics say a modern example of this is the current executive of the U.S. In the view of some critics (e.g. Paul Krugman) the tax policies of the Bush administration vastly favor the wealthy over the poor and the middle class. The argument underlying this is that progressive tax systems are being scrapped in favor of regressive tax systems, driving wealth condensation (by allowing the wealthy to retain more of their wealth as disposable and investible income.)

Some advocates believe wealth condensation is common throughout democratic countries with free market economies, which they claim exemplify the old phrase "The rich get richer and the poor get poorer." (Although most would concede that the extent to which this is true varies from regime to regime, particularly in regard to "unearned income tax" policies.) For instance, the "law of the centralization of capital" was posited by Marx as applying to all capitalist societies.

In defense of wealth condensation

Few people have actually argued that raising wealth differentials is a good thing in itself, but whether it is inherently harmful or unjust has been questioned. For defenses of economic inequality see that article or: Equality of outcome.

Some types of condensation are legitimate, others are not

Proponents of free market economics argue that this "leveraging of wealth" can be explained either by the legitimate creation of wealth by its owners or by specific instances of malfeasance. Therefore, by this line of argument, the results do not constitute a "process" or "effect", and to describe it as such could even be misleading because it would conflate two distinct sorts of behavior: one legitimate and positive, the other dishonest and harmful.

The trickle down effect

An argument in support of free markets and the wealth disparity they create is that even if the gap between rich and poor widens, the poor themselves are actually better off than they would have been in the more equal state without free enterprise. This is a central element of the theory called the "trickle down effect".

Free market supporters claim that wealth condensation theory applies less strongly to democratic countries. They point to the United States as a counter-example of the theory, on the grounds that its middle class is materially the most prosperous in recorded human history, with America's poor being as economically well off as the middle class of other, less industrialized countries.

Critics of this position point out that the total wealth of the United States is vastly higher than most other nations, and that the relatively superior standard of living of the American poor is solely due to this single disparity. They argue that the relative wealth of the lower and middle class of the United States is due to a kind of global wealth condensation, which allocates global resources disproportionately to the wealthier countries.

Winner-takes-all markets

If returns to scale are positive, or if superstars are exponentially more valuable than the average, some argue that it is natural and efficient to reward some vastly more than others. Again; it is argued that this will lead to benefits for all, even though it will hurt the second-best in the short term.

The theoretical economic conditions for wealth condensation

The first condition is an unequal distribution in the first place. Without this there is nothing for the new wealth to 'condense' onto. This condition is surely safisfied in developed nations in 2005. In their wealth condensation model Bouchard & Mezard estimate that 90% of "total wealth" is owned by 5% of the population in many rich countries. They say that the distribution of wealth throughout the population is closely described by a Pareto-tails function, which decay as a power-law in wealth. (See also: Economic inequality).

A team from Jagellonian University produced statistical model economies showing that wealth condensation can occur whether or not total wealth is growing (if it isn't this means that the poor get extremely poor).

A correlation between being rich and earning more

Given an initial condition in which wealth is unevenly distributed, several economic mechanisms for wealth condensation have been proposed:

Either:

• A correlation between being rich and being given high paid employment (oligarchy).
• A marginal propensity to consume low enough that high incomes are correlated with people who have already made themselves rich (meritocracy).
• The ability of the rich to influence government disproportionately to their favor thereby increasing their wealth (plutocracy).

In the first case, being wealthy gives one the opportunity to earn more through high paid employment (e.g. by going to elite schools). In the second case, having high paid employment gives one the opportunity to become rich (by saving your money).

In a capitalist society with a marginal propensity to consume below one these are 'automatic' causes of wealth condensation due to variable incomes. The following points relate to the concentration of wealth (capital) itself, even in the absence of variable wages...

A positive net real rate of return to capital

This condition would bring wealth condensation around more quickly than the two possibilities above (because there is so much net worth in the world). The general rate of return to capital investment is sometimes called the rental rate by economists, but here we consider the actual private income received, after taxation.

Very roughly, the

net real rate of return = (nominal risk-free interest rate - Inflation) - (unearned income tax, dividend tax, and other capital-gains taxes).

If this rate is positive then owners of capital (George Orwell's "dividend-drawing class") will get richer if they neither produce or consume but simply "leave their money in the bank". It is under this condition (positive net return to capital) that widespread wealth condensation is most likely. (Wealth condensation would be inevitable in the long run in this case, unless the unearned income were consumed more rapidly that it was accumulated.)

Even if the rate of net return to capital is not positive on average, wealth condensation will also occur if the largest owners on average receive a higher return than smaller owners; this would constitute wealth condensation within the capitalist class rather than at the expense of the non-capitalist class.

Examples of Negative real returns:

• These were a long term Japanese phenomenon, despite and because of their high rates of private saving before deflation.
• Many countries in the 1970s experienced stagflation and surprise inflation which meant that the purchasing power of savings was substantially reduced even with the interest income, (which implies a negative real rate of return to capital).
• Since capital gains taxes apply on nominal earnings the net amount of wealth can decline even when the risk-free yield is above inflation. This is why inflation is sometimes said to be a "Wealth Tax", which prevents wealth condensation. Furthermore, the tax bands are not typically inflation-adjusted, so a higher share of nominal income must be paid in tax each year even as real incomes remain flat.

Hypothetically, leaving a small amount on deposit and then sleeping for several hundred years will lead to great wealth through the action of compound interest. Unfortunately, historical real rates of return show that the effects of taxation and inflation would likely leave you worse off than when you started (with the money on risk-free deposit).

Asset inflation

A common econometric phenomenon throughout developed nations since the beginning of the 1990s (and earlier) is that assets (such as housing, stocks, and bonds) are inflating faster than the CPI or the commodity price index.

For instance, the money price level of bread and milk has risen by 1-5% annually in most G7 countries since the mid 1980s, but real estate prices in those same countries have inflated at least twice as fast in money terms. At the same time, business assets are becoming more expensive (as measured through decaying PE ratios in the same time frame).

If this trend continues those with "little or no net worth" will find it harder and harder to join the "ownership society" as the proportion of average salary required to buy any sort of limited asset (especially housing) increases.

References

• J.-P. Bouchaud and M. Mezard, 2000, Wealth condensation in a simple model of economy. ( ^*) Published in Physica A 282
• (Zdzislaw Burda and others at Jagellonian University), 2002 "Wealth condensation in Pareto macroeconomies" model appears in Physical Review E, vol 65

See also

• Economic Growth and Tax Relief Reconciliation Act of 2001
• Gini coefficient
• Inequity aversion

External links

• Winner-takes-all markets defined in the Economist magazine.
• Industrial Workers of the World

Wealth