28 January 2019

The myth of the idle rich


This month Oxfam released a report, as it does every year, pointing out that there are some very rich people in the world and how terrible this is. The report gained a great deal of media attention (as it does every year), with the vast majority of political commentators agreeing that it really is disgusting that some people are very, very rich.

Despite the report’s very obvious flaws, and Oxfam’s unhelpful obsession with inequality, it does raise an interesting question. Just who are the wealthiest people in the world, and how did they get so filthy rich?

The traditional left-wing view is that people become rich through avarice and exploitation. The way to get rich, according to the Marxist worldview, for example, is on the back of the talents and hard work of the oppressed proletariat and greedily maximising profits at the expense of wages and working conditions. Either that, or they simply inherited their money from their parents or grandparents. Regardless, the life of wealthy is one of constant leisure and relaxation, completely free from toil.

The common retort to this accusation is that the rich deserve their wealth because they work hard for it. The argument goes something along the lines of: “People such as CEOs become rich through hard work and determination”.

So, who is right — how do you get rich? Both views are wrong. Let’s start with the leftists’ argument. Although it’s certainly true that there are some examples of businesses who exploit their workers, this is most certainly not the norm. People do not become rich by keeping other people poor.

What is more, although some people are obviously rich due to the largesse of their parents or grandparents, this is becoming increasingly uncommon. For example, a study by Merrill Lynch found that 70 per cent of rich families lose their wealth by the second generation, and 90 per cent by the third.

As for the view that it is all about hard work, this is also obviously not correct. If it were true, then people working in labour intensive roles would be the richest people around the world. Not only is this obviously untrue, it is strikingly similar to the labour theory of value posited by Marx.

You can work flat out every single day, but if nobody is willing to pay you for your goods and services then it’s completely worthless. People become rich by providing value to others. This is not to play down the importance of hard work in becoming rich (or at least keeping yourself above the breadline), but it is the market that determines value, not labour.

The debate often misses the point, which is why an academic paper published last month entitled ‘Capitalists in the Twenty-First Century’ is so helpful. The economists who wrote the paper studied tax data in the US and found that most top earners are working rich, deriving their income not from physical or financial capital but rather from human capital.

This is important as it dispels the myth of the idle rich. The wealthiest people are those in work. What is more, they are not becoming rich through exploiting others, they earn their wealth by using their skills adding value to their firms.

The paper is a reminder is the importance of human capital. It is often overlooked in debates about wealth, but its importance was first explained by Adam Smith in The Wealth of Nations:

“Fourthly, of the acquired and useful abilities of all the inhabitants or members of the society. The acquisition of such talents, by the maintenance of the acquirer during his education, study, or apprenticeship, always costs a real expense, which is a capital fixed and realised, as it were, in his person. Those talents, as they make a part of his fortune, so do they likewise that of the society to which he belongs. The improved dexterity of a workman may be considered in the same light as a machine or instrument of trade which facilitates and abridges labour, and which, though it costs a certain expense, repays that expense with a profit.”

Therefore, Smith recognised that human capital, alongside the other three types of fixed capital was an essential ingredient for wealth creation.

This is not just useful for demonstrating why those on the left are wrong about wealth and inequality, but has implications for how businesses and governments should act.

As ‘Capitalists in the Twenty-First Century’ points out, human capital is a major contributing factor in wealth creation for individuals and firms. This has undoubtedly always been the case. But, it is now more important than ever. As Jonathan Haskel and Stian Westlake point out in their brilliant book, Capitalism Without Capital, major developed economies have been investing more heavily in intangible assets such as design, branding, research and development, and software as opposed to machinery, factories, and computers.

Human capital is also an intangible asset. However, it belongs to individual workers, not to businesses. What is more, it is generally not fungible. This is especially true when the worker has a very high level of human capital. Therefore, if firms want to be successful, then it is now more important than ever that they invest in training for their workers to ensure they have the relevant skills. Moreover, given that human capital is not something which can be simply replaced overnight, companies will need to keep their employees engaged and motivated so that they do not leave to join a rival firm.

This has wide-ranging impacts for government policy. It was established by Gary Becker that human capital is something which can and should be invested in. Furthermore, there is a great deal of evidence which demonstrates that human capital plays an important role in economic growth and the overall economic welfare of the population. The importance of human capital in relation to productivity has also been recently highlighted in a paper from the Oxford Martin School.

Unfortunately, the UK only ranks 15th in the World Bank’s Human Capital Index. The Government should take a long hard look at its spending priorities. It currently wastes huge amounts of money on projects such as HS2 and attempts to pick winners through its industrial strategy. What it should be doing is spending taxpayers’ money wisely, on things which will increase human capital, such as education.

It should also resist pressure from politically motivated charities such as Oxfam and their incessant calls for higher taxes. Rather, they should reduce the tax burden on businesses so that they can invest more in their workers by spending money on training them.

Oxfam gets it wrong when it comes to wealth. Most people are not wealthy because they exploit others. Wealth creation is dependent on a number of factors, with human capital playing an increasingly important role. Therefore, if we want to see the economy grow and allow more people to become rich, then taxing the wealthy is not the solution. Instead, the Government should focus its spending priorities on proven ways to increase human capital and allow businesses to do the same by taxing them less.

Ben Ramanauskas is a Policy Analyst at the Taxpayers' Alliance.