Housing vs financial wealth

Chris Giles deserves great credit for his careful scrutiny of Thomas Piketty's data, and Piketty also deserves credit for the openness of that data and for his generous response to Chris. Like Justin Wolfers and Paul Krugman, though, I wonder just how damaging Chris's critique is of Piketty's central thesis.

Chris says that, in the UK, "there seems to be little consistent evidence of any upward trend in wealth inequality of the top 1 percent." He points to ONS data showing that the top 1% owned 12.5% of all wealth in 2010-12.

However, this proportion is depressed because house prices are high. These mean that the owner of quite a modest home has substantial wealth which naturally depresses the proportion of wealth held by the really well-off.

If we look only at financial wealth, we see a different picture. The top 1% owns 36.4% of all financial wealth, and the top 10% owns 75.9% (table 2.6b of this Excel file). As the ONS points out, the Lorenz curve for financial wealth is much steeper than that for property wealth. If you believe the ONS is under-counting offshore wealth,  inequality is even greater.

This poses the question: should we conflate housing and financial wealth as Chris and Thomas both do? Perhaps not, because housing wealth might not have as much "wealthiness" as financial wealth, in four senses:

1. Is housing net wealth at all? Willem Buiter argued that it isn't, because high house prices are a liability for non-owners who'd like to buy. On this view, the liabilities of non-owners are greater than the ONS estimates and so wealth is more concentrated than it claims.

Housing is only wealth for those planning on trading down - and these are probably a minority of home-owners.

2. Does housing do as good a job as financial wealth in cushioning us from shocks? There are two reasons to think not. One is that housing wealth doesn't protect us from local economic risks. If a big local employer closes down, home-owners might lose their job and see their house price fall. Also, housing doesn't protect us from distribution (pdf) risk. Think of house prices as being capitalized future wage earnings and share prices as capitalized future profits. If there is a permament(ish) shift in income from wages to profits - say because of robotization, globalization (pdf) or other increases in capitalist power - house prices will fall as wages do but share prices will rise. Financial wealth will therefore be a better hedge than housing against a drop in wages.

3.Does housing wealth give us as much freedom as financial wealth? I suspect not, in part because it's lumpier than financial wealth: it's easy to create an income by drawing down financial wealth, but less easy to draw down housing wealth as home equity release schemes are often poor value.

4. Does housing give us political power? To some extent, yes; nimbyism prevents new building, and there's a strong lobby in favour of low mortgage rates (though its power consists in harming the incomes of moderately well-off savers rather than the mega-rich with more diversified portfolios). But on the other hand, it is ownership and/or control of capital that confers power over economic policy-making, for example by being able to demand low taxes or that governments don't damage business "confidence".

My point here is a simple one. Wealth inequality matters because of what wealth does. (For me, one curious omission of Piketty's book is that he doesn't tell us enough about why we should care about inequality.) It's possible that financial wealth does more than housing wealth. If so, it is inequality of this that is more important. 

Comments

[SK]

So someone who is saving for a deposit (who is fighting against the will of FLS/HTB/QE/ZIRP) is more wealthy than someone who has a house (who gets subsidised by the above)?
This does not sound right.

[Metatone]

Good post - I think the choice of the FT to feature Giles' critique so heavily, before it was peer-reviewed by anyone else is interesting as well.

Piketty is now conveniently tainted, - any mention will result in howls of "debunked in the FT."

No doubt this will be described in the language of "needing a scoop" but it is surely politically convenient for the FT demographic.

[paulc156]

The other interesting consequence of discarding residential property from Piketty's data is that his 'stable' return on 'capital' disappears. So his whole thesis goes with it. If 'r' is not stable over the centuries at 4-5% as he claims [apparently it isn't if you exclude residential property] and yet 'g' falls below that figure, then there is no reason to suspect that inequality must therefore follow on. Which seems to imply that Marx was closer to the truth than Picketty, since he, unlike P maintained that 'r' was indeed quite variable.

[Doug carmichael]

Lot going on about P's numbers. Corrections however will show that the picture P gives us is worse because of under reporting.

But the main "correction" is on the implications. Dollars convert to consumer goods, but the more important issue is access to those who know, those who have power. More wealth allows one to live and work in the neighborhoods of the more wealthy. Its the ability of money to encourage a person to participate in the hierarchy upstream from where they are that is the most important and amplifies their wealth. Consumption, according to the economists narrow view, is more just buying where you are.

[Chris Cook]

Like most economists, the exclusion of land from Piketty's analysis (forget housing - we are talking about land here) tends to invalidate his conclusions.

Putting to one side Chris Giles' hatchet job - and he should be ashamed of some of the front-page polemic, snide references and cheap shots so clearly aimed to please his readership - I would say a plague on both their houses.

It is self evident to anyone not deaf and blind that we have once again - in yet another cycle, the greatest yet - reached the unsustainable end point of the toxic combination of compound interest on debt and private property in the commons of land.

Since the vast bulk of monetary wealth was created as a result of bank-created credit secured against land, then the huge swathe of debt claims on land reduces by the same amount the 'wealth' of the millions of people with mortgage loans secured on that land.

The systemic problem of the shrinking purchasing power (forget wealth for a minute) of the 99% gets worse by the day as automation eats away at the middle class, and austerity hits everyone except the 1%.

The effect of this is that property wealth - whoever owns it - is simply unrealisable, because the purchasing power does not exist in the economy to acquire it other than as buy-to-let (the 1% again) in which case mortgage slaves become rent slaves.

Back to the Victorian Future.

[Dave Timoney]

Houses are visible and easily priced, so there is the likelihood of selection bias in the study of wealth trends. This will have been exacerbated since 1979 as rules on capital mobility have been eased - i.e. it has become easier to hide/under-report non-property wealth.

The cost of housing also has a bearing on Piketty's (perfectly reasonable) decision to illustrate a common trend in European inequality by using a simple rather than a weighted average. Though he didn't include it, Germany appears to have very high inequality because so many people rent and property ownership is concentrated towards the top of the scale.

The problem then is that housing wealth is an imperfect guide to total wealth, and may even be misleading in international comparisons, but it may be the most comprehensive proxy we've got while states allow so much wealth to be offshored or hidden.

[Nick]

Hang on does ANY form of wealth actually satisfy your four criteria satisfactorily? Or if we take 4 seriously, why not describe senior political party membership or social networks or a jey civil service job as a form of capital. Your argument risks hitting the no true scotsman fallacy. No single kind of wealth delivers all these supposed components of capital. A diverse portfolio of different kinds of wealth might in aggregate get a bit closer, and of course, for many homeowners diversifaction is a problem.

[Ben]

Great blog entry.

On point 1, even if boomers do downsize they can only do it in small numbers, en-masse the "wealth" is not realisable.

Housing wealth is the greatest trick the UK establishment ever played on the plebs. They can't all downsize, other equivalent housing costs the same amount. Transaction taxes are % so wage wealth is lower. Borrowing is up so more money goes to The City. It really is the emperor's new clothes writ large.

The UK will live to regret this chimera. Or rather the boomer spawn will.

[John]

I would say financial wealth gives more freedom since it's more liquid

[gaddeswarup]

A layman's question. Why is housing wealth considered not liquid? In 1995, I bought a house in Melbourne for 150,000 Australian dollars with a ten percent deposit. Since then prices have been going up and it is now worth over a million dollars. Over years I have borrowed various amounts of money to fund business for a family member or houses for children from amounts varying between hundred to over two hundred thousand. I think that I can borrow over three hundred thousand and invest in stocks if I want though I never did that.

[Tom]

Chris - what do you make of the paper prominently featured on Marginal Revolution that taking in account housing wealth weakens, not strengthens, Piketty's argument that wheat inequality is increasing: "According to four French economists, Piketty’s measure of the capital stock is greatly influenced by the Europe-US housing bubble that preceded the financial crisis...Adjusting for that factor seems to make the main results go away..."
http://marginalrevolution.com/marginalrevolution/2014/05/what-do-the-piketty-data-problems-really-mean.html

[NoniMausa]

Two things about wealth to remember in many of these arguments:

First, the effects of wealth do not ramp up smoothly; they have break points above and below which the possessor's options and strategies abruptly differ. Above a certain very high level, some wealth attains black-hole status. A billionaire, in control of some 20,000 median wages, has more and different power than 20,000 middle class workers.

Secondly, what we call wealth is a protean substance, more or less useful at any one time depending on which form it takes. The wealthy have the spare resources to shift their resources now here, now there, depending on the most advantageous form. Many of those forms are not monetary.

It is seldom the fact that dominating one form, whether cash, land, gold, political power, power through intimidation and violence, power through cleverness and skill, and so on, provides a secure spot, over generations, at the top of the totem pole. Rather, a structured mix of several forms is needed, and that requires a large surplus over the comfortable cost of living, in the range of 200X upwards, to establish and maintain.

Noni

[chris]

@ Tom - the 4 economists make a good point. But it's about the aggregate wealth-income ratio, not the distribution of wealth.