Season Investments


The Capitalist Dilemma

Posted on July 8, 2014

“Labor produces subsistence at best. Capital can produce affluence.” – Louis Kelso, economist

The two most divisive topics of conversation are probably money and politics. At the risk of alienating some of our readers, we will tackle a topic that hits on both today. Over the past couple years, much attention has been given to the wealth gap here in the United States and around the rest of the world. Movements like Occupy Wall Street have sprung up to express the discontent of the masses about the inequality of wealth held by the top 1% of income earners in our economy. Some might dismiss these types of protests as nothing more than simple jealousy. But the question we must ask is whether the current gap between the “have’s” and the “have not’s” creates a fundamental problem for our society and if so, how do we fix it?

Most free market capitalists believe that the “invisible hand” of the marketplace self-regulates without the need for government intervention. Milton Friedman even went as far as to state that freedom, which can also be construed as free markets, will naturally produce equality.

A society that puts equality—in the sense of equality of outcome—ahead of freedom will end up with neither equality nor freedom.… On the other hand, a society that puts freedom first will, as a happy by-product, end up with both greater freedom and greater equality

In theory, the belief in a self-regulating, free market economy producing the greatest amount of equality is nice, but in practice it is rarely the case. Look at today’s economy for example. We continue to improve our productivity through automation and computerization, which brings the cost of goods sold down, which is good for the economy as lower costs should make products more widely available and increase demand. The problem with this virtuous cycle is that the increased productivity is coming at the expense of human capital (jobs). The cycle can’t be virtuous if it is taking jobs and income away from the people who consume all the “stuff” being produced. In other words, we are increasing productivity at the expense of demand for the very things we are producing.

"When capital workers (owners) replace labor workers as the major suppliers of goods and services, labor employment alone becomes inadequate because labor's share of the income arising from production cannot provide the progressively better standard of living that technology is making possible. Labor produces subsistence at best. Capital can produce affluence. To enjoy affluence, all households must engage to an increasing extent in capital work." - Louis Kelso, Economist

The concentration of wealth in today’s society is with those that have access to and control capital versus those that can perform a trade or service. This is why the 400 wealthiest Americans own more productive capital than the bottom 150 million Americans combined. According to historical income data from the IRS compiled by Professor Emmanuel Saez at California Berkley, the top 1% of income earners account for roughly 19% of the total income pie here in the United States or 23% when capital gains are included in the calculation. The embedded chart shows how we are reaching levels of inequality today which haven’t been seen since the end of the Roaring 20’s right before the Great Depression.


So if we believe that income inequality is indeed a natural by-product of capitalism, the next logical question to ask is whether or not it is bad for our society. Richard Wilkinson who is a retired professor of Social Epidemiology at the University of Nottingham gave a TED talk back in 2011 using publically available data to show how there was a high degree of correlation between nations with higher degrees of income inequality also showing higher degrees of things like illiteracy, infant mortality, homicides, obesity, and mental illness.

Professor Wilkinson might be oversimplifying the situation to state that income inequality is to blame for his long list of societal ills, but it is probably safe to say that income inequality is at least an influential factor with an overall negative effect on our society. If that is the case, why is our society reaching all-time high levels of inequality?

As previously stated, technological advances have had a huge impact on the growing inequality gap. Technology is continuously changing the fabric of society. Whether we are talking about the invention of the wheel, the light bulb, or the internet, all of these innovations had dramatic impacts on society. The speed of technology and the interconnected world affords the opportunity for people to create “overnight successes” in business and subsequently amass great fortunes in a relatively small period of time (e.g. Bill Gates, Steve Jobs, Mark Zuckerberg, etc.). The ability to “go viral” with a product and reach so many people in such a short amount of time means that entrepreneurs have the potential to be catapulted into the 1% strata in a relatively short period of time compared to centuries past were family wealth was built over multiple generations. The difference between the 1% of the Roaring 20’s and those of today is that a century ago, the highest income earners derived most of their income from wealth that had been built up and accumulated from previous generations…what we would now call “trust fund babies.” Today, the top income earners are “working rich” with high paying executive level jobs or entrepreneurs who have been very successful with their business. This is one reason why the gap between the 99% and the 1% is so large today.

So what can we do to fix it? This question does not have an easy answer. Some like Professor Wilkinson would advocate for constraining the earnings of the 1% (taxes). Others have gone as far as to propose a Capital Homestead Act to redistribute wealth. Neither idea is a perfect solution, and we would venture to guess that there is no perfect solution to this problem, but what if instead of concentrating on how to keep the 1% from getting richer, attention was instead turned toward how to increase the wealth of the 99%? As Louis Kelso stated in the opening quote, a job (labor) provides sustenance, but it is capital that produces wealth. With that in mind, why aren’t we doing more to promote entrepreneurship and investing instead of encouraging our children to go into eyeball popping amounts of debt in order to learn a skilled trade? Maybe those two scenarios are not mutually exclusive options, but our society might be better served by emphasizing entrepreneurship and the importance of investing in capital assets at a young age than the importance of getting good grades in school in order to secure a high paying job which one day might be replaced by an automated machine.

elliott_headshot_bw.jpgAuthor Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.

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