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You’ve got some spare cash, maybe an inheritance from your parents. What should you do with it? Surely you should invest it wisely, by buying something that will produce a secure source of income and a pension in later life. As a smart investor you deserve a return on your investment, don’t you?
You could buy a property to rent out. If you can’t afford to buy one outright you could borrow some of the money, using the rent to pay off your mortgage, and give you a bit extra too. You can probably rely on house price inflation to push up the value of your property, so you’ll benefit from capital gains as well. But there’s always a risk, so you can think of your gains as justified by that. You are a risk-taker, just what the economy needs, aren’t you?
In doing this kind of thing you will be demonstrating your ‘self-reliance’, won’t you, instead of relying on state handouts?
Wrong on all counts: the ‘smart investor’, the landlord, and the bank providing the mortgage are all ‘rentiers—recipients of unearned income, based on the control of existing assets that others need or want, rather than on contributing to the provision of new goods and services. As such, their income is a form of free-riding on the labour of others. Let me explain.
If the asset, say a house, already exists, then there are no costs of production apart from maintenance costs. Those who receive unearned income from existing assets do so not because they are in any sense ‘deserving’—they have not contributed anything that did not previously exist—or because they are judged by others as needy and unable to provide for themselves, but because they can. This is power based on the unequal ownership and control of key assets, what J.A.Hobson called ‘improperty’ in the 1930s.
Let’s say you get £10,000 profit from your house. That money can only have any value if there are goods and services you can buy with it. And for that to be possible, the makers of those goods and services have to produce more of them than they can consume with their own (earned) income. So your £10,000 of unearned income is parasitic on the work of others.
The distinction between unearned income like this and earned income—income based on contributing to the production of goods and services—was central to classical political economy, socialist thought, and the early taxation system in the UK. But in the last three or four decades it’s fallen out of use, just when unearned income based on the control of assets has increased, producing a huge transfer of income to those who control the most improperty—the rich! And it’s the rich, far more than small-time landlords and ‘investors,’ who benefit from this.
What about the self-reliance argument? Well it’s hardly self-reliant to siphon off wealth from others, which is what unearned income presupposes. Rentiers are dependent on wealth produced by others. ‘Independently-wealthy’ is an oxymoron.
But wait, you might say, why this fuss about rentiers? Aren’t today’s wealthy mainly ‘the working rich’, with most of their income coming as salary rather than rent or interest or dividends? Yes, that’s true, though inherited wealth is considerable (28 per cent of wealth in the UK) and getting bigger as wealth is concentrated at the top, as Thomas Piketty has shown. Inheritance mainly provides the children of the rich with huge windfalls.
But the working rich in the top 0.1 per cent mostly either work for rentier organisations that collect and seek rent, interest, dividends, capital and speculative gains, or control key positions where they can determine their own pay. This is most obvious in the financial, insurance and property sectors where many rich people work, but companies in the non-finance sector have made an increasing share of their profits in finance too by ‘investing’ in securities. In the UK in 2008, 69 per cent of the 0.1 per cent worked in finance and property, and 34 per cent were company directors, as were 24 per cent of those in the rest of the one per cent.
Why put ‘investing’ in scare quotes? Investment is surely a good thing, so ‘investors’ must be good people. But the term can mean two very different things: a kind of wealth creation, or a means of wealth extraction.
Think of investing in equipment, a new firm, a school, a training programme, or wind farms. Here the term is used to refer to wealth creation—things which improve the provision of goods and services like better machines, new products, new skills and cleaner energy.
But then think of gains ‘investors’ might get from renting, lending, buying stocks or bonds and other financial assets, buying up existing property and waiting for its value to go up, and speculating. Investments of this second kind need have no connection with investments of the first kind. They need not create anything new. All they are supposed to do is provide a return for the ‘investor’—wealth extraction, regardless. On this definition, gambling is a form of investment.
Using the same word for these two radically different things is a great way of passing off wealth extraction as wealth creation. True, sometimes, the second kind of investment can be connected to the first kind, so the investor or funder gets some of the benefits of an objective investment in new products and services or ways of producing them. But with the shift of the financial sector from servant of the economy to master over the last 30 years, the second meaning has become dominant in practice and more disconnected from the first.
Most of what it funds is not productive industry but lending against existing assets: in the UK lending by the financial sector to productive businesses declined from 30 per cent in 1996 to 10 per cent in 2008, and has stayed low since, while lending to other financial institutions and the property market grew. But then, to the financial sector £1 million profit from useless speculation is no different from £1 million from any other source. Yet the difference matters to the economy as a whole and hence to us.
As for risk, and all that macho talk of risk-taking, there may be a risk in real investment, in which case there’s an argument for the investor getting a return. But if it’s mere rent-seeking—as in buying to let—then the risk is just a matter of betting on what you can extract, and deserves no reward, for as Winston Churchill said, rent (over and above maintenance costs) is a payment for a disservice. We need to rediscover a lost vocabulary, including not only ‘unearned income’, but ‘rentiers’, Hobson’s ‘improperty’ and Keynes’ ‘functionless investors’.
It’s important to know not only how rich the rich are, but how they get their money and whether it’s legitimate. As I show in my book, Why We Can’t Afford the Rich, the key to their success has been wealth extraction, not wealth creation. Unearned income is not only unjust, a form of parasitism, but dysfunctional, because it diverts resources away from the productive economy. We need either to block or tax it: in fact I suggest we tax earned income less and unearned income more.
Is it not bizarre that we think it’s ok to tax the income of those who work to provide goods and services for others, so they share in the burdens of supporting society, but think it’s wrong to tax those who—like the beneficiaries of inheritance—just get a windfall without doing anything.
We need to ask if the rich’s incomes are conditional upon contributing to the production of goods and services or based merely on controlling assets that others need. Money is not wealth. It is a claim on goods and services produced for sale by others, so how people get their money is important. The money pages of newspapers encourage us to think of the rewards from ‘investments’ as rewards for prudence and smartness, which will enable us to be independent, but they are actually encouraging dependence based merely on power.
No-one ever got rich or poor outside of social relations between people—between buyers and sellers, employers and employees, landlords and tenants, lenders and borrowers. We need to think about whether those relations are fair and contribute to the good of society. Talking about the ethics of unearned income is a good place to start.