1.1 Introduction
In common parlance, wealth usually refers to the stock of valuable possessions yet the specific meaning of wealth changes contextually. In economics, the wealth means net marketable value (worth), which consists of the sum of all real and financial assets less debt of the economic entities. Net worth
of the
ith individual can be expressed as follows (
Cowell and Van Kerm 2015, 673):
where
are type of the
jth asset, price of the
jth asset and level of debt owned by the
ith individual, respectively.
4 The expression in
eq. (1) underlines three key features that any analysis of wealth should take into consideration:
- – Which assets to be included in the expression ,
- – Valuation criteria for the assets ,
- – Implications of debt and negative wealth .
Although which assets to be included in the definition of the wealth might be seen as a naïve question, the reality is that it has nontrivial implications on measuring the distribution of wealth. The confusion and controversy about which financial assets to include in the definition of wealth are relatively small. On the contrary, when it comes to non-financial assets there is pronounced divergence not only between theoretical and policy-related outcomes but also among the wealth definitions of different institutions, agencies and other domestic or international organizations. One example is the conflation of land and productive capital and resulting conflation between return to capital and return to wealth. Having consistent valuation criteria for the assets is also important since sharp changes in asset prices can significantly alter the level of the wealth inequality (Wolff 2013, 337). For instance, boom in asset prices (real estate and stock market) were responsible for 40% of the rise in private wealth to income ratios in recent decades in the world (World Inequality Lab 2017, 165). Besides, existence of debt in calculation of the wealth, as with eq. (1), has important repercussions. Finally, negative net worth requires different parametric models from those employed for income distribution analysis (Cowell and Van Kerm 2015, 675).
Understanding why the wealth has been so unevenly distributed and how much distribution of wealth can further be unequal require, above all, having a basic knowledge-base in composition and distribution of wealth, as well as, how wealth inequality has evolved over time and what the underlying determinants of wealth inequality are. Chapter 1 aims at giving such a basic understanding of the wealth distribution. We start by introducing a detailed exposition of the composition of the wealth since different definitions of the wealth ends up with different levels of wealth inequality. Another motivation regarding the composition of wealth is to highlight the fact that wealth and capital are different concepts, yet they are usually conflated both in theory and practice. Such confusion has indeed significant effects in understanding what determines the wealth inequality. Dissociating wealth from capital also helps the reader understand the concept of wealth residual, which is the “measure of the mainstream economics’ ignorance” in measuring the wealth inequality.5 Finally, we discuss why income and wealth distributions have diverged in the last several decades. We highlight that assuming wealth as a culmination of the savings and income flows give rise to overlooking the substantial role played by valuation effects and other factors. The bottom-line is that interest-based debt contracts and distortions in the financial system have played consequential role in formation of the divergence between income and wealth inequalities.
1.2 Composition of Wealth
The composition of the production function and elasticity of substitution among the factors of production are important determinants of income inequality because these two components determine how value-added is shared between (and within) capital owners and labor (Atkinson and Bourguignon 2015, xiix). By the same logic, composition of wealth directly affects how wealth is distributed among and within economic actors. As opposed to ample data in composition and distribution of income for many countries over a long horizon of time, the economics literature has still lacked in detailed historical data covering many countries to understand how composition of wealth has evolved across and within countries, yet data sources in wealth distribution, which aim at providing data in a systematic and transparent manner, have been augmented. There are now several studies with their datasets which allow us to understand how composition and distribution of wealth have evolved for numerous countries in the short-run, such as Allianz’s Global Wealth Reports and Credit Suisse’s Global Wealth Reports, and for several countries in the long-run, such as the World Inequality Lab’s World Inequality Report.
In the macro field, the System of National Accounts (SNA) provides a framework for wealth and its components for the whole economy.6 Furthermore, there are recent attempts to develop standardized definitions and classifications for micro-statistics on household wealth such as the OECD’s Guidelines for Micro Statistics on Household Wealth (2013). Although the definitions and classifications overlap, to a large extent, between these two guidelines, there are certain and important differences between micro (household level) and macro (national accounts) fields. These differences are worth explaining in detail since the inconsistency of definitions of the wealth components between the theory and the datasets give rise to incomplete, even biased, results in economics of inequality. A trace of such conflation, to give an example, can even be found in Piketty’s Capital in the Twenty-First Century. Total capital is assumed to equal to the total wealth in his notion of “fundamental inequality” in the book (Piketty 2014, 25). The corollaries derived from this seemingly innocuous assumption is one of the reasons for the controversy in the literature stemmed from Piketty’s findings.
Below, we shortly expound the components of the household wealth based on the OECD (2013) Guidelines. Subsequently, we focus on the definition and components of wealth on the basis of the SNA in more detail. This is because the SNA methodology expands on productive and non-productive capital distinction, which is typically missing in mainstream theory in explaining the drivers of the wealth inequality. Table 1 shows the main components of household wealth based on the OECD (2013) Guidelines. Net wealth of the households consists of three main elements, namely, non-financial assets, financial assets and liabilities. Real estate is the main component of non-financial assets, followed by the durable goods such as vehicles. Financial assets of the households mainly consist of money, deposits, debt securities, listed and unlisted shares, insurance and pension funds. The liabilities are composed of different types of debt instruments. As with the OECD Guidelines for Micro Statistics on Household Wealth, the SNA decomposes wealth into financial assets, non-financial assets, and liabilities for the whole economy. Non-financial assets are composed of produced tangible capital, non-produced tangible capital and intangible capital. Produced tangible capital (henceforward called as productive capital) is the ‘capital’ which is the subject matter of the theory of growth and distribution. Machinery and equipment, dwellings, buildings and inventories are all classified under this rubric. Non-produced tangible assets encompass natural resources including land, subsoil land and other natural assets....