Two weeks ago, I described two ways of looking at the capital of a modern economy: we can measure the value of physical assets or the total of household wealth. These aggregates are similar but not identical. The widely cited work of Thomas Piketty relates primarily to the value of physical assets.
The quality of available data on the value of physical assets, even in the modern era, is not very high. We have good information about current investment in various categories of assets — plant and machinery, vehicles, offices, shops and warehouses, roads and cables — but not about their current value.
National accounts figures for these assets are mainly estimated using a “perpetual inventory” method, in which allowances are made each year for depreciation, while new investments are added to the existing total. The resulting figure forms the basis of the next year’s calculation. Think of the solera process, where Spanish wine producers draw off a portion of mature sherry from a cask, before replacing it with each year’s new wine.
The calculations are sensitive to the assumptions made about depreciation and the price of capital goods. More fundamentally, it is never clear what one is trying to measure when one asks: “What is the value of the London Underground?”
But with these caveats we can look, as Professor Piketty did, at the long-term development of the physical assets of countries, such as Britain and France, which have a well-documented economic history.
Two centuries ago, agricultural estates were the principal components of capital, and hereditary ownership of such estates the principal determinant of wealth (and its inequality). But agriculture today represents a much diminished share of total output, and farm values in Britain and France were reduced by the opening of territories in North America and other parts of the world. Stately homes are today liabilities, not assets, and modern dukes make ends meet by serving tea to visitors.
These visitors are the new owners of capital. In both Britain and France, more than half of the value of physical assets is represented by residential property.
About 60-70 per cent of houses are owner-occupied, and they have a higher proportion by value. Even after deducting outstanding mortgages — about one-third of property values — owner-occupied housing is the largest component of personal wealth.
Accordingly, the main factor behind the phenomenon that “capital is back” is the increased value of urban land. This is a very different explanation from Prof Piketty’s claim that the growth of capital, and the inequality of its distribution, is driven by an ineluctable historical tendency for the rate of return on capital to exceed the underlying rate of economic growth (leading to indefinite capital accumulation by the wealthiest).
Property wealth comes in two forms: the return from occupying a house one owns, and steadily rising property values. Far from being accumulated, the return from owner-occupation is consumed on an annual basis through the act of living in a house. The rise in house prices, however, has a significant effect on the distribution of wealth; in particular, on the transmission of inequality between generations.
The ability of young people today to benefit from future house price appreciation depends in large part on their parents’ capacity to pass on the benefits of past house price appreciation to them. But that injustice is different in nature and cause from the inequality that concerns Occupy Wall Street, or the purchasers of Prof Piketty’s book.
The growth of housing equity and the value of pension rights have done a lot to distribute wealth more broadly. Their impact on inequality is less laudable.
This article was first published in the Financial Times on December 10th, 2014.