Capital in the Twenty-First Century (78 page)

All too often, the global debate about great wealth comes down to a few peremptory—and
largely arbitrary—assertions about the relative merits of this or that individual.
For example, it is rather common to contrast the man who is currently the world’s
wealthiest, Carlos Slim, a Mexican real estate and telecom tycoon who is of Lebanese
extraction and is often described in the Western press as one who owes his great wealth
to monopoly rents obtained through (implicitly corrupt) government favors, and Bill
Gates, the former number one, who is seen as a model of the meritorious entrepreneur.
At times one almost has the impression that Bill Gates himself invented computer science
and the microprocessor and that he would be 10 times richer still if he had been paid
his full marginal productivity and compensated for his personal contribution to global
well-being (and fortunately the good people of the planet have been the beneficiaries
of his “positive externalities” since he retired). No doubt the veritable cult of
Bill Gates is an outgrowth of the apparently irrepressible need of modern democratic
societies to make sense of inequality. To be frank, I know virtually nothing about
exactly how Carlos Slim or Bill Gates became rich, and I am quite incapable of assessing
their relative merits. Nevertheless, it seems to me that Bill Gates also profited
from a virtual monopoly on operating systems (as have many other high-tech entrepreneurs
in industries ranging from telecommunications to Facebook, whose fortunes were also
built on monopoly rents). Furthermore, I believe that Gates’s contributions depended
on the work of thousands of engineers and scientists doing basic research in electronics
and computer science, without whom none of his innovations would have been possible.
These people did not patent their scientific papers. In short, it seems unreasonable
to draw such an extreme contrast between Gates and Slim without so much as a glance
at the facts.
²⁰

As for the Japanese billionaires (Yoshiaka Tsutsumi and Taikichiro Mori) who from
1987 to 1994 preceded Bill Gates at the top of the
Forbes
ranking, people in the Western world have all but forgotten their names. Perhaps
there is a feeling that these men owe their fortunes entirely to the real estate and
stock market bubbles that existed at the time in the Land of the Rising Sun, or else
to some not very savory Asian wheeling and dealing. Yet Japanese growth from 1950
to 1990 was the greatest history had ever seen to that point, much greater than US
growth in 1990–2010, and there is reason to believe that entrepreneurs played some
role in this.

Rather than indulge in constructing a moral hierarchy of wealth, which in practice
often amounts to an exercise in Western ethnocentrism, I think it is more useful to
try to understand the general laws that govern the dynamics of wealth—leaving individuals
aside and thinking instead about modes of regulation, and in particular taxation,
that apply equally to everyone, regardless of nationality. In France, when Arcelor
(then the second largest steel company worldwide) was bought by the steel magnate
Lakshmi Mittal in 2006, the French media found the actions of the Indian billionaire
particularly outrageous. They renewed their outrage in the fall of 2012, when Mittal
was accused of failing to invest enough in the firm’s factory in Florange. In India,
everyone believes that the hostility to Mittal is due, at least in part, to the color
of his skin. And who can be sure that this did not play a role? To be sure, Mittal’s
methods are brutal, and his sumptuous lifestyle is seen as scandalous. The entire
French press took umbrage at his luxurious London residences, “worth three times as
much as his investment in Florange.”
²¹
Somehow, though, the outrage is soft-pedaled when it comes to a certain residence
in Neuilly-sur-Seine, a posh suburb of Paris, or a homegrown billionaire like Arnaud
Lagardère, a young heir not particularly well known for his merit, virtue, or social
utility yet on whom the French government decided at about the same time to bestow
the sum of a billion euros in exchange for his share of the European Aeronautic, Defense,
and Space Co. (EADS), a world leader in aeronautics.

One final example, even more extreme: in February 2012, a French court ordered the
seizure of more than 200 cubic meters of property (luxury cars, old master paintings,
etc.) from the Avenue Foch home of Teodorin Obiang, the son of the dictator of Equatorial
Guinea. It is an established fact that his share of the company, which was authorized
to exploit Guinea’s forests (from which he derives most of his income), was acquired
in a dubious way and that these forest resources were to a large extent stolen from
the people of Equatorial Guinea. The case is instructive in that it shows that private
property is not quite as sacred as people sometimes think, and that it was technically
possible, when someone really wanted to, to find a way through the maze of dummy corporations
by means of which Teodorin Obiang administered his capital. There is little doubt,
however, that it would not be very difficult to find in Paris or London other individuals—Russian
oligarchs or Quatari billionaires, say—with fortunes ultimately derived from the private
appropriation of natural resources. It may be that these appropriations of oil, gas,
and aluminum deposits are not as clear-cut cases of theft as Obiang’s forests. And
perhaps judicial action is more justified when the theft is committed at the expense
of a very poor country, as opposed to a less poor one.
²²
At the very least, the reader will grant that these various cases are not fundamentally
different but belong to a continuum, and that a fortune is often deemed more suspect
if its owner is black. In any case, the courts cannot resolve every case of ill-gotten
gains or unjustified wealth. A tax on capital would be a less blunt and more systematic
instrument for dealing with the question.

Broadly speaking, the central fact is that the return on capital often inextricably
combines elements of true entrepreneurial labor (an absolutely indispensable force
for economic development), pure luck (one happens at the right moment to buy a promising
asset at a good price), and outright theft. The arbitrariness of wealth accumulation
is a much broader phenomenon than the arbitrariness of inheritance. The return on
capital is by nature volatile and unpredictable and can easily generate capital gains
(or losses) equivalent to dozens of years of earned income. At the top of the wealth
hierarchy, these effects are even more extreme. It has always been this way. In the
novel
Ibiscus
(1926), Alexei Tolstoy depicted the horrors of capitalism. In 1917, in St. Petersburg,
the accountant Simon Novzorov bashes in the skull of an antique dealer who has offered
him a job and steals a small fortune. The antique dealer had become rich by purchasing,
at rock-bottom prices, the possessions of aristocrats fleeing the Revolution. Novzorov
manages to multiply his initial capital by 10 in six months, thanks to the gambling
den he sets up in Moscow with his new friend Ritechev. Novzorov is a nasty, petty
parasite who embodies the idea that wealth and merit are totally unrelated: property
sometimes begins with theft, and the arbitrary return on capital can easily perpetuate
the initial crime.

In order to gain a better understanding of unequal returns on capital without being
distracted by issues of individual character, it is useful to look at what has happened
with the endowments of American universities over the past few decades. Indeed, this
is one of the few cases where we have very complete data about investments made and
returns received over a relatively long period of time, as a function of initial capital.

There are currently more than eight hundred public and private universities in the
United States that manage their own endowments. These endowments range from some tens
of millions of dollars (for example, North Iowa Community College, ranked 785th in
2012 with an endowment of
$
11.5 million) to tens of billions. The top-ranked universities are invariably Harvard
(with an endowment of some
$
30 billion in the early 2010s), Yale (
$
20 billion), and Princeton and Stanford (more than
$
15 billion). Then come MIT and Columbia, with a little less than
$
10 billion, then Chicago and Pennsylvania, at around
$
7 billion, and so on. All told, these eight hundred US universities owned nearly
$
400 billion worth of assets in 2010 (or a little under
$
500 million per university on average, with a median slightly less than
$
100 million). To be sure, this is less than 1 percent of the total private wealth
of US households, but it is still a large sum, which annually yields significant income
for US universities—or at any rate some of them.
²³
Above all—and this is the point that is of interest here—US universities publish
regular, reliable, and detailed reports on their endowments, which can be used to
study the annual returns each institution obtains. This is not possible with most
private fortunes. In particular, these data have been collected since the late 1970s
by the National Association of College and University Business Officers, which has
published voluminous statistical surveys every year since 1979.

The main results I have been able to derive from these data are shown in
Table 12.2
.
²⁴
The first conclusion is that the return on US university endowments has been extremely
high in recent decades, averaging 8.2 percent a year between 1980 and 2010 (and 7.2
percent for the period 1990–2010).
²⁵
To be sure, there have been ups and downs in each decade, with years of low or even
negative returns, such as 2008–2009, and good years in which the average endowment
grew by more than 10 percent. But the important point is that if we average over ten,
twenty, or thirty years, we find extremely high returns, of the same sort I examined
for the billionaires in the
Forbes
rankings.

To be clear, the returns indicated in
Table 12.2
are net real returns allowing for capital gains and inflation, prevailing taxes (virtually
nonexistent for nonprofit institutions), and management fees. (The latter include
the salaries of everyone inside or outside the university who is involved in planning
and executing the institution’s investment strategy.) Hence these figures reflect
the pure return on capital as defined in this book, that is, the return that comes
simply from owning capital, apart from any remuneration of the labor required to manage
it.

The second conclusion that emerges clearly from
Table 12.2
is that the return increases rapidly with size of endowment. For the 500 of 850 universities
whose endowment was less than
$
100 million, the average return was 6.2 percent in 1980–2010 (and 5.1 percent in 1990–2010),
which is already fairly high and significantly above the average return on all private
wealth in these periods.
²⁶
The greater the endowment, the greater the return. For the 60 universities with endowments
of more than
$
1 billion, the average return was 8.8 percent in 1980–2010 (and 7.8 percent in 1990–2010).
For the top trio (Harvard, Yale, and Princeton), which has not changed since 1980,
the yield was 10.2 percent in 1980–2010 (and 10.0 percent in 1990–2010), twice as
much as the less well-endowed institutions.
²⁷

If we look at the investment strategies of different universities, we find highly
diversified portfolios at all levels, with a clear preference for US and foreign stocks
and private sector bonds (government bonds, especially US Treasuries, which do not
pay well, account for less than 10 percent of all these portfolios and are almost
totally absent from the largest endowments). The higher we go in the endowment hierarchy,
the more often we find “alternative investment strategies,” that is, very high yield
investments such as shares in private equity funds and unlisted foreign stocks (which
require great expertise), hedge funds, derivatives, real estate, and raw materials,
including energy, natural resources, and related products (these, too, require specialized
expertise and offer very high potential yields).
²⁸
If we consider the importance in these various portfolios of “alternative investments,”
whose only common feature is that they abandon the usual strategies of investing in
stocks and bonds accessible to all, we find that they represent only 10 percent of
the portfolios of institutions with endowments of less than 50 million euros, 25 percent
of those with endowments between 50 and 100 million euros, 35 percent of those between
100 and 500 million euros, 45 percent of those between 500 million and 1 billion euros,
and ultimately more than 60 percent of those above 1 billion euros. The available
data, which are both public and extremely detailed, show unambiguously that it is
these alternative investment strategies that enable the very largest endowments to
obtain real returns of close to 10 percent a year, while smaller endowments must make
do with 5 percent.