Great Expectations, part 2 -- The World that Was

As I showed in my previous article, Americans are deeply dissatisfied with the long-term course of the economy. Fewer Americans identify themselves as "middle class". They fear they will not be comfortable in retirement, and will have to retire later in life, if they can retire at all. They're convinced wealth in America is distributed unfairly, and that wealth disparity is increasing.

There are reasons for these fears and concerns. The "middle class" is a recent phenomenon in human history. There is no economic law that forces a middle class to exist. For most of the time civilization has been around, people have been divided into a tiny group of immensely wealthy rulers, and the great mass of extremely poor workers who support them. The middle class only came into existence about a hundred years ago. It was brought about by changes in policy, and it can be easily dismantled -- or can be saved -- by further changes to policy.

What created the middle class? What is its likely fate over the next generation or two?

What is the Middle Class?

Much of what follows is taken from Thomas Picketty's groundbreaking Capital in the Twenty-First Century, from which I will unabashedly steal a number of graphs and much of my analysis. (Buy the book. Read it. Learn it.) To have a clue as to where we're going, we have to understand how we got here.

To begin, let's ask the question, "What is the middle class?" We can answer this in any number of ways. One of the clearest and most meaningful is the approach Picketty takes. In the developed world today, we can divide people into three distinct groups based on ownership of capital. (And what is "capital"? I'll get to that in a minute.)

1) There is the bottom 50% or so, who own practically nothing. Half of all the people who live in developed countries have zero (or even negative) net assets. That is, if you take the value of everything they own, and subtract from that the amount of money they may owe, you will come out with zero net worth (or close to zero, or even negative net worth). Between them all, the bottom 50% may own about five percent of a nation's wealth.

2) At the other extreme, there are the richest 10%, who own around sixty to seventy percent of a nation's wealth. We can further divide this group into smaller subsets, which I will do later -- for now, treat them as a single group. Consider this for just a second -- we're talking about one tenth of the population, who together own significantly more than half of all the wealth that exists in the country. That's called "wealth disparity".

3) With fifty percent of the people on the bottom, and ten percent on top -- that leaves 40 percent in the middle. If the bottom half own as much as 5 percent of the nation's wealth, and the top group owns 60 to 70 percent, that leaves about 25 to 35 percent of the wealth -- between one quarter and one third -- to be owned by this middle 40%. This is the "middle class".


What I have just described is the situation as it exists in developed nations today. Each nation varies from the others in detail, but not in kind. This is true for America, Canada, France, England, Germany, Australia, China, Japan, Scandinavia -- virtually all developed nations, and most of the developing ones, too. About half the people own pretty much nothing. About one tenth own the lion's share of around 60 or 70 percent of everything. That leaves a group of about 40% of the people, who own between one quarter and one third of the things that can be owned.

From Piketty, Capital, p215. In Europe and America, the top 10% own between 60% and 70% of everything. The bottom 50% own about 5%. The middle class owns between 1/4 and about 1/3. This inequality is worse in America than in Europe, and was worse in the past than it is today.

I will note in passing that this wealth disparity is greater in the United States than it is in any other developed nation. The top 10% of Americans own a bigger share of America than the top 10% in England own of their country. The middle class in America owns far less of America than the middle class of France owns of France. The Scandinavian countries are most equitable and have the smallest wealth disparity. American wealth disparity is the greatest of all the developed nations.

Capitalists will say this is a Good Thing, and that it is one bit of proof that America is the Most Greatestest Country in the World Ever. Well, a capitalist would say that, wouldn't he? After all, if you're a capitalist, you can be richer here than you can be anywhere else. Not only can you be richer, but the contrast between the rich and everyone else is greatest here, which is emotionally satisfying if you're one of the rich.

As I said, this division -- from bottom to top: 50/40/10, owning roughly 5/30/65 -- This is the current state in the developed world. It was not always this way.

Before the Middle Class

For most of human history, there were really only two groups, not three. The top 10% owned about 90% of everything. Picture a city block with ten houses on it, and 100 people living in that block. Ten of the block's inhabitants together own nine of the houses. The other ninety people on the block are crammed into the last house at the end of the line. That was the state of the world from the invention of agriculture, in around 6000 BCE, up until about the beginning of the twentieth century.

We can subdivide those two groups. The top 10% had its own top group -- the top tenth of the top tenth, amounting to maybe 1% of the total population.  They owned about 50% of everything. You can think of them as royalty -- the kings and queens and princes, who never worked a day, and could acquire or appropriate anything they wanted. In out "city block" example, one person owns five of the ten houses on block. The rest of the wealthy people -- the next nine (think of them as "nobles" instead of "royalty") -- between them own four of the ten houses. The one King owns five houses, the nine nobles between them own four, and the last house is split between the ninety serfs.

The poorer 90% of the population was made up of A) tradesmen (who may have owned, say, a forge or a kiln or a loom), and B) peasants (who owned nothing). Wait -- "nothing"? Don't things like clothes and furniture count? No, they do not (but don't amount to much anyway). We're talking about economics here. We're concerned with what's called "capital", which you can think of as "stuff you can use to make money -- or to make other stuff." A house counts as "capital" because you can charge someone rent for living there. Clothes are not capital. The rags on your back can't be used to make money (unless perhaps you're in a very particularized sort of profession -- say, an actor -- and then they're not "clothes" but "industrial equipment").

In our city block, a group of maybe 20 people -- the tradesmen -- jointly own that last house, and they use it to produce goods and services. The final 70 people own nothing, and have to rent rooms to live.in from the people who do own something. They earn their money to pay rent by working for the tradespeople -- or, more likely, by working as farmers to produce food for the nobles and the King.

This was the state of the world up through the seventeenth and eighteenth and into the nineteenth centuries. The wealthy 10% owned the land and the farms, which were worked by peasants, who paid rents to the nobility in order to purchase the privilege of working the land. A few tradespeople made tools that the peasantry bought from them -- and made weaponry, and built houses and castles that were purchased by the nobles and kings. But often, even the forges and kilns of the tradespeople were owned by the nobility, and were only rented by the tradespeople.

In the seventeenth and eighteenth centuries, most wealthy people got their income from two sources -- either from rents, or from interest on money they'd loaned to the government. Governments, you see, would often borrow money -- sometimes for public works (roadbuilding, dams and flood control, police and constabularies, and so on), and often to pay for wars. Landowners would loan this money to the governments, which would tend to run long-term debts. The interest payments made by the government to the lenders would be financed by taxes and by conquest.

So the major forms of capital before the nineteenth century were: 1) land and real estate, from which the owner could obtain income in the form of rents, and 2) government debt, which furnished (usually) reliable interest payments. The people who owned capital -- and who lived off of this capital -- were "capitalists". All other people were serfs.

This pattern changed slightly in the eighteenth and nineteenth centuries, with the advent of the Industrial Revolution. Real estate and rural lands were reduced in importance with the coming of factories. Now, buildings, mines, machinery, and urban land (along with the ever-reliable government debt) became the things to own. Financial assets also became important -- investors could own companies, and then ever-more elaborate investment entities and various forms of "intellectual capital" including patents and trademarks.

The nature of capital changed --but not its distribution. Serfs moved into the cities, and technological changes made it possible to support the population with fewer people working the farms. Throughout the nineteenth century, the "developed world" still had about 10% of the population owning about 90% of everything, and the great mass of serfs now working the factories and the streets instead of merely the land. There still existed no "middle class".

Growth, Inheritance, Inflation

The world as I've just described it was quite stable. There were wars and various forms of civil unrest from time to time, even the occasional plague or banking crisis to mix things up a bit. But certainly until the eighteenth century, technological change was glacially slow, and population grew no faster.

From Picketty, Capital, p96.

The data Picketty presents shows that, over a period of centuries -- even millennia -- annual population growth averaged on the order of 0.01% or less. It stands to reason -- if the world population was in the tens of millions two thousand years ago (it was actually far more than that), then annual growth of even 1% per year would mean we'd have over 4,000,000,000,000,000 people today -- almost a half million times the number of people we actually have.

The same sorts of considerations apply to economic growth. The lot of most people changed very slowly, if at all. It could take dozens of generations to see any difference in the lives of most people.

Consider this fact carefully. For most of human history, economic growth rates were very slow indeed. Today, if our economy doesn't grow at a rate of at least 2 or 3 percent every year, we consider that to be a crisis. Until the eighteenth of nineteenth century, it might take many generations to see an economic growth of 2 or 3 percent.

From Picketty, Capital, p 102

With little growth (in either population or the economy), there also was little inflation. Prices for things like food or housing or clothes -- or land, or labor, or ships or raw materials -- remained virtually constant for centuries at a time. Writers and novelists and economic theorists in the sixteenth and seventeenth centuries could talk about the prices of good and services, or the incomes of tradespeople, or the wealth obtained by selling a parcel of land -- and those prices, whether expressed in gold or in national currency (the pound, the franc, the ruble) would be comprehensible and pretty much the same two or three hundred years later.

The world is different now from how it was before the beginning of the twentieth century. The distribution of wealth has changed -- there is now a middle class. We now have the phenomenon of inflation. Population growth and economic growth is now far greater that it has ever been.

Are there laws of economics, as inevitable as the laws of physics, that brought about these changes? Is there any force that will ensure the middle class continues into the future? I showed last time that actually fewer people consider themselves "middle class" than there used to be, and they have a profound unease about what is to come.

What created the sea change in world economics? Where is it likely to go? I'll address these questions in my next post.