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Friday, 15 September, 2017

A widening rich/poor divide hurts us all.

Summary: The rich/poor divide is an important indicator of economic and social well-being. The wider it is the weaker the economy and the higher the social discontent and hardship suffered by those at the bottom of the scale. One of the main drivers of this widening gap is our inadequate and inappropriate business measurement standard, which serves the needs of the rich. Currently, business is a tool for the enrichment of a few at the expense of all others. However, a new measurement standard would stop this by serving the needs of all business constituents through a balanced approach.

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Our inadequate and inappropriate business measurement standard has turned us into profiteers. Our profiteering practices have contributed to the widening rich/poor divide as business is focused on short-term profit generation for the exclusive benefit of shareholders; the owners of capital - the rich.

Wealth distribution which is skewed disproportionately towards the rich is bad for the economy and society for these reasons.

  1. A strong middle class indicates a strong economy as their income is recirculated quickly and almost in its entirety within what I call the “active economy.” Adam Smith (the “father” of modern economics) identified three forms of income - profit, wages and rent. Profit and wages are earned in what I call our “active economy” as the owners of capital and labour have to do something to earn a profit and wage respectively (i.e. they are active participants in the economy.) However, rental income does not involve active participation; it involves the transfer of money from one party to another based on one party’s ownership of a scarce resource. The owners of property undertake no active role in the economy. Therefore, it would be inaccurate to include this income with that of the active economy as no productive output is involved. Consequently, it is allocated to what is referred to as the “rentier economy”.
  2. As the rich only consume a small portion of their income (i.e. they can only eat a few meals a day and only buy a limited amount of clothes compared to mass consumption,) they generally invest the balance in the rentier economy as risks are (often) lower and returns higher than the active economy. Money earned in the active economy, but withdrawn from it, weakens it. This is not good for the majority of us as the active economy is the engine of our economy and society.
  3. When our active economy is weakened (through fund withdrawal,) investment returns weaken, with a proportionate increase in risk. This redirects greater funds out of the active economy, thereby accelerating the downward cycle.
  4. For the above reasons the so-called “Trickle Down Effect,” where the wealth of the rich is supposed to trickle down and positively influence the less well off does not work, because only a small percentage of their income remains in the active economy, with the bulk redirected to the unproductive rentier economy.
  5. Income generated by “rent” (from our ever-expanding rentier economy) masks growth, as rent cannot be classified as productive economic activity. Government’s understanding of economic growth and planning is therefore flawed. This impacts negatively on wider society.
  6. As our inadequate and inappropriate business measurement standard focuses on profit creation for the exclusive benefit of shareholders (the rich), these profits ultimately find their way into the rentier economy. In other words, funds are syphoned off from the active economy dampening it down even further. Our inadequate and inappropriate measurement standard represents an inbuilt fund syphon for the rentier economy. Once there, it becomes “dead funds”, unlikely to ever return to the active (or productive) economy, as explained in the next section.
  7. The rentier economy is innovation and risk-averse, so once funds end up in this economy they are unlikely to return to the active economy, which is dependant on innovation for returns. While innovation holds the potential for high rewards, it is equally risky. So funds don’t flip-flop between the two economies. Once funds enter the rentier economy they are generally lost forever to the active economy.
  8. The rich are also good at tax avoidance, so the greater the rich/poor divide a greater portion of revenue avoids taxation, resulting in governments shifting the tax burden down the line to the less well-off and those who can ill afford further financial burden.
  9. The wider the divide between rich and poor, the higher the social discord, which could ultimately lead to social unrest and upheaval, which probably won’t serve the rich well. We have already witnessed the start of unrest in the form of the “Occupy Movement.”

When I refer to the rentier economy you must realise this does not only include income generated from property, but from a wide, and ever-expanding source of “scarce” resources. This includes control of natural resources and intellectual property, which incorporates copyright, trademarks, trade secrets and patents. While there are many benefits to be had in developing intellectual property for the active economy, problems arise in their excessive protection. These often well exceed the investment and risk undertaken in the first instance and become a vehicle for the rentier economy.

We face a serious problem where in rich economies a large and ever increasing portion of the economy moves towards the rentier economy. This keeps driving the rich/poor divide which in turn dampens our active economy. This certainly does not bode well for its citizens.

What concerns me is that our inadequate and inappropriate business measure play a key role in this problem, making it another important reason to introduce a new measurement standard.

Adrian Mark Dore

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