Why wealth inequality is not as bad as it is projected

Wealth inequality soars

In recent years, wealth inequality appears to have reached unprecedented levels, with the wealthiest 1% of Indians holding a disproportionate share (about 40%) of the national assets. This is in keeping with the trends in many market-economy-driven countries.

A significant proportion of this imbalance is inflated due to traditional wealth calculations based on market value—the fluctuating worth of stocks and investments in financial markets. This article proposes a better alternative approach: using book value (net assets minus liabilities) to provide a fairer and more accurate measure of the economy’s role in facilitating the generation of wealth for the different economic strata of society.

Market value vs book value: The core difference

Market value represents the price an asset could fetch if sold today, heavily influenced by market sentiment and speculation. For wealthy individuals and large corporations, this value can skyrocket during stock market booms, significantly skewing perceived wealth.

In contrast, book value is based on the original cost of assets, adjusted for depreciation and liabilities, reflecting a more grounded and consistent measure of actual net worth.

The skewing effect of market value on wealth distribution

1. Inflated wealth figures: Market value includes unrealized gains – profits on paper, not yet cashed in. For the wealthiest, whose assets are often tied to stock markets (including mutual funds), this value can dramatically rise in a bullish market, creating a perception of greater wealth inequality.
2. Disproportionate focus on the top 1%: Using market value highlights the wealth of those heavily invested in stocks, often widening the apparent gap between the richest and everyone else. Most people lack substantial stock holdings, so their wealth, primarily in tangible assets like homes, remains unaffected by market swings.
3. Misrepresentation of real wealth: For the average household, wealth isn’t in stocks but in more stable assets, which don’t appreciate at the same rate as equities. Book value better reflects these real assets and the debt individuals owe, presenting a clearer picture of net worth across all income levels.

A practical illustration

Consider an example of three children – A, B, and C – who each inherit Rs.10 lakhs. Over 20 years, A spends all his/ her inheritance; B spends Rs.5 lakhs but invests the rest in fixed deposits, earning a modest 6% return; while C spends Rs.5 lakhs and invests the rest in shares/ mutual funds, achieving an average annual return of 16%.

After 20 years:

• A – Has nothing left from the inheritance.
• B – Has grown their Rs.5 lakh investment to around Rs.16 lakh.
• C – Benefiting from higher-yield investments, now has about Rs.1 crore.

This example demonstrates that even with identical initial wealth, outcomes diverge significantly based on savings and investment type. It would be unreasonable to conclude that the inheritance was distributed unequally. Instead, the choice and nature of investments lead to exponential growth for C, highlighting how asset-based wealth tends to multiply over time and drive inequality.

Why book value is a more balanced measure

1. Stability and reliability: Book value doesn’t fluctuate with market trends, offering a consistent measure of long-term wealth. It prevents inflated wealth readings driven by speculative markets.
2. Inclusive of liabilities: Book value incorporates debts, reflecting what an individual actually owns. This is particularly important for ordinary households, whose liabilities (like mortgages or loans) impact their net worth but are often ignored in market-based calculations.
3. Universal applicability: While market values primarily apply to the wealthy with investment portfolios, book value captures the tangible wealth of all socio-economic groups, making it a fairer metric for gauging economic inequality, removing the role of savings and investment class from the equation.

A fairer view for emerging economies

In countries like India, where a small elite controls most marketable assets, wealth distribution is highly skewed under market-value-based metrics. Book value offers a clearer view of actual net worth, accounting for assets common among the general population (like homes, vehicles, small businesses, etc) and factoring in their debts.

For policymakers in developing nations like India, book value can highlight the needs of the broader population more effectively. It reveals economic inequalities grounded in actual assets and debt rather than speculative wealth, providing a better basis for policy decisions that address wealth inequality.

I expect (based on my hunch) that book value-based computation is likely to show that the top 1% of the elite hold about 20% of the national wealth.

Implications for policymaking

Shifting to book value as a measure of wealth distribution would involve some adjustments:

• Expanded debt reporting: Comprehensive data on household and corporate debt is essential for accurate book-value-based assessments.
• New wealth reports: Wealth reports from financial institutions could include both book and market values, offering a more rounded perspective.
• Enhanced public understanding: As GDP is compared with GDP per capita, wealth can similarly be reported in terms of book and market values, helping the public and policymakers understand true wealth dynamics.

Conclusion: Toward a more equitable wealth measurement

Using book value for wealth distribution would be more reflective of the true state of the economy. This approach could lead to policies better aligned with actual economic disparities, contributing to a fairer distribution of resources and a more comprehensive understanding of wealth inequality across societies. Also, it will avoid punishing the efficiency of the generation of wealth, which could otherwise lead to the flight of capital.

Note:
1. Text in Blue points to additional data on the topic.
2. The views expressed here are those of the author and do not necessarily represent or reflect the views of PGurus.

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