Ativo Capital

Rigorous Thinking

Financial and economic commentary reflecting Ativo’s world view:

Trade, Labor, Capital, the Rich and "The Rich"

Tuesday, September 24, 2013


Bloomberg writer Megan McArdle cites a recent Brookings paper addressing the long-term decline in labor’s share of U.S. national income. The Brookings paper refers to “import exposure,” which sounds like a fancy name for “cheap foreign imports.” Although there’s much more to the Brookings paper, and McArdle’s article, the bottom line seems to be that the U.S. share of wages is down because free trade allows offshore labor (in the form of imports) to undercut U.S. labor.

So I asked myself the question, “What about cheap foreign capital?” Cheap foreign imports may hurt U.S. workers (although, yes, the pain of lower wages is somewhat offset by all the cheap stuff they can buy at Wal-Mart). But if an influx of offshore money lowers the U.S. cost of capital, the result is higher asset prices in the U.S. In other words, the free flow of goods and capital helps the rich get richer, while workers lose out. (Sound familiar?)

It certainly looks like the rich get richer, since the prices of their assets go up. In fact, they hold their own, at best. Think about what happens to a bondholder when interest rates fall. The value of the bond rises, but the interest and principal payments don’t change. It may look like the bondholder is richer, but if she holds the bond to maturity she doesn’t get a dollar more than she would have otherwise. (Although she could sell the bond to buy a different investment, the lower cost of capital means that the prices of all investments have gone up, so she won’t be any better off.) In fact, lower interest rates (i.e., cheap foreign capital) leave her somewhat worse off, in that she earns less on anything she invests from this point forward. The gain from falling interest rates is at least partially an illusion.

Who does benefit from cheap foreign capital (a lower cost of capital)? Those operating in the real economy: A factory owner whose lower loan payment makes that extra machine affordable, or the entrepreneur who gets a bigger IPO payoff for the risk she shouldered when starting her company. And all of us who enjoy the goods and services provided by a growing economy.

In some circles it has become fashionable to distinguish among different groups of “the rich.” We have the “deserving” rich who earned their money the good old-fashioned way, versus those disreputable rich, who gained it through financial “manipulation.” But maybe our economy gets it at least partially correct. Asset holders may appear to make out like bandits, but the gains aren’t as great as they look. The real winners are those that create something, whether goods or ideas, and those of us who benefit from that.