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The Rich Get Poorer: the Myth of Dynastic Wealth

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Entrepreneurs and small business owners can learn useful lessons from the errors in Thomas Picketty’s theory

In the recent paper, “The Rich Get Poorer: the Myth of Dynastic Wealth,” Robert D Arnott, William J. Bernstein, and Lillian J Wu analyze the arguments and logic of Thomas Picketty.

Picketty, you may recall, wrote the massive bestseller, Capital in the 21st Century. And he clearly deserves credit for his work and for contributing to the debate about economic inequality.

But Picketty, it now seems clear, stumbled in more than a few places in his analysis. Arnott, Bernstein, and Wu do a good job of describing and discussing these stumbles. You want to read their paper if you read Picketty’s tome or have followed the story.

Note: You can download a free copy of the “The Rich Get Poorer” paper.

But to me, there’s another subtler story line here. A story line that is especially relevant to small business owners and entrepreneurs.

But a Quick Reminder First

One upfront reminder, though, about this blog: This isn’t a political blog. It’s a how-to small business blog.

We’re interested in teasing out techniques that will help you run your business more profitably. Or in a manner that lets you successfully operate the venture for longer. That sort of stuff.

I want to make this point first because most of the discussion about Picketty’s work has been very political.

And now on to the useful takeaways small business owners and entrepreneurs can glean…

Diversity Improves Analysis

A first comment about the paper written by Arnott, Bernstein, and Wu.

I think (and see if you agree, if you read the paper) that the Arnott, Bernstein, and Wu paper is considerably more balanced and robust in its argument. And here’s the reason, I suspect. While Mr. Picketty has one, maybe strong political point of view, the co-authors of the “Rich Get Poorer” paper included (per the statements made in the paper), someone left of the political center, someone right of the political center and someone sitting roughly in the center.

One has to wonder if this balancing of political viewpoints didn’t help Arnott, Bernstein, and Wu do a better job. Any of us can overly focus on the bits of an issue we feel strongly about. Any of us can glance over subtle errors that undermine our prejudices. All of us benefit from having a second set of eyes look over our work.

If you think about applying this idea to a small business, you have to wonder if we small business owners aren’t also vulnerable to a lack of diversity in our analysis and decisions. Maybe we’re even particularly vulnerable because we also often work in small organizations and with fewer peers.

The lesson here? Well, what we need to do is easily enough to describe—but pretty hard to put into practice. We need to include people on our teams who think differently and come at issues from different points of view.

Bad Accounting Leads to Bad Decisions

I’m going to simplify Picketty’s core argument here to make the next point.

Basically what Picketty argues is that if the return on people’s wealth (their investments) exceeds the growth in the economy, the rich have to keep getting richer at the expense of everybody else.

For example, if the economy doesn’t grow (so the pie stays the same size) and the return on wealth equals 5%, then every year the wealthy grow their share of the pie by 5% other pie holders have to see their shares shrink.

Note: Picketty doesn’t really see the economy as a zero-sum game, but the same grinding logic applies if the economy grows by 2% or 3% but the return on wealth equals 5%.

Here’s the problem with Picketty’s accounting though. He forgot to include the expenses that get paid out of the return.

In other words, he basically looked at the revenue but ignored the expenses. (You can read the “Rich Get Poorer” paper for a complete description of the expenses Picketty forgot to include, but probably the big three are taxes on the income, management fees, and living expenses paid out of the return.)

And here’s how this connects to small businesses and entrepreneurs—at least in my mind: You know what Picketty did here? He goofed the accounting up! His accounting “system” omitted a bunch of the transactions needed to get a complete picture of the situation.

The obvious, awkward lesson here for small businesses? We all need to make sure we’re doing a good job with the accounting. Good accounting can lead to better decisions. Bad accounting leads to bad decisions.

Entrepreneurship Creates Wealth

A final quick point—and one that really gets hammered home in the “Rich Get Poorer” paper.

Entrepreneurship (and this includes successful small business ownership) creates wealth. Furthermore, entrepreneurship creates wealth not just for the entrepreneur and his or her family but for the employees of the firm and the community in which the firm operates.

Investment activity, in comparison, often doesn’t on its own create or grow wealth. Yes, an investor should earn positive returns. But unfortunately all the things that eat away and erode the wealth of a billionaire—taxes , management fees, and the investor’s living expenses—will  also eat away at and erode the wealth of a middle class investor or “merely” upper class investor.

The practical application to this point? You want to run your entrepreneurial activities as long as you want to grow your wealth or your family’s wealth.

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