NEW YORK: Celebrated economist Martin Feldstein in a recent Wall Street Journal op-ed argued that US wealth inequality is much less than advertised. The reason, Feldstein says, is that future Social Security, Medicare and Medicaid payments are a form of uncounted wealth that dramatically boosts the wealth of the poor by trillions of dollars. If we take entitlements into account, Feldstein says, wealth inequality isn’t so bad.

It isn’t such a novel observation and counting future payments as wealth is OK, as far as the economics goes. Capitalising a future income stream — valuing it in terms of its present value and counting it as today’s wealth — is standard practice in finance, and there’s no reason this can’t be applied to Social Security and Medicare. But if we want to look at wealth in these terms, we have to add a lot more than just entitlements.

For example, maybe we should add human capital. That refers to the capitalised value of people’s skills and knowledge. In the future, my skills will command a premium, allowing me to have much higher earnings over the course of my life than if I were able to do only manual labour.

Rich people, in general, have much more human capital than poor people. They’ve worked in big companies and gone to good schools, which most poor people have not.

Another big chunk of wealth is network capital (also called social capital). This refers to the value of people’s business contacts and friends. Having a strong network helps you get a job, do business deals, and get investment capital. It is hugely important to people’s long-term earnings potential, so it too should be capitalised into wealth.

Together, human capital and net capital determine a large portion of people’s future earnings, and future lifetime earnings add up to some pretty substantial numbers. Thus, if we are to measure the kind of inequality that Feldstein wants to measure, we will have to add these in. Adding network capital and human capital will hugely increase wealth inequality. That doesn’t seem to be what Feldstein has in mind.

After making his point about wealth inequality, Feldstein switches gears, and argues that poor people are getting a low return on their implicit wealth. Feldstein writes:

“By my calculations, the implicit real rate of return on [capitalised entitlement wealth] will be less than 3pc. That is substantially less than the 5.5pc real return earned historically by contributions over a working life to an individual IRA or 401(k) plan invested in a balanced combination of stocks and high-quality bonds.”

Here I believe he is totally wrong. This would be correct only if stocks had no risk. In fact, the risk is very substantial. That 5.5pc historical return sounds great, but not all retirees enjoy that kind of success. And over time, the high volatility of the stock market means that many retirees will experience stock returns much lower than the average.

Entitlement wealth, however, is relatively low-risk. Obviously Social Security and Medicare benefits can be cut, which is a real risk. But the volatility of benefits is surely much less than the Standard & Poor’s 500 Index, which can easily fluctuate by double-digit percentages in a given year.

By arrangement with The Washington Post

Published in Dawn, December 20th, 2015