r > g and Inequality in Indonesia

In his controversial book, “Capital in the Twenty-First Century”, Thomas Piketty outlines the apparent cause of inequality in the world. He espouses the notion of “r > g”, i.e. as long as the rate of return from capital (r) is bigger than the GDP growth (g), most of economic growth is accumulated by capital owners. This, Piketty says, worsens the inequality.

Even though Piketty vehemently denies that he is a Marxist, the concept of capital accumulation is indeed best elaborated by Karl Marx. In Marxist lens, it could be argued that “r > g” would naturally follow as long as capital owners appropriate surplus value and further accumulate wealth by valorisation of fictitious capitals. (Whether this condition can be dismantled by introducing wealth tax/extreme progressive taxation for the rich or by seizing the means of production, is where Piketty and Marx depart from each other.)

I'm not gonna explore further about Piketty vis-à-vis Marx. I am more interested in knowing whether Piketty’s “r > g” actually hold, especially in Indonesian context.

In a 2017 paper titled “The Rate of Return on Everything, 1870-2015”, Òscar Jordà and co. provided interesting tool to empirically probe this theory. In this short blog post, I try to apply their method with some modification. I modify some of Jordà, et al. specifications due to the unavailability of the data here in Indonesia. However, I would try to be as faithful as possible to their methodology.

Variable Construction

Jordà, et al. define r as the weighted average real returns (inflation-adjusted) of risky investments (housing and equities) and safe investments (government bonds and bills). The general equation is r = r_housing x w_housing + r_equities x w_equities + r_bonds x w_bonds. This method has its limits, however. Income from dividends, interests from private debts, or alienation of immovable property cannot be captured here.

For the rate of return on housing, Jordà, et al. uses price-to-rent ratio. I use Residential Properties Price Index (RPPI) instead. RPPI a composite index of housing price from 16 cities in Indonesia. As a caveat, RPPI also cannot capture rent income as other source of returns for house owners, as well as depreciation and maintenance costs that may reduce the returns of housing investment.

For the housing weight, the paper uses stock of housing wealth scaled to GDP. The absence of such data in Indonesia compels me to use real estate contributions towards GDP in lieu of housing stocks. This choice is actually problematic as it severely discounted weight because big portions of Indonesian housing wealth aren’t captured, although inequality in housing (or generally, land) is evident here. For instance, Indonesian land Gini coefficient shows increasing trend as shown by graph below. (A land Gini of 0 means everyone have the same amount of land; a Gini of 1 means every land in Indonesian is owned by 1 person).

As an important note, the paper by Jordà finds that housing comprises significant portion of investments in many countries.

For the rate of return on equities, I use the growth of IHSG (Jakarta Composite Index) as it is representative of stock market returns. The limit for this, of course is in its inability to capture private/unlisted stock values. Similar to Jordà, et al., I use market capitalization scaled to GDP as weighting.

For the rate of return on safe investments, I use the 10-Year Indonesian government bond yield. Again, following Jordà, et al., I use public debt to GDP ratio as weighting.

There are still other types of financial instruments that should actually be included for any discussion about inequality. For instance, a report by OJK (Financial Service Authority) in Q2 2017 shows that 48 conglomeration group own 66.96% of total financial assets in the financial service system (SJK). Further, according to the report by LPS (Deposit Guarantee Body) on October 2017, 56.87% of total deposit in banks are owned by only 0.11% of bank account. 98.07% of bank accounts own just 14.03% total deposits.

Regardless of the limitation, I shall proceed with Jordà's paper. All the above-mentioned variables are entered into the general equation specified before, resulting in the variable r. For g, I use real GDP growth. The inequality measure I use is Gini ratio. If r - g is positive, i.e. r > g, we would observe an increase in Gini ratio and hence an increase in inequalities. In other words, we want to know if changes in Gini ratio trail the value of the excess of r over g.

Results and Discussions

Unlike Jordà and co. which manage to collect data spanning hundreds of years, I only have 10 data points for Indonesia. There is not much degree of freedom here, so it may not be appropriate to use inferential statistics. (It would lead to bias). Nevertheless, by visual inspection it seems that whenever r minus g is positive, change in Gini ratio is also positive. In other words, when r > g, Gini ratio for that year is also increasing from the previous year. And vice versa.

I further add a trendline of those two variables (r minus g and changes in Gini ratio) and find out that they show similar trends. Thus, Piketty’s theory of r > g as the cause of economic inequality may be true here in Indonesia.
 
For additional comparison, here is how the net worth growth of 40 richest Indonesian (based on Forbes), compared with growth of per capita GDP of Indonesian people.

If we calculate r-g based on the difference between growth in 40 richest Indonesians' net worth and GDP growth, then compare it to changes in Gini, it would look like this:

So, what could be done in the light of such fact? The ultimate solution is like what Marx said: if means of production or the capitals are owned by all, then the returns from those capitals are appropriated by all. However, in a nation still haunted by the invoked spectre of the dead PKI party, proletariat revolution is politically hard to implement. It may as well be impossible.

A practical application of such non-capitalistic underlying principle actually exists: a co-operative. To be quite simplistic, there are no shareholders to appropriate the surplus value in a co-operative. Co-operative thus poses no agency problem. It also reduces the incentive to take aggressive/speculative profit-taking behaviors. So basically, if you manage to scale up this type of economy into the size of a nation, r will pretty much the same with g. (Some Marxists will see co-operative as insufficiently revolutionary, though. But still.)

What are the other options? Generally, as long as r < g, society would be getting more equal. So, financial crisis and war could theoretically be the great leveler. But we all do not want that. Thus, reducing the excess of r over g via super-progressive income tax combined with wealth tax, is one of the option to lessen the inequality. But this one is also politically hard to implement – in Indonesia or anywhere else.

References

Durand, Cédric. 2017. Fictitious Capital: How Finance Is Appropriating Our Future. Verso Book

Jordà, Òscar, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan M. Taylor. 2017. “The Rate of Return on Everything, 1870–2015” Federal Reserve Bank of San Francisco Working Paper 2017-25. https://doi.org/10.24148/wp2017-25.

Piketty, Thomas. 2014. Capital in the Twenty-First Century. Harvard University Press

Scheidel, Walter. 2017. The Great Leveler: Violence and the History of Inequality from the Stone Age to the Twenty-First Century. Princeton University Press

The data for RPPI is from Global Property Guide. IHSG and market cap data are from IDX. Indonesian government 10-Y bond yield is from Bank of Indonesia. Debt-to-GDP and real GDP growth data are from IMF. Real estate as portion to GDP, inflation, land Gini ratio, and GDP current price data are from BPS. I also use the reports from LPS and OJK.