This post first appeared on Harvard Business Review's blog, and is posted in conjunction with the publication of the October 2014 issue of the magazine's feature article, "The Rise (and Likely Fall) of the Talent Economy," which can be read in full here.
Anyone thinking about democracy and capitalism today needs to take account of Thomas Piketty's monumental book, Capital in the 21st Century. There lots of similarities between his argument and the one I make in my most recent HBR article. We both look squarely at the same phenomenon -- income inequality -- and have similar interpretations and I am thrilled at the huge positive impact that he has had on this important issue.
There are also important differences -- or complementarities, I would like to believe. To begin with, he is a macroeconomist and as such he sees natural resources, capital and labor as the prime drivers of economic productivity. From this perspective, inequality is a function of the accumulation of capital, which provides control over natural resources, principally land, and allows the capitalist to collect increasingly huge rents from such ownership. I concur that during most of the 20th Century, that was a pretty good way to explain income inequality.
But I'm a business strategist and from where I'm looking, the game has changed dramatically in the past 50 years. Talent has become the critical force in the economic equation, more important than either raw materials and labor, and a worthy if not overwhelming adversary for capital.
To be fair, macroeconomists don't view human resources as completely generic "labor." Many have worked on the returns to skills and returns to education, showing that labor is more highly paid if it is educated and skilled and also that it increases business productivity. However, they don't see talent as a distinctive actor in the economic equation, an opponent of capital independent of labor.
But my take is that talent is now a force in its own right. Every capital-intensive business is threatened by the proverbial two-kids-in-a-garage who might demolish it, without the benefit of either capital or natural resources. Whether they are Hewlett and Packard, Jobs and Wozniak, or Page and Brin, established and accumulated capital has everything to fear from the power of talent. And increasingly, this talent is aimed at taking all the spoils. Its implicit goal is to be the moral equivalent of equity capital. It wants to capture all of the upside. And it wants to turn equity capital into the moral equivalent of debt -- it should earn a fixed return on its investment and nothing more.
To be sure, Piketty does note (with some incredulity) the rise of the "supermanager" as an economic agent but in the end, he still sees capital accumulation by investors as the main source of inequality and the biggest challenge to the functioning of the modern economy. I think that recognizing the importance of talent enhances the quality of the picture. As I argue in my article, managerial and entrepreneurial talent has started to extract a huge share of economic rewards, at the expense of both traditional capital and traditional labor.
The second enhancement that I would suggest to the Piketty narrative is to draw a distinction between the real economy and the capital markets. The real economy is the one in which real companies, individuals and governments buy and sell real things for real prices. Macroeconomists (such as Piketty himself) add up these real transactions to produce numbers like Gross Domestic Product.
The capital markets, however, are not the real economy. The value of stocks and bonds are not directly determined by economic actions or events. They are driven by expectations of future economic actions and events. Market participants imagine what will happen in the future and pay prices for securities -- whether stocks, bonds or real estate investments -- that reflect their beliefs about the future value of such securities. That future may or may not happen but in the intervening time, those who make such projections define the value of those instruments with their shared expectations.
This may sound like semantics, but one of Piketty's key observations is that a vast amount of capital was "wiped out" during the crises of the two World Wars and the Great Depression in between. I see things a bit differently. Yes, hard physical assets like buildings and machinery in France, Germany, and England were indeed destroyed by bombs in the great wars. But those losses pale in comparison to the paper losses on the value of financial securities caused by lower expectations about future economic performance, which is what Piketty observed as the destruction of capital.
In my view, however, paper losses on financial securities don't necessarily equate to the destruction of capital. There is a story (possibly apocryphal) about Hong Kong's richest billionaire, Li Ka-Shing, that illustrates this point. In the middle of the great Asian Financial Crisis of 1997, a huge one-day fall in the value of Hong Kong's Hang Seng index drove down the market value of his holdings by close to US$10 billion, then the largest one day fall in an individual's fortune ever recorded.
Asked by a reporter about how he felt about this, Li reputedly replied that he hadn't lost a single dollar: "What have I sold in the last day? Before the price drop, I owned a set of assets. After the drop, I own the same assets. I am no poorer. Their earnings prospects were the same the day before and the day after. Had I sold, I would have been poorer, but I didn't." He was absolutely right and the value of his holdings soon returned to more than their previous glory. The same happened to capital in the modern democracies after World War II. The resurgence of capital values in the 1950s was not about the creation of new assets to replace those destroyed by war but rather a re-evaluation of assets that had largely always been there.
The distinction is important because managerial talent is largely rewarded through the expectations market, though equity-based compensation. That opens up the possibility (I would suggest certainty) that managers will focus on shaping (or even manipulating) expectations more than creating real economic value in the form of products, services, and jobs.
The bottom line is that we need a richer story about inequality that takes into account the importance of talent and the difference between the real economy and the capital markets. Saving democratic capitalism from itself will need that understanding, because what's going wrong with our economy is a vicious dynamic in which a talent elite not only appropriates an ever-greater share of economic rewards but also channels its energies away from economically productive activities. To me, the key challenge to democratic capitalism in the 21st century is talent, not capital.
To read "The Rise (and Likely Fall) of the Talent Economy," click here.