A Rising Tide Lifts All Boats? Sometimes.



Imagine a giant tidal wave forming even as the tide is rising. There is more water in the general area than before (we stipulated that the average tide is rising), but part of the ocean is rising faster than the rest.

Where does that water come from to form the wave? It must come from the surrounding sea. And so, even while the wave is rising above the average sea level, some area surrounding the wave must be falling below the average sea level.

The average sea level is rising, so these surrounding areas might still be rising a little as well, just less quickly than average. But they might also stay at the same level they were at before the sea started rising. And they could even sink some. All these are possible depending on how fast the tidal wave is growing, how fast the sea is rising, and how wide an area the wave is drawing its water from.

Now imagine that, instead of one large tidal wave, there are several giant growing mounds of water in the sea. And they just keep growing and growing at a rate that’s faster than the rate the overall sea is rising.

These giant stacks of water never dissipate, and they never crash to shore. It gets to the point that 20-25% of all the water in the sea is in these giant standing mounds, and almost all of the new water entering the area is going into those giant growing mounds of water and not into the surrounding sea.

The average sea level is rising. But most of the sea is not.

Now put boats in the scene. There are boats scattered randomly about. One in one-thousand happens to sit atop a giant mound of water. These boats just keep rising and rising, while most of the boats just stay at the same level, and might even be lowered a bit.

What does this mean for the economy? Once we see that the rising average tide represents the overall growth in economic output (G), and the rate at which the giant mounds are growing represents the rate of return on invested wealth (R), then we can see that the rising tide slogan becomes suspect when R >> G.
When R >> G, those who have wealth to invest far in excess of their needs will continue to grow their fortunes at rate R on average (or faster, since the wealthy can invest almost all of their wealth, and they tend to have access to better than average investments), while the wealth of the rest must, on average, be growing at less than G, and might even be shrinking.

Piketty tells us that, historically, R has tended to be about 5% and G has tended to be about 1.5%.

There are, of course, in the economy, not just giant fortunes and people living in poverty. There are many fortunes lying between these extremes. Some people with little capital are earning more than 5% returns. And some with vast wealth in a given year will see returns below 5%. These are long-term, average returns.
And there are also taxes to consider.

Steep inheritance taxes (causing the mounds of water to crash against the shore), capital gains taxes (causing a gentler dissipation out at sea), and other policies, will cut into the 5% growth rate of wealth, and bring the growth rate of the wealth of the wealthy down closer to the overall growth rate of the economy. This prevents much of the water from accumulating into standing mounds, leaving more of it to fill out the surrounding sea.

Unfortunately, we dismantled many of those mechanisms over the last 40 years.

And if rising individual wealth means rising individual power to affect legislation and regulation, then the wealthy can rig things so that even more of all the new wealth goes into the monster mounds of water instead of into the surrounding sea.

And that, my friends, is how a rising tide can fail to lift all boats.