The Rich Get Richer and the Poor, Poorer - But Why?

A Brief Digression into Heterodox Economics

The rich get richer and the poor get poorer. The Parable of Talents, found in Matthew 25:24-30, is perhaps the earliest written statement of this famous aphorism:

For unto every one that hath shall be given, and he shall have abundance: but from him, that hath not shall be taken away even that which he hath.

Because of this verse, the entire phenomenon of “the rich getting rich and the poor getting poor” is often called the Matthew Effect.

However, the aphorism was first stated in its modern formulation by the great Romantic poet Percy Bysshe Shelley. In his 1821 book A Defence of Poetry, Shelly criticized the “utilitarians” of his day by remarking that under their administration “the rich have become richer, and the poor have become poorer.” Today the aphorism is commonly expressed in present indicative tense, expressing a seemingly unchanging pattern observed over time: “the rich get richer and the poor get poorer”

Whatever its source and tense, no one disputes the truth of the Mathew Effect. Indeed, its factuality is in evidenced everywhere! The Guardian reports:

The world’s five richest men have more than doubled their fortunes to $869bn (£681.5bn) since 2020, while the world’s poorest 60% – almost 5 billion people – have lost money.

The details come in a report by Oxfam as the world’s richest people gather from Monday in Davos, Switzerland, for the annual World Economic Forum meeting of political leaders, corporate executives and the super-rich.

The yawning gap between rich and poor is likely to increase, the report says, and will lead to the world crowning its first trillionaire within a decade. At the same time, it warns, if current trends continue, world poverty will not be eradicated for another 229 years.

The left-wing Wikipedia pithily remarks:

The aphorism… describes a positive feedback loop (a corresponding negative feedback loop would be e.g. progressive tax).

The aphorism is commonly evoked, with variations in wording, as a synopsis of the effect of free market capitalism producing excessive inequality. [emphasis added]

But’s not just left-wing socialists making this assertion. The pro-capitalist Fool.com explains:

The latest edition of Oxfam's annual Inequality Inc. report is out, and it states: "Since 2020, the richest five men in the world have doubled their fortunes. During the same period, almost five billion people globally have become poorer.

[H]ere are those five richest people and their recent gains (which account for inflation):

• Elon Musk, CEO of Tesla, saw his wealth surge to $245.5 billion in late 2023, up 737% from March 2020.

• Bernard Arnault, chairman of French luxury goods giant LVMH Moet Hennessy Louis Vuitton, and his family saw their wealth pop 111% over the same period to $191.3 billion.

• Jeff Bezos, founder of Amazon, saw his wealth jump 24% to $167.4 billion.

• Larry Ellison, founder of Oracle, experienced a wealth increase of 107% to $145.5 billion.

• Warren Buffett, CEO of Berkshire Hathaway, saw his wealth rise 48% to $119.2 billion.

How did they do it? In most cases, it's by stock price appreciation. [emphasis added]

The only difference between the left- and right-wing viewpoint, at least within what I call the “contemporary consensus” that defines our public orthodoxy, is in how one ought to feel and respond to the fact that the rich get richer and the poor get richer. The Left bemoans it as a failure of progress, and urges the rich to redistribute their wealth to the poor by supporting socialist policies. The Right celebrates it as the reward of merit, and urges the poor to growth wealth and become rich by undertaking capitalist activity.

Sometimes, something is so taken for granted as being the case that it does not even occur to ask whether it must be or should be the case.

The Foundation of Economic Growth

Very few people understand the foundation of economic growth - perhaps even fewer than those that understand the source of profit in a circular flow economy. One of the few who does is the late Lyndon LaRouche, “a controversial and highly divisive figure who provoked various sharply contrasting viewpoints. His supporters regarded him as a brilliant and original thinker, whereas critics variously saw him as an extremist, a conspiracy theorist, a fascist, an anti-Semite, and the leader of a political cult who took positions on the far right.”

(OK, meme aside, I can’t actually endorse any of Mr. LaRouche’s political positions or beliefs because I’m simply ignorant of them; I’ve only read one book by him - but it was a good book: So, You Wish to Learn All About Economics? A Text on Elementary Mathematical Economics. )

LaRouche’s approach to economics, which he called "physical economy," focused on the physical processes that underlie economic production. He believed that the true measure of economic value was not money, but rather the ability to sustain and improve human life through increased physical productivity. The de-emphasis on money and trade places him entirely outside of the neoclassical orthodoxy and probably within the tradition of physiocracy and American System economics.¹

Now, how does one increase physical productivity? This involves the efficient use of energy and resources to produce goods and services that meet the physical needs of society. The core component of LaRouche's theory was the concept of "energy flux-density," which he used to measure the intensity of energy throughput per unit area, per unit time. LaRouche argued that the progress of human civilization was directly linked to increases in energy flux-density within economic processes.

This is a hard concept to grasp but it’s easier when we contemplate mankind’s earlier . During pre-modern conditions, a farmer could sow 2 bushels of grain in the spring and get 10 bushels of grain in the fall, for a 4:1 yield. In similar (primitive) conditions, a shepherd with 1 ram and 8 ewes could expect the ewes to birth 6 lambs, of which 4 would survive, leaving him with 3 rams and 10 ewes. In both cases - real economic growth!²

But how is this possible? Physics tells us that entropy always increases; things always become more disordered whereas economic activity by living beings is, like life itself, negentropic. In a closed system, increasing entropy guarantees that the poor get poorer and the rich also get poorer.

The answer, of course, is that our world is not a closed system; we are bombarded at every moment by solar energy. It is the availability of exogenous energy to our system that is the basis of economic growth.

Indeed, LaRouche explicitly described economic development in terms of anti-entropy. He argued that successful economic systems must increase their level of organization and decrease their entropy, contrary to closed systems in thermodynamics which tend towards disorder. Economic growth, for LaRouche, was about moving towards higher states of order and energy efficiency. LaRouche writes:

As mankind progresses in technology, the amount of usable energy used by society increases both per capita and per square kilometer… [H]istorically, the increase of usable energy-throughput is roughly divided into two general phases. In the first phase, the emphasis is upon increasing the effective capture of solar energy. The agricultural revolution, the use of water power, and the use of windmill power, are examples of this indirect use of energy sources. The second phase is a gradual shift of emphasis towards use of non-solar sources: fossil fuels, fission energy, and controlled thermonuclear fusion.

Economic growth is presently limited because energy is limited. As LaRouche explains:

The average solar radiation striking the Earth’s surface is a mere 0.2 kilowatts per square meter. As burnable energy captured in biomass, the yield from capture of solar energy by plant life is merely 0.0002 kilowatts per square meter…

With fossil fuels… mankind has made a large step toward breaking out of the constraints of solar radiation sources. Yet, fossil fuels [are] a limited resource for mankind. The same general observation applies to fission-energy potential on Earth, at least insofar as we rely on fissionable materials… With controlled thermonuclear fusion, we [could] escape such limitations…

The proposal to rely upon “renewable energy” resources…is clearly suicidal policy. We have indicated adequately the problem of use of “biomass” as a substitute for nuclear energy and fossil fuels. In the case of the solar collector or solar cell, the amount of energy consumed by society in producing such devices exceeds the total energy collected over the useful life of the device. In other words, the “energy payback” to society for relying upon such devices is negative.

If this sounds like the concept of energy return on investment by another name, that’s because it is. But when LaRouche published his book in mid-1984, the concept of EROI hadn’t even premiered in the scientific literature; Charles A. S. Hall, a systems ecologist from the Ecosystems Marine Biological Laboratory, introduced EROI in a paper in November 1984. LaRouche independently worked out the central concept. The tables from his book show his work in this area:

Why have we undertaken this long digression into Lyndon LaRouche, energy flux density, and energy return on investment? Partly because it’s interesting to me and here at Contemplations on the Tree of Woe I like to think through big ideas. More importantly, though, it’s this: if we don’t understand the source of economic growth, we cannot evaluate or understand the distribution of economic growth.

To summarize the LaRouchean perspective we’ve adopted for this article:

• Economic activity is and depends on biological activity

• Biological activity requires negative entropy, e.g. energy input

• Entropy always increases in a closed system, e.g. energy loss

• Therefore, economic activity depends upon an exogenous source of energy added to the system

• In the absence of technological advancement, the only exogenous source of energy is solar radiation, which is transformed by plants into biomass that provides energy to animals

• With technological advancement, other sources of energy become available which can fuel additional economic activity.

• The real rate of economic growth will therefore depend on the available physical and energy resources, and the technology and practices available to harvest them.

The Matthew Effect and the Real Rate of Economic Growth

Let us now consider the Matthew Effect in the context of physical economy and the real rate of economic growth. For simplicity of analysis, we’ll again revert to a pre-modern era in order to create a “pocket economy.”

Imagine a pastoral society that survives on mutton from slaughtered sheep. The sheep, in turn, survive on grass and shrubs from grazing. The grass and shrubs, in turn, survive on solar energy from the Sun. We will assume there’s enough land for the sheep to graze and enough sheep for the population to eat at subsistence levels.

Now, every year, let’s assume that for every 8 ewes, 4 new lambs survive birth and weaning, of which 2 are ewes and 2 are rams. The 2 rams are slaughtered for meat, while the 2 ewes are added to the herd. However, between 1 and 2 of the 8 ewes dies of old age each year (1.5 on average), leaving us with 8 + 2 - 1.5 = 8.5 ewes. Given the formula

Growth Rate=(Final Population−Initial Population​) / (Initial Population) ×100

The rate of real economic growth in our pocket economy is 6.25%. If the population of pastoralists is static, then each year they can eat 6.25% more meat, because more ewes will produce more rams; if the population is growing, they can feed up to 6.25% more people per year; or any combination thereof.

Note that the rate of profit from pastoralism is not the same as the rate of growth. The rate of profit, in mutton rams produced per ewe, is 2/8 or 25%. If the pastoralists were to eat the newborn ewes in addition to the rams, the rate of profit from shepherding will be increased (4 edible sources of mutton per 8 ewes instead of 2 sources of mutton per 8 ewes, so 50% instead of 25%), but the rate of growth will go to zero. The pastoralists will be fat with mutton, but will have no prospect of increasing their future consumption or population. The trade-off between consumption and growth is explained in my essay Solving the Profit Puzzle.

Now, let’s assume that the sheep are actually all owned by an oligarch for whom the pastoralists work. The oligarch permits each pastoralist to eat enough mutton to survive in exchange for his or her services as a shepherd, but he takes all surplus ewes to himself. Note that because the pastoralists are already at subsistence levels (q.v. above), their income cannot be reduced further; the poor cannot become poorer. But the rich oligarch can become richer — each year, for every 8 ewes, the oligarch gains 0.5 ewes. The oligarch’s wealth can grow at 6.25% per year compounding.

What the oligarch’s wealth can’t do is grow faster than the real rate of growth. And yet, somehow, in 2024, that’s exactly what happens.

Growth in the United States

Let’s turn now from our pocket pastoral economy and consider the actual US economy. The first thing we want to know, in order to understand the Matthew Effect, is the average real rate of economic growth.

Now, orthodox economics does not provide us with a measurement of economic growth in the sense that we’ve defined it above The closest analog to the real rate of economic growth in orthodox economics would be the annual inflation adjusted growth rate of the Gross Domestic Product (GDP), known as the “real GDP growth rate.”³ The real GDP growth rate provides a measure of the economy's expansion in real terms, discounting the effects of price changes. It’s not a great measure, but it’s the best measure we have.

Historically, the U.S. economy has experienced varying growth rates due to factors like wars, economic policies, technological advances, and global economic conditions. From 1913 to the present, however, the average real GDP growth rate in the U.S. is roughly estimated to be around 3% to 3.5% annually.

Now, remember the article from Fool.com earlier, which explained how the rich get richer? The money shot (so as to speak) was this:

How did they do it? In most cases, it's by stock price appreciation. [emphasis added]

So let’s now ask what is the average rate of stock price appreciation? We want the annual return on U.S. stocks in general, taking into account both price appreciation and reinvestment of dividends. This rate is often referred to the total stock market return. (The equity premium is the total stock market return minus the so-called risk-free rate.)

Over the long term, from 1900 to 2024, U.S. stocks have experienced various phases of boom and bust, influenced by economic expansions, recessions, wars, changes in regulatory environments, and technological advances. Historically, the total stock market return has been around 10% annually over the 20th and early 21st centuries.

Now pause and consider this. The average real rate of economic growth in the U.S. over the 20th and 21st centuries has been 3.5%, while the average total stock market return has been 10%. How is it possible that the stock market return exceeds the real rate of growth? Where is the “extra” growth coming from. What a puzzle!

Fortunately, I know an economist, Professor Jeepie Tea, who has learned the entire corpus of orthodox economics. I asked this font of wisdom “If the economy is only growing by 3%, how can the value of the companies in the economy grow at 10%?”

GPT answered as follows:

The question of how stock market returns can average around 10% annually when the economy (as measured by real GDP growth) grows at a slower rate, such as 3%, is a fascinating one. This apparent discrepancy can be explained through several factors:

1. Reinvestment of Earnings: Companies often reinvest their earnings to grow faster than the economy. This reinvestment can lead to higher productivity and more significant expansion within specific industries or companies than in the overall economy.

2. Economic Profit vs. GDP: Companies in the stock market can generate economic profit that grows faster than GDP by capturing economic surplus or by increasing their market share within the economy, even without the entire economy growing substantially.

3. Global Operations: Many companies in the U.S. stock market generate a substantial portion of their revenues and profits from global operations. Thus, their growth is not limited to the U.S. economy but is tied to global economic conditions and markets, which may grow faster than the domestic market.

4. Innovation and Efficiency: Corporations continually seek to innovate and improve efficiency, leading to profit growth that outpaces overall economic growth. Technological advances and management improvements can expand profit margins over time.

5. Market Composition Changes: The stock market's composition changes over time as new companies grow and enter markets, and older companies may shrink or exit. High-growth sectors like technology can have an outsized impact on overall market returns, especially if they represent a growing share of the market.

6. Valuation Changes: Stock market returns are also influenced by changes in the price-to-earnings (P/E) ratios, i.e., how much investors are willing to pay per dollar of earnings. An increase in investor confidence, or a decrease in alternative investment returns (like bonds), can lead to higher P/E ratios and thus higher stock market returns.

7. Leverage: Companies can use debt to enhance returns, which can magnify their earnings growth relative to their equity base. This financial leverage allows earnings to grow faster than the company's underlying economic growth.

These factors combined explain why there can be a significant difference between the growth rates of the overall economy and the financial performance of the stock market. In sum, stock market growth encapsulates a broader range of economic activities and efficiencies than GDP growth, which measures overall economic output.

Although written by an AI, this is (in my opinion) an exceptionally fair presentation of the position of orthodox economists on the matter.

It is also total bunk.⁴

Consider:

1. Reinvestment of Earnings: GPT asserts “companies often reinvest their earnings to grow faster than the economy.” This might be true for particular companies, but it mathematically cannot be true for all companies overall, because the reinvestment of their earnings would result in economic growth to match.

2. Economic Profit vs. GDP: As in the example above, individual companies might “generate profit that grows faster than GDP by capturing economic surplus or by increasing their market share within the economy,” but this cannot be mathematically true for all companies overall.

3. Global Operations: GPT asserts “many companies in the U.S. stock market generate a substantial portion of their revenues and profits from global operations. Thus, their growth is not limited to the U.S. economy.” That’s true but it doesn’t solve the problem, because the average real rate of GDP growth globally is also 3-3.5% and the average total stock market return globally is also 10%. The rate 6.5% gap is a worldwide phenomenon.

4. Innovation and Efficiency: GPT’s answer once again doesn’t solve the problem, because while innovation and efficiency do increaser return on equity, they do so by causing real growth. It leaves unanswered were the “extra” growth comes from.

5. Market Composition Changes: GPT asserts that “high-growth sectors like technology can have an outsized impact on overall market returns.” Again, this doesn’t solve the problem, which is situated in the economy as a whole.

6. Valuation Changes: GPT explains that “stock market returns are also influenced by changes in the price-to-earnings (P/E) ratios, i.e., how much investors are willing to pay per dollar of earnings,” such that “increase in investor confidence” can lead to higher stock market returns. That’s certainly true, but it still doesn’t explain how the return on all companies collectively can exceed the return on the economic growth of all those companies collectively.

7. Leverage: GPT suggests that “companies can use debt to enhance returns.” Ah, here it is — a real answer!

But this real answer - leverage - begs the question of where the money the companies have borrowed comes from. In a commodity money system with full-reserve banking, all lending must come from savings, which (as shown in the profit article earlier), can only come from actual economic output.

However, we don’t live in a commodity money system with full-reserve banking. We live in a fiat money system with no-reserve banking, where the money supply can be, and is, increased infinitely.

In fact, the M2 “base money” supply has grown from $18.7 billion in 1913 to $22 trillion in 2024. What is the rate of growth? The formula for the compound annual rate of growth is:

CAGR = ((Ending Value / Beginning Value) ^ (1 / Number of Years)) - 1

Therefore, the annualized rate of growth of the money supply, is (( $22 trillion / $18.75 billion) ^ (1 / (2024 - 1913) ) ) - 1 = 6.5%.

So, from 1913 - 2024:

• The annual total stock market return is 10%.

• The annual real rate of economic growth is 3.5%.

• The annual growth rate of the money supply is 6.5%.

One cannot help but notice that 10% - 3.5% is…. 6.5%.

In other words, the mysterious "equity premium” is mathematically explainable as asset inflation caused by the increase in the money supply.

This should not surprise long-term readers; as I explained in my series Running on Empty, petrodollar printing and recycling has demonstrably created egregious asset inflation.

Now ask yourself: what are the means by which the money supply is increased? It’s basically this. Billionaires and mega-corporations borrow money at low interest rates against the value of their assets. The money they borrow is made out of thin air (really, it is; they just magically make more money at will.) The borrowed money is then re-invested into buying assets, which appreciate in value. They then borrow more money against the appreciated value, pay off the interest, and invest the remainder, which (in totality) just increases the assets more, permitting them to borrow more.

To the extent that any of this additional money is spent buying goods and services, it has the effect of causing price inflation for consumers. This price inflation does not affect the billionaires and mega-corporations who borrowed the money, because they got more money — but it does affect everyone else, who is now forced to pay higher prices for the same goods and services.

This known as the Cantillon Effect, named after the 18th-century economist Richard Cantillon (whom I’ve written about several times). The Cantillon Effect describes how the distribution of money and its impact on prices varies depending on where money is injected into the economy. Cantillon posited that those who receive new money first (often closer to the financial sector and government spending) benefit from its purchasing power before prices have risen. By the time the new money trickles down to others in the economy, prices may have already increased, diminishing the purchasing power of the later recipients.

Over time, as interest payments on the ever-increasing monetary debt grow larger and larger, the economy “financializes,” that is to say, it shifts its orientation from production to finance. That causes de-industrialization, resulting in a reduction in real economic productivity. That in turn results in yet-higher prices, the impact of which is felt by those who haven’t benefited from the financialization.

TLDR: The rich get richer and the poor get poorer because our banking system systematically lends new money to the rich, who in turn benefit from asset inflation (when they invest the money) and Cantillon effects (when they spend the money), while the poor lose out from asset inflation (tried buying a house lately?), Cantillon effects, and deindustrialization.

I’ve said it before, but I’ll say it again - Nothing in America can truly be fixed until we fix our broken money supply. Our monetary system has been corrupt from its inception. It is “built on other’s people’s resources, made for profit by our private banks, enforced by military might on the rest of the world.” It has “created a new gilded age, made homes unaffordable to wage owners, and deindustrialized what was once the world’s most powerful manufacturing base. It has left America running on empty.” And it’s done so at a compound annual rate of 6.5% per year since 1913.

Contemplate this on the Tree of Woe.

1. Readers of Tree of Woe will be interested to learn that LaRouche considers himself to belong to the American School of economics and favorably cites both Friedrich List and Henry C. Carey, whom I recommended in my Recommend Reading series. While LaRouche himself does not cite the Physiocrats, his approach also aligns with that august group. Apart from this book, though, I really can’t say much about him other than that my mom voted for him several times.

2. Those of you who’ve read Adventurer Conqueror King System II Judges Journal, Appendix E: Economics, are probably going “wait a minute, I’ve seen this data before.” Indeed. It’s called dual-use research!

3. For avoidance of doubt, let’s acknowledge that it’s not a perfect analog, because present-day GDP calculations impute value to rentier activity.

4. Chat-GPT kindly acknowledged its answers as such when I offered it the criticism above. “You're absolutely right in noting that reinvestment, innovation, and efficiency should theoretically increase production capacity, jobs, and ultimately the GDP.” It then suggested that the crux of the problem was “economic inequality.”