Spare a dime? A special report on the rich April 4th 2009

RRICHsu.inddICHsu.indd 3 224/3/094/3/09 11:03:5311:03:53 The Economist April 4th 2009 A special report on the rich 1

Easier for a camel Also in this section Show them the money The rich have become disillusioned with the people who look after their fortunes. Page 3

Bling on a budget Designer belts are being tightened. Page 5

A thing of beauty The best works of art still command fancy prices. Page 6

Dropping bricks A runaway boom in property prices has gone into reverse. Page 7

More or less equal? The gap between rich and poor has been widening for 30 years. It has started narrow• ing again. Page 9

Giving it away Will the rich become less charitable? Page 10

Plucking the chickens After decades of prospering mightily, the wealthy may now be in for an But taxes have their limits. Page 12 extended period of austerity, says Philip Coggan

Paying the bill VEN the wealthy burghers of Monaco money against the security of their assets The rich will become a little poorer. That may Eare feeling the pinch. At the principal• have seen their fortunes almost disappear. be no bad thing, but beware a backlash. ity’s Le Metropole shopping mall the win• In Russia the number of billionaire oli• Page 14 ter sales were still in full swing in early Feb• garchs has halved, according to Finans ruary. Upmarket retailers such as Lacoste magazine, and the assets of the ten richest and Christian Lacroix felt obliged to o er tycoons have lost two•thirds of their value. 50% reductions. Most spectacularly, one Russian business• The rich will get little sympathy, but man who had reportedly agreed to buy a they have taken a big hit from the †nancial villa in the south of France for ¤400m is in crisis. After all, they own a disproportion• danger of losing a ¤39m deposit after back• ately large share of the equity and proper• ing out of the deal. ty markets. Many of them derive their To many people this come•uppance of wealth directly from the †nancial sector, the rich will seem to be a good thing. The working for hedge funds, private•equity extremes of wealth in ŒAnglo•Saxon †rms or investment banks. A survey by Ol• America and Britain had reached levels iver Wyman, a consultancy, estimates that not seen since the 1920s. The gains from re• Acknowledgments Apart from the people quoted in this report, the author the †nancial crisis has caused high•net• cent economic growth ‡owed dispropor• would also like to thank the following for their help: worth individuals (as the banking indus• tionately to the wealthy. According to one Walter Berchthold, Olivier de Givenchy, Marten Hoekstra, try calls the rich) to lose $10 trillion, or a study by Robert Gordon of Northwestern Neil Honebon, Axel Hoppenot, Mark Kibblewhite, Andrew Milligan, Helena Newman, Xavier Rugeroni, Deborah quarter of their wealth. The annual Forbes University and Ian Dew•Becker of Har• Sterescu, Gilles Tonelli and Chris Watling. list found that the global number of bil• vard, the top 10% of earners received the lionaires last year fell to 793 from 1,125, and vast majority of the bene†ts of the Œpro• A list of sources is at a report by Spectrem Group, a research ductivity miracle of 1996•2005. Another Economist.com/specialreports company, saw a drop in the number of international study found that only Mexi• American millionaires from 9.2m to 6.7m co and Russia had more unequal income An audio interview with the author is at between 2007 and 2008. distributions than America. Economist.com/audiovideo A few businessmen who borrowed Ajay Kapur, a strategist at Mirae Asset 1 2 A special report on the rich The Economist April 4th 2009

2 Management, dubbed this state of a airs a creased most. The big question is whether Œplutonomy, an economy dominated by Egregious 1 this will be short•lived, linked solely to the the spending of the rich. It was a world Ratio of top earners’ pay to that of bottom 90% crisis, or turn out to be something more where the wealthy might be born in US structural. Social safety nets are much bet• France, work in London, park their money ter developed than they were in the 1930s, 80 in Switzerland and have their business which may make the poor less desperate Top 0.1% headquarters in the Cayman Islands. Such and constrain their anger at the rich. But people seemed to inhabit a di erent coun• 60 the search for scapegoats will be on. try from other people, which Robert Frank, For the moment the pressure is being a writer, called ŒRichistan. 40 felt by businesses that service the rich. Fer• That world of the wealthy emerged Top 1% retti, a top•of•the•range yacht manufactur• from economic and political changes in 20 er, has defaulted on part of its debt; credi• the early 1970s. Fixed exchange rates were tors are set to get just 11cents on the dollar. abandoned, †nancial systems were liber• 0 The decision by Saks, an exclusive retailer, alised, trade unions were confronted and 1947 60 70 80 90 2000 06 to slash prices during the 2008 holiday sea• Source: Economic Policy Institute taxes were cut, all of which helped usher son caused consternation among some in the asset•price booms of the 1980s and luxury•goods groups. Sales at Ti any’s 1990s. Some of those who played the mar• ing growth and jobs, but now it has be• American jewellery stores have plunged. kets with borrowed money‹the founders come more suspicious. Why did bankers De Beers has suspended production at one of hedge•fund and private•equity †rms‹ enjoy bonuses during the boom years but of its biggest diamond mines. became billionaires. leave taxpayers to foot the bill during the And even wealthy people who are not A rebound in pro†ts from the low levels bust? Why should companies be allowed feeling the pinch may have become more of the 1970s, combined with the use of to dodge taxes and sack workers by shift• cautious about spending ostentatiously. share options as incentives, allowed chief ing operations overseas? Net•a•Porter, an upmarket fashion website, executives to make fortunes. The opening What is happening now could mark now o ers the option of having designer up of the Russian, Indian and Chinese one of those sea changes in public policy out†ts delivered in a brown paper bag. economies, allied to a boom in commodity that seem to come along once in every gen• prices, created a whole new batch of eration. In the late 19th and early 20th cen• Fee for no service emerging•market plutocrats. tury a decline in American farm incomes Those who look after rich clients’ wealth The size of the accumulated wealth was prompted a rise of populism and progres• are already in trouble. Surveys indicate stupendous. The Forbes 400 richest people sivism that led to attacks on corporate that the better•o are highly dissatis†ed in 1982 had a combined net worth of $92 trusts in America under Theodore Roose• with the service provided by their private billion; by 2006 they owned $1.25 trillion. velt. In the 1930s the Depression led to the banks, which failed to protect them from To make it onto the †rst list in 1982, you New Deal and the re•regulation of the †• the market falls of the past 18 months. The needed a net worth of $75m; by 2006 you nancial sector in America, and the rise of fraud that caused investors who handed had to be a billionaire. A lot more of this fascism in Europe. Reaction to the eco• their money to Bernard Mado to lose tens money was self•made; inherited wealth nomic crisis of the 1970s ushered in the of billions of dollars has raised new made up over 21% of the †rst list and under Thatcher and Reagan reforms. doubts about the safety of portfolios and 2% of the 2006 roster. And almost a quarter Governments are already trying to deal about the due diligence undertaken by of the 2006 rich owed their fortunes to the with public anger about manifestly unfair wealth managers. †nance sector, compared with less than a gains by capping bankers’ bonuses. The All that said, there are still plenty of rich tenth back in 1982. level of regulation will increase, and taxes people around. Someone was con†dent will inevitably rise as governments strug• enough to pay $20m for a Degas bronze at The rich man in his castle gle to contain their bulging budget de†cits. an auction at Sotheby’s in February. Diners It would have been easy to conclude that As President Obama’s budget proposal at the Hotel Metropole in Monaco are still the tide of history was simply resuming its showed, the rich will be tempting targets willing to shell out ¤137 for a grand dish of usual ‡ow towards greater inequality. For for those tax hikes. rock lobster. much of the time since records began the It is also possible that globalisation may But the outlook for the rich is no longer normal state of a airs has been extremes come under threat as governments seek to the Œglad, con†dent morning that it of wealth, whether in the hands of aristo• placate their voters by protecting local jobs seemed just two years ago. In a survey of cratic landowners or industrial entrepre• and industries. Already banks are being high•net•worth Americans by Harrison neurs. The period after the second world urged to lend money to domestic rather Group in January, 78% said their sense of †• war, labelled by economists as the Œgreat than foreign businesses. The German and nancial security had been undermined by compression, when wage di erentials American governments are leading an at• the crisis; only 46% were optimistic about narrowed and taxes went up, looked like tack on bank•secrecy laws in tax havens. their own future, against 93% in 2005. an historical anomaly. The elite may no longer †nd it so easy to This special report will explain how But now the tide is turning again, re• move itself and its capital from country to disparities in wealth and income became ‡ecting widespread resentment of the country, depending on where the returns so wide in the †rst place and ask whether mess in which the †nancial sector has are highest and the taxes lowest. that process will now go into reverse. And landed the economy. The public may have All this may bring a reduction in in• it will examine how well the rich are cop• been willing to tolerate extremes of wealth equality, especially in the Anglo•Saxon ing with the crisis‹because that will mat• and pay when the economy was produc• economies where it seemed to have in• ter for everyone else too. 7 The Economist April 4th 2009 A special report on the rich 3

Show them the money

The rich have become disillusioned with the people who look after their fortunes

NE of the problems with being rich is performance †gures, and the best you will cess of a private•client manager. A lot may Othat you cannot just leave your mon• get is the record of some model portfolio; depend on the trust between the individ• ey to sit there: you have to do something clients are all di erent, managers say, and ual client and the relationship manager at with it. Few people feel con†dent enough have di erent attitudes to risk. Besides, the bank; if the bond is strong, then a bad to throw themselves into the hurly•burly they argue, looking after a client is not just year such as 2008 can be explained away. of †nancial markets on their own. The about performance, it is also about tax This can be an advantage to private banks wealth•management industry exists to management, family structures and all once clients are on the books; inertia may take that problem o their hands, for a manner of other things. Some clients have keep them there, if only because clients pretty hefty fee. strong opinions and will want a say in can rarely be sure that they would be bet• Unfortunately for all concerned, the in• how the portfolio is run; others will have ter o elsewhere. dustry tends to promise more than it can long•standing positions in particular busi• deliver. Last year was disastrous for †nan• nesses or properties that they may be un• Who rates as rich? cial markets, with the MSCI World index of willing or unable to sell. So a private•client How much money do you need to count as equities falling 42%. Moreover, many cli• portfolio will normally look quite di erent wealthy in the †rst place? For a wealth ents, having been persuaded of the bene• from a pension•fund version with its care• manager, it depends on how big a portfolio †ts of diversi†cation in recent years, had ful mix of equities, bonds and property. you can give him to manage. For example, bought alternative assets, such as hedge These constraints are real enough, but Merrill Lynch’s wealth•management re• funds and private equity, which supposed• they make it very hard to measure the Œsuc• port starts counting at $1m in Œinvestible ly o ered absolute (positive) returns un• assets. That excludes people’s main correlated with the stockmarket. But when homes, which may seem reasonable. But it the crisis came, those assets turned out to means that a Londoner who sells his home be highly correlated to the mainstream and decides to rent can suddenly †nd him• and lost value as well. self Œrich. The †nal straw came at the end of last In fact, a lot of wealth managers will year when the extent of the Mado scan• not bother with anyone who has less than dal was revealed. Bernard Mado pleaded about $10m in assets. After all, a portfolio guilty to running a Ponzi scheme in which of $1m these days would generate an in• he was paying early investors consistent come of only $30,000 if invested in Trea• returns by taking the money from later sury bonds, which does not leave much ones, with potential losses in the tens of scope for the playboy lifestyle. billions of dollars. Just what were wealth Putting performance to one side, anoth• managers doing to earn their fees if they er big issue for the industry is the quality of could not spot the scam? advice on o er, and whether it is suˆ• So there is now fairly widespread dis• ciently impartial. In many cases private satisfaction with the industry. ŒThe old banks may be part of larger groups that see wealth•management universe is not just an advantage in having a captive client broken, it’s been broken and tossed away, base for their other activities. This link is says Russ Prince of Prince & Associates, a made explicit in a recent report on the market•research †rm. ŒNobody believes wealth•management industry by Boston anything anybody is saying any more. A Consulting Group (BCG). ŒSome players survey by his company showed that 15% of position their private banks within their the wealthy had left their main adviser last corporate or investment banks, the report year and a further 70% had pulled some of says. ŒThis approach aims to keep the cli• their money away. ent’s wealth in a single institution and tap A survey of rich Americans by Harri• product•development synergies. son Group found that 63% had lost faith in These synergies often turn out to bene• †nancial institutions. And Caroline Garn• †t the banks a lot more than the clients. As ham of Lawrence Graham, a London law Stefan Jaecklin of Oliver Wyman puts it, †rm, says that half of her clients do not use Œin the integrated banking model there are private wealth management at all, and limited bene†ts for the private bank from half of the remainder are dissatis†ed with having an investment bank attached; the the advice they received. bene†ts mainly ‡ow the other way round. The private wealth•management busi• A lot of private banking has not been ness has always been rather murky. Ask for about advice but about pushing products. 1 4 A special report on the rich The Economist April 4th 2009

2 Often bankers will be rewarded not just on shares that were falling rapidly. and into cash and government bonds. the basis of assets under management but Asian clients may have been sold more Some have called it the Œback to basics on product sales. of these products because they were gen• market. ŒFor the next 18 months to two Jacques de Saussure of Pictet, a Swiss erally seen as being willing to take rather years, investors will be a little cautious, wealth•management group, agrees. ŒWe more risk. As one observer remarks, many says HSBC’s Mr Parmar. ŒThey are going to have avoided having an investment bank of these clients were people who were demand more explanation of what is in within the Pictet group because it creates earning 25% a year from their own busi• their portfolios. It is hard to sell a black•box lots of con‡icts of interest, he explains. nesses; they found it hard to understand product today. ŒThe wealth•management business can why private banks were o ering much become a distribution channel. lower returns. Raj Parmar of HSBC Wealth Golden glow An important development in recent Management says there was Œlittle doubt Indeed, there is considerable demand for years has been the use of so•called struc• that the Asian wealthy did exceptionally that most ancient of †nancial products, tured products. Like the toxic versions that well in the past †ve to seven years and bet• gold. According to the World Gold Council, were undone by the collapse in the Ameri• ter than their counterparts around the investment demand for bullion between can housing market, these products in• world. However, a lot of institutions were 2007 and 2008 rose by 64%. Pictet, the volve the use of derivatives. That makes knocking on their door and outbidding wealth•management group, decided some them a tempting sales opportunity for in• each other on returns, often using leverage. time ago to take physical delivery of gold vestment banks with derivative expertise. By late 2008 many Asian investors gave (rather than get exposure via the deriva• An enthusiast would say that these pro• away a substantial proportion of the pro• tives market), and has had to †nd extra ducts often have tax advantages and can †ts they made in those †ve to seven years. space in its vaults. be used to manage an investor’s risk pro• Many Asian clients will have been This change in behaviour is, in itself, a †le; a cynic would say that the structures caught out by the sharp falls in local mar• challenge for the private•banking sector. can disguise a lot of fees and charges. kets last year, with the Shanghai A share Oliver Wyman suggests that the shift from market dropping by 65%. Even so, the in• equities and structured products into cash A gamble by another name dustry sees the region as a promising area and †xed income will reduce private•bank Some structured products may be a rea• for expansion. According to BCG, assets revenues by around 20%. sonable way of enticing investors to take a under management in China grew at a Moreover, the Mado scandal and the bit more risk; for example, with an invest• compound annual rate of 25% between controversy surrounding Sir Allen Stan• ment that o ers 90% of the growth in an 2002 and 2007, though the †gure will have ford, a rich Texan accused of an $8 billion equity index but with a guaranteed return taken a big hit in 2008. Another growth investment fraud, raises a lot of questions of capital if the market falls. But others, area was central and eastern Europe, about what private wealth managers actu• particularly those involving commodities, which had four of the ten fastest•growing ally do with their clients’ money. How may be a vehicle for gambling. ŒA lot of wealth markets in 2002•07: Poland, Slova• could such groups pass due•diligence tests structured products were speculative in kia, Hungary and the Czech Republic. when they used obscure auditing †rms nature, with questionable purpose in a Wherever the clients are based, they are and kept their investment processes so se• private•banking context, says Mr Jaecklin. likely to have been chastened by the expe• cret? According to Jérôme de Lavenère Lus• These structured products can quickly rience of the past 18 months. Like everyone san of Laven Partners, a company that spe• turn into dead money if markets move else, rich people want the impossible: high cialises in due diligence, Œthere has been a against them, with clients locked in for returns with no risk. But their biggest fear, degree of complacency and laxness about years or able to redeem only at †re•sale naturally enough, is losing a chunk of their how people choose investments. prices. ŒStructured products can become il• wealth so large that they would have to ad• There may well be some consolidation liquid and pricing can be at the mercy of just their lifestyles to live on a smaller in• in the fund•of•hedge•funds industry, the issuer, says Pictet’s Mr de Saussure. come. So at times of trouble they will re• where many people have been amazed to Another issue emerged from the col• treat from risky assets such as hedge funds †nd that managers charged 1% or 1.5% of the lapse of Lehman Brothers. In some cases sums invested a year for their supposed the guarantee on a structured product was skill in scanning the industry, only to send provided by the failed investment bank; Even the rich get poorer 2 clients’ money to Mr Mado . With the sec• this meant that clients did not get their Global wealth pools of high-net-worth individuals tor already losing money after su ering promised money back after all. $trn unexpected losses in 2008, many funds• But the bigger problem has been invest• Latin America Asia North of•funds may be forced to close. ŒWe ex• ment losses. During the boom years some Middle East Europe America pect that †rms which su ered from expo• Asian private•banking clients were sold a 50 sure to Mado (almost regardless of the toxic product known as an accumulator. scale) will see material redemptions as in• The structure sounded simple. If shares in 40 vestors react to perceived lapses in the due• a company, say General Electric, stayed 30 diligence process, says Huw van Steenis, a above a given level, investors received a †nance•sector analyst at Morgan Stanley. high yield; if the shares dropped below 20 The rest of the wealth•management in• that level, they ended up owning the stock. 10 dustry may also have to change. Fees have In e ect, the clients had written a put op• not been transparent, with clients getting tion on the share price. That was †ne in ris• 0 charged for a whole range of services and ing markets but proved to be a disaster in 2002 2007 2008* some managers taking Œretrocessions or Source: Oliver Wyman *Estimate 2008 when clients ended up owning kickbacks from outside funds with which 1 The Economist April 4th 2009 A special report on the rich 5

2 they place money. ŒThe industry needs to than others; Credit Suisse and JPMorgan that they made the right choice of adviser move to a model where advice is being are both reporting signi†cant in‡ows. An• in the †rst place, or will Œcling to nurse, for charged for and money ‡ows are transpar• other section of the market that may do fear of †nding something worse. They ent, says Mr Jaecklin. well is private family oˆces, which deal may also feel they lack the expertise to Downward pressure on fees seems in• with the wealth of a single dynasty or a evaluate the service they are getting. ŒPriv• evitable. In the 1990s, when investors were small group. Their main drawback is that ate clients don’t know enough about the earning 20% a year, fees seemed a trivial is• they require considerable resources to set industry to be able to demand what they sue; but when cash is yielding 1•2% and up, so may not be worthwhile unless a need, says Ms Garnham. But the †nancial government bonds 3•4%, they take a much family has around $1 billion. Multi•family crisis will have shaken many clients out of bigger chunk of total return. oˆces, such as the London•based Fleming their lethargy. The next few years will see Given their losses in 2008, clients may Family & Partners, are another option. big changes in the wealth•management in• also be attracted to banks which they be• There is a natural inertia about wealth dustry. In future, †rms will have to deliver lieve to have weathered the crisis better management. Clients may want to believe as well as promise. 7 Bling on a budget

Designer belts are being tightened

WEALTHY Mexican walked into an ex• rather better than the rest, reporting rev• ing to this by trimming non•essential Aclusive shop in Vail, Colorado, late last enue growth of 4% in the fourth quarter, al• spending; using potted plants as decora• year and picked out $11,000•worth of though the watches and wine divisions tions, for example, instead of fresh ‡owers clothes to lay on the counter. He perused su ered small drops year•on•year. that have to be replaced every day. them for a minute, then o ered the sales Moreover, shoppers for luxury goods Just like ‡owers, servants are being assistant $6,000 for the lot. The shop coun• can be frustratingly inconsistent. Although pruned. David Gonzales of the Domestic tered with an o er of $6,800. the overall trend is down, demand in one Placement Network in southern California The rich are economising, and the busi• shop can be up 50% one day and down says that a number of chefs have lost their nesses that deal with them are having to 50% the next. Manufacturers and retailers jobs. Live•in chefs are very expensive to cope. In a survey of wealthy individuals †nd it hard to budget or plan stock levels. maintain and their employers can econo• conducted by Harrison Group, 80% said The wealthy are cutting back on leisure mise by eating out more, entertaining less they were looking at each spending catego• spending as well. According to Smith Tra• and using contract caterers when they ry to see what they could save, 77% were vel Research, in the week ending February have dinner parties at home. buying fewer big•ticket items and 78% 21st occupancy rates in luxury hotels were Nor has the crisis driven the wealthy to were waiting for the sales before buying 17.5% down on the same period in 2008, drink. Champagne exports fell by 4.8% last such items. Across the board, Harrison’s and revenue per room was 27.5% lower. year. An index of †ne•wine prices dropped Jim Taylor reckons the wealthy are spend• That has caught out some hotel owners by 18% after the Lehman Brothers collapse; ing 30% less than before, the sole exception who took on too much debt; in Colorado, Simon Staples of Berry Bros & Rudd, a Lon• being items for their children. the owner of the Vail Plaza Hotel & Club don•based †ne•wine merchant, says that Claudia d’Arpizio of Bain Consulting †led for Chapter 11bankruptcy in October. some prices have dropped by 40%. But that reckons that the luxury•goods market Vivian Deuschl of the Ritz•Carlton ho• still leaves the prices of some vintages, probably grew by only 1% last year, having tel group says corporate bookings have such as the sought•after 2005s, well above su ered heavily in the fourth quarter. A been particularly badly hit. This has be• their initial levels. dramatic estimate of the decline during come known as the ŒAIG e ect, after the the holiday season was made by Spen• insurance group that was rescued by the Flash fatigue dingPulse, part of the MasterCard credit American government last autumn and There seem to be two main reasons why group, which calculated that luxury•goods several times more since. Shortly after the the wealthy are tightening their purse spending between November 1st and De• †rst bail•out it emerged that the group had strings. The obvious one is the hit to their cember 24th 2008 was down 34% year•on• spent $440,000 on a spa retreat for sales• portfolios from the equity and property year. Bain thinks the †rst half of this year men. Political outrage at the junket led oth• markets. ŒIt’s not just that they’ve lost mo• will also look grim. er companies to rethink their plans. ŒEven ney, says Russ Prince of Prince & Asso• The e ects are showing up across the if businesses have money, says Ms ciates. ŒThey’re not sure how much more industry. Bulgari of Italy reported a 17% Deuschl, Œthey are very skittish about they’re going to lose. drop in jewellery sales and a 28% decline spending it at luxury hotels. The second reason is a feeling that it is in watches in the fourth quarter; Ti any’s In addition, the conference market is wrong to show o at a time when the said sales in its American stores dropped taking a hit because of the business down• economy is in recession and people are 35% in November and December; Riche• turn. The Fairmont hotel in Monte Carlo, feeling poor. Conspicuous consumption is mont, a Geneva•based group with brands which is close to the Grimaldi conference out. The top end of the watch market is suf• such as Cartier, saw its sales fall by 12% in centre, says events are being booked at fering, not least because such watches are the three months to December. LVMH did much shorter notice. Some hotels are react• often bought out of bonuses in the †nan•1 6 A special report on the rich The Economist April 4th 2009

2 cial sector, which have largely dried up. running costs will be in the millions. sumers; luxury•goods groups have to aim Mr Taylor of Harrison Research points The cost of †nding trained crew has a bit wider to do well. But expansion can to a boom in sales of used luxury cars. gone up sharply in recent years, says Mr create a dilemma. If it is overdone, a brand ŒYou don’t want to pull up in your drive• Abery, although the trend has softened re• can lose its cachet. way with a new Mercedes when you cently. Wages for domestic servants have Guy Salter of Walpole, a British luxury• know your neighbour is su ering. Tastes also shot up: Mr Gonzales says demand goods association, says the industry has may shift from the ‡ashy to the practical; has tripled in recent years. Steven Ferry of done so well for so long that it lost sight of cashmere knitwear may still be acceptable the International Institute of Modern But• some of the issues. ŒA hundred years ago whereas extreme fashion is not. lers says there has been a big jump in the luxury•goods manufacturers were small All this comes after many boom years use of butlers in hotels, where they serve family•owned businesses who knew their in the luxury sector. An indication of the the occupant of a suite or a range of suites. customer base very well. By the 1970s and demand for top•of•the•range goods can be It is not quite a return to the world of 1980s there were lots of people ‡ocking to found in Forbes magazine’s Œcost of living P.G. Wodehouse’s Jeeves (a valet, not a but• buy luxury goods who were happy to pay extremely well index which includes ler), who looked after Bertie Wooster. Mod• for the ‡ash and the logo. The companies items such as facelifts, fur coats and Gucci ern butlers often act as household manag• stretched the elastic too far, he argues. loafers. It almost quadrupled between 1982 ers rather than serving up drinks on silver and 2006, whereas the broadly based con• trays. Their employers tend to be asset•rich Crafting a new strategy sumer•price index merely doubled. and time•poor and need sta to maintain a The recession may cause manufacturers to Stephen Abery of the broker Fraser range of properties. rethink their strategy. Ledbury’s Mr Cohen Yachts says that roughly half of the world’s The market for luxury goods and ser• says the wealthy may decide they will buy 100 biggest yachts have been built since vices is highly strati†ed. There is a big gap fewer things but will go for higher quality: 2000. Some are more than 150 metres long, between those who can a ord a butler and less bling and more craftsmanship. This half as much again as a football pitch. Even those whose only foray into the market is may favour a group such as Bottega Veneta a 70•metre version could cost ¤100m to to buy a Gucci handbag. Marc Cohen of which produces handbags without a logo build. And what with a dedicated crew, Ledbury Research points out that the high• but with a distinctive stitching pattern. mooring, fuel and insurance, the annual pro†le wealthy make up only 0.1% of con• Another group that thinks it can bene†t 1

The best works of art still A thing of beauty command fancy prices

N CHRISTIE’S Paris auction room on the What the February auctions showed the Ds, death, debt and divorce, says Mr Ievening of February 23rd it was as was that there is still money around to bid Dolman. ŒThere is a fourth D, discretion• though the †nancial crisis had never hap• for exceptional pieces. But the auctioneers ary selling, but there has not been much pened. A sale of works of art collected by are being much more selective about the of that so far. the late designer Yves Saint Laurent works they are o ering for sale and have The previous art•market downturn brought in $264m, well ahead of the esti• abandoned the boomtime practice of was 20 years ago, after record prices were mate of $232m (though a Chinese buyer guaranteeing prices. These attracted buy• paid for Impressionist works, including refused to pay for some bronzes as a ers and allowed auctioneers to take part in $54m for ŒIrises by Vincent van Gogh. nationalist protest). Records were set for the upside, but carried a big risk when the The buyer of that work, Alan Bond, an works by Piet Mondrian and Marcel Du• market turned. Australian tycoon, turned out to have bor• champ, although a Picasso failed to meet That risk has duly surfaced. Sotheby’s rowed part of the purchase price, and its reserve price and was withdrawn. reported a 52% decline in revenue in the struggled to repay the loan after his busi• At Sotheby’s, meanwhile, sales of Im• fourth quarter of 2008, with a 46% fall in ness empire collapsed. At the time he was pressionist, modern and contemporary auction sales. The company reported Œsig• competing for the paintings with a group art in February raised $100m, including a ni†cant auction•guarantee losses and in• of Japanese buyers whose fortunes had record £13.3m ($20m) for a Degas sculp• ventory writedowns and is cutting its been boosted by the boom in their coun• ture. The same piece had been bought for sta by 15%. ŒWe are forecasting lower try’s land and share prices in the late $9.1m in 2004. sales volumes for 2009, says Ed Dolman, 1980s. When the Japanese economy But the art market has hardly come chief executive of Christie’s. ŒBut there slumped in the early 1990s, the art market through the crisis unscathed. Ian Peck of have been seen some very high prices fell back sharply. the Art Capital group reckons that prices paid for individual items, including the Art•buying during the recent boom have dropped by 20•30%, with the con• highest price ever paid for a diamond. has been far more broadly based, taking in temporary market particularly badly hit. Some buyers, such as the hedge•fund Asia, Russia and the Middle East. The Rus• His group, which lends money to art buy• titans, may have been hit by the †nancial sians may now have receded again, but art ers, has reduced estimated values of col• crisis, but the art world has yet to see a lot experts hope that the rest of the market lateral by up to 50%. of forced sales. ŒThe market is driven by will prove more resilient this time. The Economist April 4th 2009 A special report on the rich 7

dened with excess stock in January, but ri• val shops were made to look very expen• sive and felt they had to follow suit. Nordstrom, a department•store group, reported a 68% fall in fourth•quarter net pro†t, thanks to a decline in margins prompted by price cuts. The markdowns solved the immediate problem of excess stock but did nothing to solve the medium• term issue of slumping demand; the Seat• tle•based retailer is forecasting a 10•15% de• cline in same•store sales this year. There is also the longer•term question of whether consumers might get hooked on price cuts. ŒThe very big discounts by department stores may have created a dangerous atti• tude in shoppers, that it is a little bit irratio• nal to pay the full price, says Bain’s Ms d’Arpizio. Many of the wealthy may be migrating 2 from the change in mood is NetJets, which luxurious. Rather than cutting prices, the to the internet. Mr Salter cites a survey allows both the rich and the corporate elite hotel is o ering more services for the same showing that they are happy to buy online; to ‡y privately without the expense of price in an e ort to keep clients loyal. some 40% said they preferred net•based owning their planes. The company says It is a tough call to make. Keeping stan• shopping because they felt uncomfortable the average corporate client spends dards and prices high maintains elite ap• going into luxury•goods stores. But online ¤700,000•800,000 a year, compared with peal but risks losing some customers to shopping holds its own dangers. Last year the ¤17m•18m it would cost to buy a mid• lower•cost alternatives. What makes the a French court †ned eBay ¤40m for allow• size jet. NetJets is hiring 12 new salespeople call even more diˆcult is that the ranks of ing auctions of fake luxury items on its site. in a bid to capture market share; it may be the rich have changed over the past 20 The problem of counterfeiting may get helped by the fact that owning a jet has years; old money has become less impor• worse as wallets get squeezed. come to symbolise corporate excess. tant. ŒA lot of the wealth of the past 20•30 Senior people in the industry admit this Most companies associated with the years is self•made and they are looking for is going to be a very diˆcult year. The best luxury•goods market, however, will have value, says Walpole’s Mr Salter. ŒMost of they can hope for is that the rich will con• to adjust to a decline in demand. Mr Salter even the super•rich were middle•class 20 centrate their spending on the highest• says that manufacturers cannot react to the years ago. quality stu . Cutting corners can be a false squeeze by cutting costs unless they can economy; a cheap handbag, one expert ar• maintain quality. ŒIntegrity comes from Cheap thrills gues, can drag down the rest of a woman’s having craftsmen, he says. ŒThe wealthy Retailers’ plans were thrown into disarray out†t. Manufacturers think it is better to ac• are not going to economise on good taste. when Saks Fifth Avenue decided to cut cept lower sales than lower margins. They Luca Virgilio, who runs the Hotel Met• prices on designer clothes by up to 70% worry that just by trying to get through ropole in Monaco, says it would be a mis• even before the start of the holiday season 12•18 months of crisis, they might be ruin• take for him to compromise on quality; cli• (de†ned as Thanksgiving to Christmas). ing their brands. But it is a big bet, and ents visit the hotel precisely because it is The strategy helped Saks avoid being bur• some of those brands will not survive. 7 Dropping bricks

A runaway boom in property prices has gone into reverse

F ANY market has been distorted by the the bay, but it was not helped by an elevat• New York the wealthy want to live either Iactivities of the rich over the past decade, ed highway bang in front and a noisy by Central Park or all the way out in the it must surely have been property. For a building site next door, and the kitchen Hamptons; in Europe they aim for Monaco while it seemed as if the plutocrats were was tiny. The price was a staggering ¤8m, or the French Alps. Combine a limited competing against each other to pay the sil• enough to buy three or four substantial number of preferred locations with the liest prices for the smartest locations. houses in, say, west London. massive increase in wealth over the past 20 Even though prices are now retreating, But the rich do not want to live in the years and you get ridiculous prices. in some areas they still seem over the top. wilds of west London. Estate agents in that Monaco’s property market bene†ts A two•bedroom apartment in Monaco city say they balk at any property more from a shortage of space and tax advan• shown to The Economist did have a view of than 800 yards from Hyde Park Corner. In tages so persuasive that foreign residents 1 8 A special report on the rich The Economist April 4th 2009

2 far outnumber the locals. Last year it be• rich now seem to be a ected by the gloom. came the world’s most expensive residen• The price of a smart address 3 Russian buyers seem to have vanished al• tial location measured by price per square Prime residential property, Q4 2008 together, whether in London, Manhattan metre, according to a survey by Knight or Monaco. There is now much scepticism Frank, a †rm of estate agents (see chart 3). ¤ per sq m $ per sq ft about the plans of the Candy brothers, a The prime areas of London slipped into Monaco 50,000 6,550 †rm of British developers who have been second place because of the weakness of London 28,000 3,670 trying to create a new class of property the pound. But even Monaco’s market is New York* 16,500 2,160 with luxurious †ttings and abundant ser• su ering. Pascal Chaisaz of Savills, anoth• Moscow 16,200 2,120 vices suitable for the global elite. Will the er estate agent, says that during the frenzy Paris 16,000 2,100 rich still be willing to pay a premium for of 2006•07 prices reached ¤100,000 per Tokyo 15,850 2,080 such places? square metre. They have now fallen back Hong Kong 15,750 2,070 Although the very wealthy can pay to ¤50,000, but that is still a lot more than Rome 13,500 1,770 cash for their homes, they often do not the ¤15,000•20,000 at which they traded Singapore 11,850 1,550 want to tie up too much of their capital that six or seven years ago. Sydney 11,000 1,440 way. But borrowing has become a lot more diˆcult. Simon Gammon of Knight Frank Source: Knight Frank Residential Pricing *Manhattan The curse of Lehman says that British banks now like to see a Agents generally agree that the top end of 60% loan•to•value ratio, rather than the the market was doing very well until Sep• in nearby Aspen the local Sotheby’s Inter• 75% they would have accepted in the old tember 2008 when Lehman Brothers went national Realty oˆce has closed. In Cali• days; and the spreads against LIBOR (the to the wall. Liam Bailey of Knight Frank fornia sales of million•dollar homes fell by banks’ benchmark rate) have risen. Some says that in the †rst half of 2008 the group 43% between 2007 and 2008, according to banks now try to use mortgages as quid sold twice as many houses in the £10m• MDA Dataquick, with sales in Beverly Hills pro quo for other business opportunities; plus category as it did in the †rst half of dropping by 30%. In February the Beverly for example, clients may be required to 2007. But the super•rich segment of the Hills city manager was forecasting that the place money with their wealth•manage• market has since dropped as steeply as property downturn would cause an immi• ment arms before they are given a loan. Ms anything else. nent 15% drop in tax revenues. Liebman says American banks are also be• Knight Frank says that 37 of the 55 prime Manhattan and London are clearly af• ing more cautious, particularly about al• international locations it covers saw price fected by the downturn in the †nancial lowing for bonuses when calculating falls in the last quarter of last year com• sector. But the uppermost end of the Lon• bankers’ incomes. pared with a year earlier. Hong Kong, Lon• don market, argues Yolande Barnes of Sa• Forecasting the bottom of the market is don, Singapore and Sydney all su ered vills, prospered until September last year a tricky task, particularly at the prime end. double•digit declines over that period. The because it was the preserve of the interna• For highly prestigious properties, valua• hardest•hit market may be Dubai, which tional wealthy. However, even the very tion measures such as price per square me• indulged in a ‡urry of building in recent tre are only an approximation. Paying years in its bid to become a global †nancial $20m for an apartment might seem absurd centre. As speculators have ‡ed the market, to most people but would represent only a some prices have fallen by 50%. small part of a billionaire’s portfolio. Pamela Liebman of the Corcoran Group says the market in Manhattan has Pride before the fall su ered as well. Bonuses in the †nancial Nevertheless, it was clear that the prices of sector have either fallen sharply or disap• the best properties became in‡ated. In peared altogether, and hedge funds are 2007 Tim Blixseth, a luxury•resorts devel• struggling. Moreover, in a new spirit of dis• oper, advertised a 160•acre property near cretion, buyers do not want to see their Bozeman, Montana, part of the Yellow• names publicly associated with a high• stone Club, at a remarkable $155m. The re• priced purchase; they are trying to do deals sort has since gone into bankruptcy. The below the radar. Ms Liebman estimates property was never built and the lot was that prices for the most expensive proper• sold for $10m. ties in New York have come down by Peter Mackie of Property Vision thinks 20•30%; in the Hamptons, where the rich that London prices could easily fall 50% have their summer homes, some buyers from their peak. The market did very little are making o ers 40% below the peak. But, in 2001•05, he says, and then took o with she adds, Œthere is a real disconnect be• a whoosh because of bonus money. Ac• tween what buyers are willing to pay and cording to Savills’ global residential review what sellers will accept. That has led to a many markets have seen a decade of price big fall in transaction volumes. rises of 10•20% a year. ŒAgainst such a back• Other smart addresses are also su er• drop, even today’s largest falls of 50% in ing. In Vail, Colorado, the number of trans• some cases will still leave a long•term lega• actions in December 2008 was the lowest cy of substantial price growth, says for any month since the Land Title Guaran• Charles Weston•Baker, director of Savills’ tee Company began tracking deals in 1996; international residential department. 7 The Economist April 4th 2009 A special report on the rich 9

More or less equal?

The gap between rich and poor has been widening for 30 years. It has started narrowing again

HE past 30 years have been a great time made ends meet because more women wealth disparities in developed countries Tfor the wealthy. Their businesses be• worked (and their real incomes did rise) declined sharply. But which is the anoma• came more pro†table; their equities and and because they were able to borrow ly: the earlier period of high tax rates and properties increased in value; for those money to maintain their spending. rapidly growing state involvement in the who worked in investment banking or The classic tool for measuring inequali• economy, or the rising inequality of the hedge funds, bonuses rose steeply. And the ty is the Gini coeˆcient. The higher it is, the past 30 years? further up the income scale you went, the less equal the society. In America the coef• better the rich did. Just as the bottom 90% †cient climbed steadily from 0.395 in 1974 The norm and the exception of the population have lagged far behind to 0.47 in 2006 before dipping slightly to Historically, it seems that the rich, like the the top 10%, most of those in the top 10% 0.463 in 2007. In Britain, according to the poor, have always been with us. Even so, have trailed the elite 1%. And that select 1% Institute for Fiscal Studies, the Gini has ris• the change of course in the 1980s calls for has looked in envy at the Croesus•like 0.1% en from 0.25 in 1979 to 0.35 in 2006. Figures an explanation, as does the fact that in• at the very top of the tree. from the United Nations suggest that equality has risen far more in some coun• Any explanation for this rise in inequal• America’s Gini coeˆcient is lower than tries than in others. There is a clear gap be• ity needs to account for several di erent that of many developing countries but tween America’s and Britain’s ŒAnglo• trends. In the 1980s the poor fell further be• well above the levels recorded by egalitari• Saxon model and the rest. hind the middle classes, but since the 1990s an Denmark, Finland and Sweden, where That makes some explanations for the those middle classes have been squeezed. it does not seem to have risen much. widening disparities look suspect. One is Both groups have lost ground to the elite. The recent widening of inequalities the widespread use of technology, which Between 1947 and 1979 the top 0.1% of marked a complete reversal of the previ• might be expected to favour those workers American earners were, on average, paid ous trend. From the 1930s to the late 1970s who are able to exploit it. But the Nordic 20 times as much as the bottom 90%, ac• economies are well up on technology; Fin• cording to the Economic Policy Institute, a land, for instance, is home to Nokia, a huge think•tank in Washington, DC; by 2006 the Stuck 4 mobile•telecoms group. Technological ratio had grown to 77. In 1979, 34.2% of all Median earnings in 2007 dollars of American change may explain why unskilled work• capital gains went to the top 1% of recipi• full-time male workers, $’000 ers have lost ground to graduates. But it ents; by 2005 the †gure was 65.3%. 47 does not explain why such a wide gap has All this happened during a period emerged at the very top of the income when American workers’ median real in• 46 scale, with the top 0.1% outpacing other comes stagnated (though the notional val• 45 professional workers. ue of any health insurance would have ris• The disappearance of the ultra•high tax en steeply). In 2007, according to the 44 rates that were prevalent in the 1970s Census Bureau, the median income of 43 helped the rich hang on to their gains. But American male workers was $45,113, less work by two academics, Thomas Piketty 42 than the $45,879 (in 2007 money) that they and Emmanuel Saez, shows that inequali• earned back in 1978 (see chart 4). At no ty has been just as marked in pre•tax as in point over that 29•year period did median 1972 80 85 90 95 2000 07 post•tax incomes. And why did govern• Source: US Census Bureau incomes pass the $46,000 mark. Families ments propose (and voters approve) such 1 10 A special report on the rich The Economist April 4th 2009

2 tax cuts in the †rst place? There was a feel• ly to cast their vote. bail out †nancial markets only added to ing in the 1970s that the post•war economic Domestic politics is clearly not the only the speculative enthusiasm. model had been corroded by rising in‡a• factor. Many people would point to global• Messrs Gordon and Dew•Becker point tion and a series of oil shocks. That helped isation, in particular the opening up of the to the rise of Œsuperstar labour markets in prepare the ground for the Reagan and Indian and Chinese markets that vastly in• which the best talent commands a huge Thatcher reforms. creased the global labour force, putting premium. The clearest examples are found As for inequality lower down the scale, downward pressure on unskilled wages. in entertainment and sport. Name recogni• a study of the literature by Robert Gordon But academic studies have not found this tion gives an exponential kick to the and Ian Dew•Becker cites the decline in to be a big factor in explaining the level of incomes of celebrities like Madonna or Da• trade unionism as a big factor, at least for wages for the unskilled in recent years. vid Beckham who can attract endorse• men. In 2005 only 14% of American work• Globalisation may, however, explain ments, souvenir sales and the rest. In †nan• ers were union members, compared with some of the changes at the very top of the cial markets, those who mastered the 27% in 1979. The decline in unionisation scale. The emergence of a global market for sophisticated instruments (such as deriva• may also help to explain the political ac• talent in areas such as banking, the law and tives) that emerged in the era of liberalisa• ceptance of the low•tax, low•regulation re• investment may explain why the top 0.1% tion were also able to cash in. gime. Political parties are no longer as de• have been so well rewarded. pendent as they were on union donations. In particular, the †nancial sector con• The halo e ect Instead, they have had to cultivate the rich, tributed an increasing proportion of stock• Another group of bene†ciaries, chief exec• who have gained greatly in lobbying pow• market pro†ts from the early 1980s to 2006. utives, may be in a di erent category. They er. A study in the late 1990s of congressio• The greater acceptance of debt allowed bene†ted from the early use of share op• nal elections found that 81% of political do• private•equity †rms and hedge funds to tions in America, which gave managers a nors earned more than $100,000 a year bet on rising asset prices with borrowed geared play on the 1980s and 1990s bull and only 5% earned less than $50,000. money, which is a quick route to riches market. Messrs Gordon and Dew•Becker The free•market consensus among par• when all goes well. There were plenty of are not sure whether the resulting wealth ties in Western countries increased disillu• incentives to take risk, in the expectation was due to their executive skill or to their sionment among the poor, who felt they that someone else would pick up the tab ability to control boards and thus the lacked any real choice between economic when things went wrong. The willingness amount they got paid. Some executives en• policies. That, in turn, made them less like• of central banks to use interest•rate cuts to joy a Œhalo of reputation, the academics 1

Will the rich become less Giving it away charitable?

N JUNE 2006 the then two richest men left Microsoft to take charge of his founda• creased its payout ratio from 5% to 7% in re• Ion the planet performed a remarkable tion, including its work in †ghting dis• sponse to the downturn. ceremony. Warren Bu ett, an eminent in• eases such as malaria and AIDS. This in• But those measures involve spending vestor, agreed to hand over the bulk of his creasingly businesslike approach of the money that has already been donated. It fortune to the foundation run by Bill new rich is re‡ected in an ugly new word, seems likely that the pace of new dona• Gates, the founder of Microsoft. It was a philanthrocapitalism (which is also the ti• tions will slow down. For example, a big gesture that recalled the philanthropic tle of a book by an Economist journalist). hedge•fund charity, Absolute Return for heyday of Andrew Carnegie, the late•19th• Again, it is hard to say whether Mr Kids, is planning a more modest annual century steel baron who became famous Gates’s approach is typical. Charitable dinner this year because the industry has for funding public libraries. giving covers a wide range of activities, shrunk. The Institute for Philanthropy How typical is such generosity of mod• from †ghting poverty in Africa to paying sees something of a downturn in dona• ern billionaires? Frustratingly, it is very for a local concert hall. Local good deeds tions from corporations and from the hard to tell. The endowments of Ameri• often owe as much to vanity as to genuine Œmass a‰uent‹the tier just below the can foundations more than doubled be• concern for others. wealthy. There is also some evidence that tween 1996 and 2006, but the increase Will the †nancial crisis reduce charita• donors are spending their money closer to only just kept pace with the rise in the to• ble giving? According to the US Founda• home, helping the poor in their own tal wealth of the Forbes 400 over that per• tion Centre, which has †gures going back country rather than overseas. iod. There is no evidence that the rich to 1975, giving did not decrease, in real But it is probably too early to tell what have been getting more, or less, generous. terms, during the recessions of the early the rich will do when they have fully un• What does seem to have changed is 1980s and 1990s. American foundations derstood the massive hit to their wealth. their attitude towards the way their mon• can be ‡exible; tax rules require them to The Obama administration is also propos• ey is used. They have become much more pay out 5% of their assets each year, but ing to reduce the tax break for charitable willing to get directly involved in the pro• this can be calculated on a rolling average. giving. The plutocrats may yet be tighten• jects they fund. Mr Gates, for example, has In fact, the Gates Foundation says it has in• ing their purse strings. The Economist April 4th 2009 A special report on the rich 11

However, these inequalities are likely to lessen now. For a start, this decade has so far seen a dismal performance by the stockmarket, which plays a crucial role in creating and maintaining wealth. Real an• nual returns from American stocks aver• aged •4.1% in the decade to the end of 2008.

The pendulum swings back Property prices are already falling sharply, as noted earlier in this special report. In• vestment bankers are losing their jobs or at least seeing their bonuses cut, and hedge• fund managers are going out of business. As long as the credit crunch continues, it will be more diˆcult to use borrowed money to boost incomes. And corporate pro†ts, which usually make a handsome contribution to the incomes of the rich, are declining steeply. Much of this is what you would expect 2 suggest, that causes directors to shower correlations between the social status of in a recession, and the poor will be su er• them with vast rewards when an equally fathers and sons; the lowest are found in ing along with the rich. But although they capable but less famous alternative might egalitarian Norway and Denmark. Things may lose their jobs and default on their have been willing to do the job at a small are even worse for ethnic minorities; a loans, they will not be troubled by collaps• fraction of the price. black American born in the bottom quin• ing asset prices because they do not own One thing holding back such executives tile of the population (by income) has a assets. Edward Wol of New York Univer• was Œoutrage constraint, a fear that mas• 42% chance of staying there as an adult, sity points out that the proportion of sive pay packages might attract unwel• compared with 17% for a white person. American households owning some come attention in the media. That may As a result, talent is being neglected. Of stocks (including mutual funds and 401k have led to an attempt to disguise execu• American children with the highest test pension plans) went up from 32% in 1983 to tive pay, with the really big increases being scores in eighth grade, only 29% of those 51% in 2001. But only 32% of the population awarded in the form of option grants and from low•income families ended up going owned more than $10,000•worth of stock, deferred compensation and bene†ts. to college, compared with 74% of those and many middle•class people are only from high•income families. Since the bet• modestly a ected by falling asset prices. Spurs to e ort ter•o can a ord to keep their children in The richest 10% of the American popula• Leaving aside the moral issues, does in• higher education and the poor cannot, tion owned 85% of all stocks. equality have any economic bene†ts? In breaking out of the cycle is hard. Ajay Kapur, the strategist at Mirae Asset the 1970s it was argued that high taxes had Perhaps Americans put up with this Management who coined the term Œpluto• reduced incentives and thus economic system because they have unrealistic ex• nomy, identi†es six factors that helped to growth. Entrepreneurs had to be motivat• pectations of their chances of success. One create the phenomenon; the existence of ed to build businesses and create jobs. But study found that 2% of Americans de• capitalist•friendly governments and tax re• extensive study by economists has found scribed themselves as currently rich but gimes; the development of †nancial com• little correlation, in either direction, be• 31% thought that they would become rich plexity, innovation and deregulation; the tween inequality and economic growth at some stage. In fact only 2•3% of those in paramount rule of law; globalisation; tech• rates across countries. the bottom half of the income distribution nology changes; and patent protection. One argument advanced in America is have a chance of becoming very well o Some of these are already being a ected that wide income disparities might en• (de†ned as having an annual income of by the recession. Governments have be• courage more people to want to go to col• more than $340,000). Just over half of come less friendly towards capitalists and lege, thus creating a better•educated work• those earning $75,000 a year think they regulations are being tightened. The rule of force. But Lawrence Mishel of the will become very well o , but experience law is being replaced by what Mr Kapur Economic Policy Institute points out that suggests that only 12•17% will make it. dubs the rule of man: politicians and cen• several societies that are more egalitarian Health outcomes too are decidedly un• tral bankers are changing the system on the than America have higher college enrol• equal; the gap between the life expectancy hoof. ŒIt is hard for investors to know the ment rates. of the top and bottom 10% respectively rules of the game because they keep There might also be an argument in fa• rose from 2.8 years to 4.5 between 1980 and changing, he says. vour of wealth disparities if social mobil• 2000. That does not meet the de†nition of With plutocrats now causing wide• ity was high and the sons and daughters of a fair society by John Rawls, a 20th•century spread anger, and with public•sector de†• oˆce cleaners could fairly easily rise to be• philosopher, who described it as one in cits widening, governments will be tempt• come chief executives. But America and which a new entrant would be happy to be ed to target the tax privileges of the Britain, which follow the Anglo•Saxon born even though he did not know his so• wealthy. But how easy will it be to get hold model, have the highest intergenerational cial position ahead of time. of their money? 7 12 A special report on the rich The Economist April 4th 2009

Plucking the chickens

But taxes have their limits

HE rich are paying more tax; the rich February called for sanctions against states Taren’t paying enough. Depending on Not fair 5 that do not play ball. which statistics you use, you can make a Gini index of income inequality in America* Countries such as Liechtenstein and convincing case either way. Monaco are historical accidents, places America’s Internal Revenue Service 0.48 that might easily have been tidied up by publishes †gures showing the proportion 0.46 Napoleon or by the Treaty of Versailles of income•tax receipts paid by di erent 0.44 after the †rst world war. They exist on the segments of the population. Back in 1986 0.42 su erance of larger states on whom they the top 1% of taxpayers were responsible depend for defence and for transport links. for 25.4% of all income tax paid; by 2005 0.40 But the EU †nds it harder to put pressure on their share had risen to 38.4%. The IRS also 0.38 faraway countries. has †gures for the top 400 American tax• Even so, with America and the EU both payers. In 2006 their incomes averaged 196775 80 85 90 95 2000 07 weighing in, there is some doubt about the *0 indicates perfect equality (everyone more than $263m, compared with $214m receives an equal income); 1 indicates long•term future of bank•secrecy laws. the year before. On those incomes they perfect inequality (all income is ŒThe combination of whistleblower legis• Source: US Census Bureau received by only one person) paid tax at an average rate of just 17.2%, well lation and a lot of upset ex•employees in down from a peak of 29.9% in 1995; 31 of the †nancial•services industry may mean those 400 paid less than 10% in tax. shrunk to just three, Andorra, Liechten• that in two or three years’ time there will These †gures are two sides of the same stein and Monaco. In March Andorra and be no such thing as a secret account, says coin. The rich are paying a lot more tax in Liechtenstein pledged to weaken their se• David Lesperance, a tax adviser. ŒAlready, nominal terms because, as this special re• crecy laws. Switzerland, Austria and Lux• if you own any US securities, any bank port has demonstrated, they have got a lot embourg o erd to share information on you want to deal with is obliged to report richer. But the rates of tax they pay have savers with other governments on a case• the fact to the US authorities. come down. Those on the political right by•case basis. Philip Marcovici of the Zurich oˆce of can cite this as evidence that lower tax Individual countries are also taking ac• Baker & McKenzie, a law †rm, says wealthy rates eventually increase tax receipts; tion. In February UBS agreed to pay a people can now do one of two things; play those on the left, that the rich have been $780m penalty to the American govern• by the rules of their home country or get getting away with lower taxes at a time ment and to disclose the names of some out. Staying in their country and breaking when median incomes have stagnated. 250 customers to avoid prosecution over the law by hiding assets and income is not Governments around the world would having helped wealthy Americans avoid an option. like a bigger share of the pie as they seek to taxes. The American authorities promptly narrow de†cits and placate angry elector• demanded that the Swiss bank hand over Want to know a secret? ates. One route they have been pursuing is the names of a further 52,000 customers, But Mr Marcovici thinks governments are to crack down on tax havens, those bolt• which would require the bank to break not approaching the issue of undisclosed holes for the world’s wealthy. Estimates of Swiss law. (The Swiss have long made a income strategically. ŒThey attack banks the amount held o shore range from $5 distinction between tax evasion‹not too and jurisdictions and that forces them to trillion to $7 trillion, so there is a strong in• serious‹and tax fraud.) John Whiting of get defensive. If they admit the problem, centive for governments to bring this mon• PricewaterhouseCoopers in London says that will get them into legal trouble. Banks ey home. the British authorities have been trying to need to be part of the solution, and scaring In 2000 the Organisation for Economic get information about their own wealth•owners into trying to hide the Co•operation and Development identi†ed o shore•accountholders in a number of money better and farther is not in any• over 40 tax havens; it has since persuaded ways, including tapping the databases of one’s interest. 35 of them to commit themselves to a set of high•street banks. Banks may react by blaming a particu• standards on transparency and informa• The German government used whistle• lar employee for aiding tax evaders when tion exchange. According to the OECD, blower laws to target citizens who had the problem is in fact endemic. Clients are some 49 agreements to exchange tax infor• banked in Liechtenstein; some 900 sus• free to leave Liechtenstein and move their mation have been signed since 2000 be• pects were pursued, including a former money somewhere that is less susceptible tween countries ranging from Antigua to chief executive of Deutsche Post. The tiny to pressure from the European authorities. Sweden. principality was outraged, but its govern• One way of trying to deal with the pro• Countries that will not co•operate are ment fell in February and the new prime blem of o shore tax evasion is a withhold• named and shamed. Seven jurisdictions minister, Klaus Tschütscher, pledged to ing tax that enables countries to deduct tax originally refused to make the commit• work with other countries and to get his automatically and leave it up to the taxpay• ment and were placed on a list of unco•op• country o the Œunco•operative list. A er to reclaim the money if he can. But this erative tax havens; the blacklist has since European Union meeting in Berlin in late may not work. The EU savings directive, 1 The Economist April 4th 2009 A special report on the rich 13

2 for example, says a withholding tax must voters are likely to become increasingly re• lustrated by the numbers showing how be imposed on interest paid to an individ• sentful towards those enjoying a free ride much the top 1% contribute in America, ual resident of an EU country or through a at the expense of other taxpayers. highlights the danger of driving such peo• bank in the EU or an aˆliated country. But In the long term it may not be politically ple away. it is easy to avoid the tax by turning the sustainable to discriminate against the na• In addition, political parties in many payment into something other than inter• tives by giving special tax deals to foreign• countries depend on wealthy individuals. est (such as capital gain), set up a company ers. In Hong Kong and Singapore it makes Politicians have had to tread carefully for to receive it or have it made through a no di erence whether you are a foreigner fear of giving o ence to their paymasters. non•EU bank. or a local: you pay tax only on income from Such pressures led to cuts in personal Such loopholes are common. One big domestic sources. Those two countries income•tax rates between 2002 and 2008 controversy in recent years has been the may be the tax havens of the future. in 33 out of 87 countries surveyed by KPMG tax treatment of Œcarried interest in priv• But the tide is not running all one way. International, a †rm of accountants, ate•equity funds. This interest gives the Just as some jurisdictions try to close tax whereas only seven saw increases. The top fund managers the right to participate in loopholes, others will keep them open. In rate fell from an average of 31.3% to 28.8%. future pro†ts without putting up capital; in Sweden the authorities dropped a wealth e ect, it is a performance fee. In both tax in 2007 in part because some rich ðbut not too much America and Britain it has been taxed as a Swedes had been moving to London. Tai• In Britain the Labour government has capital gain rather than as income, sub• wan agreed to cut its inheritance tax from a abandoned its long•standing pledge not to stantially lowering the managers’ tax bill. maximum of 50% to 10% in part because raise the top rate of income tax and im• As one private•equity manager admitted, the wealthy had been moving money to posed a 45% levy on those earning more Œany commonsense person would say Singapore and Hong Kong. In the Caribbe• than £150,000 a year. In America President that a highly paid private•equity executive an, St Kitts & Nevis o ers citizenship in re• Obama’s †rst budget proposals included paying less tax than a cleaning lady or oth• turn for a property purchase of $350,000 an increase in capital•gains tax and a rise in er low•paid workers can’t be right. plus government fees; citizens are able to the highest rate of income tax back to lev• Another issue is the status of wealthy enjoy foreign income, capital gains, gifts, els last seen in the Clinton era. That trend is foreigners who usually enjoy tax privi• wealth and inheritance free of tax. now likely to be reversed. leges denied to domestic citizens. Voters in What makes this tax competition even It seems unlikely that developed coun• the Swiss canton that includes Zurich vot• more acute is the mobility of money in a tries will ever go back to the income•tax ed in February to end the practice of o er• globalised world. Most developed coun• rates of 90% or more seen in the 1970s, but ing ‡at•rate deals for foreigners who tries abolished capital controls long ago. some of the higher taxes recently intro• choose to live in the area (the vote covered The very narrowness of the tax base, as il• duced will surely stick, for three main rea• cantonal but not federal taxes). In Britain sons. First, most countries face big budget the political parties got into a brief bidding de†cits, which makes it tempting to raise war over plans to tax the so•called Œnon• taxes to help †ll the hole. Governments doms, people deemed to be resident in that ask middle• and working•class voters Britain but not domiciled for tax purposes. to shoulder the whole of the burden may The idea was to impose a ‡at fee in return quickly lose oˆce. for ignoring their o shore earnings; previ• Second, although in theory it is possible ously foreigners were taxed only on such to move between countries to avoid tax, money as they brought into the country. there are lots of practical diˆculties. Fam• ily ties, business requirements and perso• Soak the richð nal preferences are likely to persuade The British authorities are generally agreed many people to pay somewhat higher tax• to have made a mess of the proposals. Ac• es rather than uproot their lives. The recent cording to Caroline Garnham of Lawrence crackdown on tax havens may also deter Graham, a law †rm, the big problem with many investors from moving their capital. the legislation was that the fee proposal Third, there is the issue of security. The was accompanied by 70 pages of anti• British government pointedly failed to avoidance legislation. ŒWealthy people help accountholders with the Guernsey don’t want an investigation into their af• branch of Landsbanki, a failed Icelandic fairs by the British authorities because bank. The Channel island, long seen as a they don’t know where the information tax haven for British investors, does not will end up, she says. The predicted mass have a deposit•protection scheme. exodus of foreigners has not materialised ŒThe tax authorities are trying to make so far, but then the new rules are only just it steadily more diˆcult to avoid tax, says about to kick in. Ms Garnham explains Mr Whiting. The e ect is to push evaders to that Œpeople haven’t gone yet because they the fringes of the system, where they may haven’t had to †le tax returns. be more at threat from fraudsters than It is a sign of the political times that from the taxman. Rich people may feel it is countries such as Switzerland and Britain, better to pay some of their money in tax long seen as havens for the wealthy, are than to risk losing it all in a jurisdiction changing the rules. As the recession bites, with lax rules. 7 14 A special report on the rich The Economist April 4th 2009

Paying the bill

The rich will become a little poorer. That may be no bad thing, but beware a backlash

OCIETIES have often distinguished be• Barack Obama has suggested raising the Stween the deserving poor (a‰icted by Hang them, flog them 6 tax rates on high earners and closing loop• sickness or disability) and the undeserving Responses to a British poll taken in February 2009, % holes such as the carried•interest privilege sort (the feckless and workshy). These days Bankers responsible for the problems that led to enjoyed by private•equity managers. they also seem to di erentiate between the taxpayer-funded bailouts should not get bonuses, Such tax changes may suit the public deserving and the undeserving rich. and should have to pay back past bonuses mood. The danger is that popular anger, Ordinary people do not seem to mind once released, can fasten on targets beyond that sports stars or entertainers make mil• 0 10 20 30 40 50 the rich; immigrants, say, or foreigners gen• lions; they also seem to respect genuine en• Strongly agree erally. The 1930s Depression led to fascism trepreneurs who have built businesses in Germany and the second world war. Somewhat agree that are obviously useful. But they have lit• Even if such apocalypses are avoided, tle time for bankers, hedge•fund managers Somewhat disagree the anti•rich backlash can go too far. In the and other †nanciers. Society as a whole Strongly disagree middle of a deep recession it is easy to for• may bene†t from the eˆcient allocation of get that the previous 15 years had seen capital or the increased liquidity that †• Senior bankers’ pay should be capped so that they steady economic growth in the developed nancial markets provide, but the public won’t earn such enormous sums in the future world, a remarkable growth surge in many cannot easily see the gains. emerging markets, low in‡ation and rapid A Populus poll in February, for exam• 0 10 20 30 40 50 technological development. ple, found that 64% of Britons thought that Strongly agree The trick will be to change regulation to the sta of banks part•owned by the gov• reduce the risk of running up too much ernment should not get any bonuses at all; Somewhat agree debt again but still allow new industries to the same proportion thought that senior Somewhat disagree be created and †nanced. If entrepreneurs bankers who made mistakes should repay can come up with cheap solar technology, Strongly disagree past bonuses. A remarkable 82% thought say, or develop drugs to cure cancer, they that pay for senior bank sta should be Source: Populus will deserve all the money they can get. capped (see chart 6). The world is emerging from a long per• As governments are forced to step in to Theodore Roosevelt led to the introduction iod of †nancial speculation. Some people save other sectors of the economy, it seems of a federal income tax and the establish• got rich because they were talented, others plausible that the public will take a similar ment of the Federal Reserve, which Wood• because they were lucky. That luck ran out attitude towards executives of other failing row Wilson saw as a counterweight to the in 2007. The ranks of the rich are set to be businesses. The intellectual argument that power of †nanciers such as JPMorgan. thinned in coming years‹but perhaps the high pay is needed to create incentives Franklin Roosevelt eventually brought in a wealth of those that remain will be more probably rings hollow with most people at wartime top income•tax rate of 91%. Now soundly based. 7 the moment. What is clear to the public, though, is that bankers and businessmen O er to readers Future special reports earn fortunes in good times and shout for Reprints of this special report are available at a help from the taxpayer in bad times. Countries and regions price of £3.50 plus postage and packing. Texas July 11th A minimum order of †ve copies is required. We’ve been here before Corporate o er Business, †nance, economics and ideas Revolts against the power of the rich have Customisation options on corporate orders of 100 Health care and technology April 18th been a regular feature of American history, or more are available. Please contact us to discuss International banking May 16th going all the way back to Thomas Je er• your requirements. Business in America May 30th son. It was a Republican president, Theo• The euro area June 13th Send all orders to: dore Roosevelt, who said that Œevery man Global greying June 27th holds his property subject to the general The Rights and Syndication Department right of the community to regulate its use 26 Red Lion Square WC1R 4HQ to whatever degree the public welfare may London Tel +44 (0)20 7576 8148 require it. His cousin, the Democrat Frank• Fax +44 (0)20 7576 8492 lin Roosevelt, argued that Œthe transmis• e•mail: [email protected] sion from generation to generation of vast fortunes by will, inheritance or gift is not For more information and to order special reports Previous special reports and a list of consistent with the ideals and sentiments and reprints online, please visit our website forthcoming ones can be found online of the American people. Economist.com/rights Economist.com/specialreports The era of progressivism embodied by