BS Thesis in Economics Development of the Distribution of Wealth In

BS Thesis in Economics

Development of the distribution of wealth in

Iceland 1997-2017

Katrín Svava Másdóttir

Advisor: Gylfi Zoëga Faculty of Economics June 2019

Development of the distribution of wealth in Iceland 1997- 2017

Katrín Svava Másdóttir

Thesis towards a BS degree in Economics Advisor: Gylfi Zoëga

Faculty of Economics School of Social Sciences, University of Iceland June 2019

Development of the distribution of wealth in Iceland 1997-2017

This thesis is equivalent to 12 ECTS credit towards a BS degree from the Faculty of Economics at the University of Iceland.

Printing: Háskólaprent Reykjavík, 2019

Preface

This thesis is a 12 ECTS final project for a B.S. degree at the Faculty of Economics at the University of Iceland. The advisor of this thesis is Professor Gylfi Zoëga, to whom I am extremely thankful for valuable comments and guidance throughout this process. I would also like to thank my family and friends for their support and patience throughout my studies, to them I am forever grateful.

Abstract

Inequality exists in every economy. Economist Thomas Malthus believed that inequality within societies are inescapable (Piketty, 2014). Iceland is no exception to the general structure of wealth inequality within advanced economies (AEs). In this thesis the distribution of wealth between 1997-2017 in Iceland is analyzed focusing on what are the main drivers of wealth inequality and how has the distribution of wealth changed during these twenty years especially following the 2008 financial crisis. To analyze the development of wealth distribution a principal component analysis is performed as well as comparing net wealth between percentiles. In Iceland, between 1997-2017 the top 1% wealthiest individuals of the population owned more than half of total net wealth and in 2010 that percentage increased to over 70% of total net wealth. Wealth inequality reached its high point in 2010, then decreased yearly but in recent years has risen again. Between 1997 and 2007, the years before the financial crisis, the cause of wealth inequality was mostly due to the fact that the lower percentiles did not own any assets and most had negative net wealth. Following the financial crisis their net worth decreased significantly, with the bottom 10% reaching a negative net worth of more than nine million ISK in 2010. Since 2010 the lower percentiles have increased their net worth yearly although the bottom 10% have not yet reached a positive net worth in 2017. The difference between total assets of the lower percentiles, i.e. bottom 30% of the population, compared to the top 1% has decreased since 2010. Yet the difference between total assets of the middle percentiles compared to the top 1%, has gradually increased since 2010. The analysis in this thesis of the distribution of wealth in Iceland concludes that wealth inequality rose during the years prior to the financial crisis, reached its high point in 2010 and then decreased again. Yet what is also interesting from the analysis is that the structure of wealth inequality during the period has also changed. The main reason for wealth inequality in the twentieth century and the first decade of the 21st century was due to the fact that the lower percentile groups did not own any assets and had a net worth of zero or even negative. In the last few years these groups have all improved their net worth position, with only the bottom 10% still having a negative net

worth value in 2017. Even though net worth for all percentiles has improved, the top 1% has taken a significant lead compared to other percentiles. The difference between the net worth value of the top 1% compared to all other percentiles has increased in recent years. Therefore a main cause to economic inequality today is due to the fact macroeconomic conditions have given those individuals who sit on top of the wealth ladder the opportunity to increase their wealth proportionally more compared to other wealth groups which drives up economic inequality.

Contents

Preface ...... 4

Abstract ...... 5

Contents ...... 7

Table of Figures ...... 9

Table of Tables ...... 10

1 Introduction ...... 11

2 Theoretical approach ...... 13

2.1 What is wealth ...... 13

2.2 Negative wealth ...... 13

2.3 Thomas Piketty on wealth inequality ...... 14

3 Development of wealth distribution ...... 16

3.1 Global development in the postwar era ...... 16

3.2 Bubble economy starts emerging ...... 17

3.3 Financial crisis 2008 ...... 17

3.4 Debt relief ...... 18

3.5 Recent years ...... 19

4 Data ...... 21

4.1 Principal Component Analysis ...... 21

4.2 Total asset distribution ...... 22

4.3 Liabilities distribution ...... 25

4.4 Total net worth distribution ...... 28

4.5 Total annual income distribution ...... 30

4.6 Total disposable income distribution ...... 32

4.7 The income life cycle: ...... 34

5 Influential drivers of wealth distribution ...... 37

5.1 Fiscal policy ...... 37

5.2 Rate of return on capital vs. economic growth ...... 38

5.3 The housing market ...... 39

6 Conclusion ...... 41

7 Bibliography ...... 43

A The Kuznet ratio and the kuznet curve ...... 47

B Karl Heinrich Marx ...... 49

C Thomas Malthus ...... 50

D Data ...... 51

E Measuring wealth distribution ...... 57

E.1 The wealth over people curve ...... 57

E.2 The Lorenz Curve ...... 58

E.3 Gini Coefficient ...... 58

F Principal component analysis ...... 59

Table of Figures

Figure 1. Total asset distribution through the first principal component 1997- 2017 ...... 23

Figure 2. Total asset distribution through the second and third principal component 1997-2017 ...... 24

Figure 3. Development of total asset comparison between the tenth percentile and first percentile and comparison between the fifth percentile and first percentile 1997-2017 ...... 24

Figure 4. Development of total asset comparison between the tenth and fifth percentiles 1997-2017 ...... 25

Figure 5. Liabilities distribution through PCA 1997-2017 ...... 27

Figure 6. Percentage change in household debt for the first percentile, fifth percentile and tenth percentile 2000-2009 ...... 27

Figure 7. Total net worth distribution through PCA 1997-2017 ...... 29

Figure 8. Development of total net worth for the first, second and third percentile 1997-2017 ...... 29

Figure 9. Total annual income distribution 1997-2017 ...... 31

Figure 10. Total disposable income distribution 1997-2017 ...... 33

Figure 11. The Kuznet Curve (Reference: (Economics online, n.d.)...... 48

Figure 12. Wealth over people curve (reference: (Greensuit.org, n.d.)) ...... 57

Figure 13. The Lorenz Curve (Reference: (Pettinger, 2019)) ...... 58

Table of Tables

Table 1. Eigenvalues from PCA for total asset distribution...... 22

Table 2. Factor loadings from PCA for total asset distribution...... 22

Table 3. Eigenvalues from PCA for liabilities distribution ...... 25

Table 4. Factor loadings from PCA for liabilities distribution ...... 26

Table 5. Eigenvalues from PCA for total net worth distribution ...... 28

Table 6. Factor loadings from PCA for total net worth distribution ...... 28

Table 7. Eigenvalues from PCA for total annual income distribution ...... 30

Table 8. Factor loadings from PCA for total annual income distribution ...... 30

Table 9. Eigenvalues from PCA for total disposable income distribution ...... 32

Table 10. Factor loadings from PCA for total disposable income distribution ...... 32

Table 11. Movement in income groups for the first, fifth and tenth percentiles for different age groups. (Reference: (Forsætisráðuneytið, n.d.))...... 35

Table 12. Development of total asset distribution 1997-2017 for all percentiles in constant 2017 prices...... 52

Table 13. Development of liabilities distribution 1997-2017 for all percentiles in constant 2017 prices...... 53

Table 14. Development of net worth distribution 1997-2017 for all percentiles in constant 2017 prices...... 54

Table 15. Development of annual income distribution 1997-2017 for all percentiles in constant 2017 prices...... 55

Table 16. Development of disposable income distribution 1997-2017 for all percentiles in constant 2017 prices ...... 56

1 Introduction

There has been a significant discussion about the causes and consequences of the increase in income inequality that has been observed within advanced economies (AEs) and many emerging market economies (EMEs) in recent decades. Studies have shown that too much inequality has a negative effect on economic growth. But what about wealth inequality? Interestingly the distribution of wealth is much wider than the distribution of income. When it comes to wealth, the difference between the top 1% of the wealthiest individuals and the bottom 10% is staggering. An article published by the Guardian on the 21st of January 2019 provides the facts that the richest 26 individuals in the world have a total asset value equivalent to the total asset value of the poorest fifty percent of the planet´s population which are 3.8 billion individuals. The number of billionaires that own as much as the poorer 50% of the world’s population has been decreasing yearly. The number was 61 in 2016, then decreased to 43 in 2017 and fell to 26 in 2018. The wealth distribution is a less discussed topic than the income distribution even though the gap between those who own the most wealth and those who own the least, if they own anything, is wider than the income distribution (Elliot, 2019). In the history of economic growth study, wealth has been given lesser focus than income. Yet, wealth is an important factor regarding economic opportunities and well- being. It is therefore important to study the main components of wealth and why wealth inequality is so high. It is of course important to study both aspects. Wealth can be considered a more important issue as it entails longer-run outcomes as well as longer- run consequences because wealth impacts life opportunities such as education or opportunities to create businesses. Another reason why wealth inequality is such an important, global issue is that income can fluctuate more easily than wealth. Data analysis has shown that those who fall under the bottom 10% of the income distribution have a greater possibility of moving up the income distribution ladder than those who fall under the bottom 10% of the wealth distribution (the Pew charatiable trusts, 2012). This essay will study the development of wealth distribution in Iceland between 1997-2017 focusing on the development of five variables: total wealth distribution, total

liabilities distribution, total net worth distribution, total annual income distribution and total disposable income distribution. The purpose of this thesis is to analyze how economic inequality during these twenty years has changed especially following the 2008 financial crisis, as well as looking at the main influencers of wealth inequality. The thesis is split into four main chapters. First, a theoretical approach to the distribution of wealth is presented. Second, a general discussion on the history of wealth and income distribution in Iceland over a longer period is presented. Third, a statistical analysis on income and wealth distribution in Iceland between 1997 and 2017 is performed and results from the analysis are examined with reference to the country´s history on economic inequality. Finally, some of the main factors affecting the wealth distribution is discussed.

2 Theoretical approach

2.1 What is wealth

Wealth is usually defined as total assets minus total liabilities of the relevant economic unit. In principal total assets should include all assets, both tangible and intangible, financial and non-financial. Financial assets include checking account, stocks and bonds while non-financial assets include everything from houses, businesses, transportation vehicles, jewelry and art. Debt should include all loans, from home mortgages and car loans to other personal loans such as credit card balances or instalment loans. In practice, assets and liabilities are often not measured fully. For example, factors such as human capital and retirement assets are not often included in actual data (Haskin, Isaacs, & Sawhill, 2008).

2.2 Negative wealth

Wealth has many positive effects on an individual´s well-being and can create financial opportunities. Wealth can often be used as insurance for loans which can be used to boost consumption, invest in businesses or supply collateral and security during unemployment or other negative shift in income. Wealth can also be passed down across generations, wealthy parents can enhance their children´s prospects by giving them money directly or indirectly by investing in their education for example. Negative wealth is when individual or household debt exceed its total assets. Negative wealth can have major impacts on an individual´s well-being as it can restrict ability to save for goods or restrict access to further credit. Debt can be considered good debt when the cost of the debt is lower than the return on the assets that it finances. For instance, a home mortgage can usually be considered a good debt because a family is purchasing a place to live even though there are risks involved. Same can usually be said for a student loan because it is an investment in education. Education has many future benefits as it opens up more career opportunities. An educated employer increases the value of that employer to the firm which increases the employer´s income which increases utility (Olivier Armantiet, 2016).

2.3 Thomas Piketty on wealth inequality

Over time economists have set forth many theories trying to explain the causes of income and wealth inequality. It is one of the most disputable matters in today´s society. Thomas Piketty is a French economist who has recently been in the spotlight in economic discussion about wealth and income inequality. Born in 1971, he has used the theories from previous economists to develop modern theories and ideas of what are the main drivers behind the massive inequality of wealth. He published the book Capital in the Twenty-First Century in 2013 where he analyses the historical structure of wealth and income inequality. Piketty argues that the rising inequality of wealth from 1980s is not circumstantial, but due to features of capitalism. Piketty cites evidence that economic growth and development do not have a direct link to the Kuznet effects1. Piketty discusses at length the concentration of wealth, but concentration of wealth is a state of economic distribution where most of the nation´s capital belongs to a small portion of the population. According to Piketty, the rapid increase in inequality after 1980 was due to the political decisions regarding taxation and finance. Monetary and fiscal policy decisions have created possibilities for the global rich to increase their wealth, therefore greatly increasing inequality of wealth. Piketty claims that the extreme amount of private wealth procured in many wealthy countries of Europe as well as Japan measured in years of national income since the 1980s directly demonstrates the Marxian principle of infinite capital accumulation2. The wealth distribution is influenced by how economic, social and political actors consider what is fair and what´s not. Therefore, as concluded in Piketty´s book, history has shown that the distribution of wealth has been and always will to a certain extent be a political issue. It is not possible to simplify the problem to pure economic factors. Piketty introduces the following three „laws“ to help readers understand wealth inequality. 1) a = r ∗ b

1 See appendix A for explanation of the Kuznet effects.

2 See appendix B for explanation of Marx´s theory of capital accumulation

Where a is the capitals share of national income, r is the rate of return on capital (the % return to the owner of an asset) and b is the capital/income ratio. This an identity that says that a capital´s share of national income is equal to the rate of return on capital multiplied by the capital/income ratio. 2) b = the capital/income ratio is equal to the ratio of the rate of savings and the rate of growth of the economy: � b = � This „law“ is based on the strong relationship between savings and investment. However when the savings rate goes up, the capital/income ratio does not necessarily increase to the same degree as it will depend on which variable increases more. Higher savings as a share of national income will result in faster capital accumulation but faster economic growth compared to the savings rate will slow down the relative growth of accumulated capital compared to national income. Therefore, lower growth signals a more rapid possibility for capital accumulation and, as a result, an increase in capital´s share of national income in the first „law“. 3) r > g The third „law” is according to Piketty a „fundamental inequality.“ It expresses that the rate of return on capital is higher than economic growth. According to this law, as capital accumulates and its share of national income rises, those who already hold a majority of the capital are exactly those who will gain more and over time increase their wealth. To Piketty, this is a global issue and therefore the solution must be global. Piketty proposes that the only way to stop the unrestricted increase of wealth inequality is through a progressive global tax on capital. He argues that this increasing inequality leads to weaker regulatory regimes on capital, weaker labor rights, weaker tax regimes that empower tax avoidance by high net worth individuals and corporations. What this inequality means, explained with an extreme example, is that if the growth rate, g, is one percent but the rate of return on capital, r, is four percent, then wealthy individuals only need to reinvest 25% of their annual capital income to guarantee that their capital will grow faster than average income. This is an advantage that only those who sit at the top of the wealth distribution can utilize (Piketty, 2014).

3 Development of wealth distribution

3.1 Global development in the postwar era

When studying the pattern of both income and wealth inequality over hundreds of years, one will observe that inequality is usually always rising or stable at high levels, not generally decreasing (Swanson, 2017). There are only a handful of situations that have proven to drive down income and wealth inequality. Those are wars, natural disasters, transformative revolutions and severe epidemics. Thus the two great World Wars are examples of situations that levelled out the distribution among individuals in the same society. Wars usually destroy a large part of a nation´s capital, reducing the market value of private wealth. It usually ends with a massive drop in population, increasing the demand for labour which drives up wages. According to economist Thomas Malthus, rapid population growth is the main cause to rising wealth inequality within societies. According to Malthus, population tends to grow exponentially when no outside shocks occur, for example war or famine. The supply of food on the other hand does not grow at this exponential growth rate but in best-case scenario a linear growth rate, meaning there is a maximum rate of growth each year3. The theory of linear growth rate of food supply has been proven to be false by modern developments. According to Piketty