Saturday, August 9, 2014

Reading Capital... in the 21st Century (part 6 of x)

I have now finished reading the Piketty book, so this and any further posts will be retrospective in nature. If you work full-time and have a family, budget at least three weeks for reading it. That may need to be on a sliding scale based on how much prior knowledge of economics you have.

"The logic of r > g implies that the entrepreneur always tends to turn into a rentier. Even if this happens later in life, the phenomenon becomes important as life expectancy increases. The fact that a person has good ideas at age thirty or forty does not imply that she will still be having them at seventy or eighty, yet her wealth will continue to increase by itself." (395-396)

In other words, it is absurd that Bill Gates gets to make decisions having global impacts on public health and education policy solely by virtue of having capitalized upon DOS. That absurdity obtains independently of whether or not one considers DOS to have been a "good idea". This passage, like so much of what Piketty is written, is an example of what I called "data-driven statements of what should have been obvious. And as I went on to say in that tweet, "It's not Piketty's fault that our intellectual atmosphere is so stale."

Lest we fixate solely upon Gates, however, Piketty does not allow us to lose sight of Liliane Bettencourt, the L'Oréal heiress, "who never worked a day in her life," and points out that her fortune has grown "exactly as fast as that of Bill Gates". (440)

Note that, at some point, it may be worthwhile to read Michèle Lamont's Money, Morals and Manners: The Culture of the French and the American Upper-Middle Class, an anthropological work that Piketty cites to show how widespread meritocratic ideology is. In general, Piketty is deservedly scathing toward this ideology, arguing that it "could well lay the groundwork for greater and more violent inequality in the future," based upon "a race between supermanagers and rentiers, to the detriment of those who are neither." (417)

There is a subchapter of Piketty that is likely to be of far greater interest to me than to most readers, since it deals with institutional endowments at colleges and universities in the United States ("The Pure Return on University Endowments", pp. 447-452). As someone who works at a private, liberal arts college with a larger-than-average endowment (albeit one that is smaller than most of the institutions to which we are usually compared on grounds of selectivity and educational quality--comparisons which I have heard at least once a week since starting work there), the endowment has intrinsic interest for me, touching as it does on the long term sustainability of the institution by which I am employed. For Piketty, its interest is incidental, in that the data collected by NACUBO (The National Association of College and University Business Officers), combined the various financial statements published by individual institutions, provide an unusually transparent dataset for comparing the rate of return on fortunes of varying sizes.

Regardless of whether they have interest in the broader questions of income and wealth inequality that animate Piketty, his analysis should be read by most people who work at private institutions of higher education, whether as faculty, fundraising staff, or in roles requiring financial management. The results, presented on Table 12.2 (page 448), are sobering. He presents the "average real annual rate of return (after deduction of inflation and all administrative costs and financial fees)" within the following classifications:

  • Harvard, Yale and Princeton [I have a bit of a quibble with his decision to not include Stanford in the top rank, since its endowment is comparable in size to Princeton's, which leaves me wondering if he engaged in a bit of statistical cherry-picking.]
  • Endowments highter than $1 billion
  • Endowments between $500 million and 1 billion
  • Endowments between $100 and $500 million
  • Endowments less than $100 million

For each of those categories, the average real rates of return are 10.2%, 8.8%, 7.8%, 7.1%, and 6.2%, respectively. In sum, Piketty's hypothesis that larger fortunes earn greater rates of return than smaller ones, because they are better able to secure the services of talented money managers and take advantage of certain investment types that require a large initial capital position, is supported by the data from college endowments.

There are three nationally regarded liberal arts colleges in the state of Maine. Of the three intermediate categories of endowment listed by Piketty (>$1b, $500m-$1b, $100-500m), one is in the first category, one is in the second category, and the third--my employer--is in the last. Identifying them more precisely is left as an exercise for the reader.

Piketty's data suggest that it is foolish for any of my colleagues to hope to catch up with [Super-Rich College down the block], and that it is highly unlikely even that the most effective capital fundraising campaign, paired with strategic portfolio management, would even get our endowment up on the level of [Other Rich-but-not-quite-as-Rich College in the other direction]. This is also troubling when you realize that, if you look at our educational expenditures (but not our expenditures in other categories), our per-student costs are roughly on par with [Other Rich College] and not far behind those of [Super-Rich College]. Of course there are examples of institutions successfully playing catch-up--Middlebury in Vermont comes to mind--but the nature of exceptions is precisely that they are exceptional, that they do not happen all the time. Exceptions like Middlebury get averaged with other institutions who squandered their endowments and missed critical fundraising opportunities, including some that went out of business entirely.

[Also, as a former employee of a community college in the beleaguered CUNY system, I am honor-bound to greet my recitation of the fiscal moanings of my present colleagues with a heartily sarcastic "Waaaa-hoot-waaah!"]

Nor can employees of institutions with smaller endowments take comfort that, at least their endowment managers aren't betting the house: Piketty observes laconically that "It is interesting to note that the year-to-year volatility of these returns does not seem to be any greater for the largest endowments than for the smaller ones: the returns obtained by Harvard and Yale vary around their mean but not much more so than the returns of smaller institutions, and if one averages over several years, the mean returns of the largest institutions are systematically higher than those of the smaller ones, with a gap that remains fairly constant over time." (450) So this is not a case of the better capitalized institutions making a calculated risk-vs-reward trade-off and getting lucky, but of their greater capital enabling them to access more sophisticated investment strategies in which rewards outweigh the risks.

So, for those of you who find yourselves working in higher education and thinking more about endowment than you ever thought possible, remember: Size matters.

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