1. The Effect of Equal Access to Capital Income through Equity Markets on Income Inequality
DarienLeblanc
Econ 231
ProfessorFrankLewis
November25,2016

2. As changesinsocial andeconomicpolicyattempttoclose the income gapit isof use to examine
the historical progressioninthe income of individuals asa resultof accessto capital income.
Investmentsinmanufacturingandotherlarge scale projectswere notfeasibleformajorityof citizens
duringthe Industrial revolution,due tosizable investmentrequirementsorlackof collateral neededto
access debtmarkets.The emergence of equitiesmarketsallowedforinvestmentopportunitieswithless
initial monetary outlay.Itisworthaskinghow equal accessto capital income,throughequitymarkets,
affectedincome inequality. Manyhistoriansandeconomistshave done soandrecordeddatarelative to
Income overmanyyears.Thisessaywill analyze thatdatainorder to come to an independentprognosis
regardingthe emergence of acceleratedincome inequality inrelationtocapital income changes.
I
It isimportantto firstrecognize the components of incomeif understandingitsinequalityisof
interest. Income iscomprisedof earningswhichone wouldgrossthroughthe sale of theirlabour
services,capital income whichisderivedfrominvestmentinanynumberof marketsandopportunities,
and governmenttransfersorthe redistributionof wealthperformedbythe governmentusingtaxation
and subsidies.Forthe purpose of simplicitygovernmenttransferswill be omitted fromall the following
calculation.Thusthe income equationwill become;I= E + K. It isuseful toobserve income inequality
withoutgovernmentintervention foranumberof reasons. Of greatestsignificance isthatthis essayis
not designedtounderstandorcritique how social policyeffectsincomeinequalitybutraterhow the
basicsof economicscanbe appliedtounderstandhow individualchoices andmarketcharacteristicscan
leadto an income gap betweenclasses.
It isabundantlyclearthatboth earningsandcapital have a directrelationshipwithIncome.This
meansthat the rate of appreciationordepreciationof bothearningsandcapital will directly affect

3. income bythe same rate. Examiningthe literature thatexistsregardingthissubjectone particular
conclusionfromthe prominenteconomistThomas Pikettycomestolight.Afterscrutinizingmanyyears
of income dataovera broad spectrumof countries Pikettycame tothe conclusionthat;“the private rate
of returnoncapital,r, can be significantlyhigherforlongperiodsof time thanthe rate of growthof
income or output”(Piketty, 2014, 571)8
. He exemplifiesthisusingthe historical averagereturn oncapital
(r) and trackingearningsgrowthoveran extensive timeperiod. Since capital income will appreciate ata
much fasterrate than earningsone canconclude capital income will have amuchgreatereffectonthe
change in income of individuals1
overthe longterm,oras Piketty callsitthe principal destabilizingforce.
To exemplifythisIwill show howaone dollarinvestmentinthe Britishequitiesmarketwould
appreciate overthe period1825-1870 if the investorwere toreceive the average returnforthe year.I
will alsoinvestinatheoretical earningsmarketwhere the returnisthe appreciationinthe wage forthat
year.Both investmentswill be fullyinvestedatall timestakingadvantage of compoundinginterest. The
data usedforreturn onBritishequitiesisatotal returnwhichfactorsin capital appreciationand
dividendyield.Itissafe toassume any rational individual withanaverage riskprofile whoinvestsinthe
marketwill strive fordiversificationandthustheirportfoliowill be ablendof equitiesfromall sectors
and dividendyieldingshares. The reasonforusingthisspecificdatasetwasnot onlydue to its
availabilityanditspreferredorganizationbutalsothatit addsperspective tohow aboomingequities
marketcan affectthe uninvested. The wage datausedare average nominal earningsinBritainforthe
respective year.

4. Figure 1: Investment appreciationof $1 in the British equitymarkets and the theoreticallabour market during the period 1825-
1870. Core Data for equitymarkets from Graeme G. Acheson, Charles R. Hickson, John D. Turner and Qing Ye (2009). Core
Labour market data from Gregory Clarke (2016). Calculation data listed in table 1.
Figure 2: Capitaland wage return fluctuation over the period 1825-1870. Core Data for equity markets from Graeme G.
Acheson, Charles R. Hickson, John D. Turner and Qing Ye (2009). Core La bour market data from Gregory Clarke (2016).
Calculation data listed in table 1.
The value of the dollarinvestedinthe theoretical earningsmarketoverthe 45 yearperiod
appreciatedto$1.75, a 75% increase over45 years. While the dollarinvestedinthe Britishequities
$0.00
$20.00
$40.00
$60.00
$80.00
$100.00
$120.00
$140.00
$160.00
1825
1828
1831
1834
1837
1840
1843
1846
1849
1852
1855
1858
1861
1864
1867
1870
Value
Investment in K and L Markets
Apreciation of Wage
Investment
Appreciation of Capital
Investment
-20
-10
0
10
20
30
40
1825
1827
1829
1831
1833
1835
1837
1839
1841
1843
1845
1847
1849
1851
1853
1855
1857
1859
1861
1863
1865
1867
1869
Return(%)
Change in Wage and Capital
Wage Rates
Capital

5. marketappreciatedto$169 overthe same period,a 16,800% increase. ThisExample hasproventhe
truth of Piketty’sconclusion.Hisproposal isquite profound,inthatitexemplifiesthatthose whodonot
or cannot investtheirearningswill fall substantiallybehindintermsof income comparedtothose who
do. It is because of this conclusionthatonlyone variable overtime will have aprofoundeffecton
income inequality,thatvariable beingcapital income2
. Thisallowsustofocusour studyon capital
income its emergence andtransitions, andtheirimpactondifferentincome classes.
II
If capital is the driverof income inequalityitisimportanttolook forinstanceswhere inequalityin
capital availabilityemerge betweenclasses.One instance of suchadisparitybetweenclasseswouldbe
the industrial revolution.Itisnowacceptedthatthe growthduringthisperiodwasnotas great as
previouslythought.Thiseconomicchange of heartdoesn’t alterthe factthat barriersof investment
neededtoaccessthisgrowth existed duringthisperiod.The inabilityforsome totake part inthe growth
howevermediocre itmayhave beencreates income separation betweenclasses.
The industrial revolutionischaracterizedbyinnovation drivinggrowth.Changesintechnology
that created,improvedanddrove industrylike hadneverbeenseenbefore.A suitable example would
be the textileindustry. Withinventionslikethe spinningjenny,carding engine andthe waterframe,
textile productioncouldnowbe mechanized.Thisledtofactorieswhere amultitudeof machinescould
be housedandproductionstandardized. The large productionandstandardizationof labourtasks
allowedforeconomiesof scale previouslyunexperienced.Byleveragingof these economiesof scale the
factorycouldcreate unheardof profitmarginsraisingsubstantialwealthfor theirowners andlenders.

6. To participate inthiswealth,one wouldhave toinvestinall the necessarycapital required.The
average cost of a 24 spindle spinningjennywasaround 70 shillings (Allen,2007, pg.5).Whichadjusted
to the current poundvalue3
wouldbe around £1,4724
(Lawrence H.OfficerandSamuel H.Williamson,
2016). By comparisonthe yearlyearnings of farmlabourer,middlegroupindividuals,andartisansin
1755, incurrent pounds3
,were 19.01,25.17, and 42.30 pounds respectively(Lindert,Williams,1983,
pg.12 figure 1). Asthe Investmentincapital necessaryforentryfarexceeded thananyof these income
groups’ yearlyearningsandbyextensiontheirabilitytoaccessdebtmarkets,itwouldhave been
impossible forthemtoenterthe boomingtextile manufacturing industry.Considering, onlythe rich
couldaccess thisfromof capital income theyheldanalmostcomplete monopolyoverit.Creating
unequal capital income andtherebyacceleratingincome inequality.
Usingdata collectedbyPikettywe canexemplifythischange.Firstlyhe allowsustostudythis
change by analysingthe makeupof capital income duringthisperiod.Ashe explainsamajor
transformationof capital tookplace. More specifically, thatfinancialcapital andindustrialcapital
emerged asthe mainsource of investmentratherthanthe previouslydominantlandcapital (farmland)
(Piketty, 2014, pg.342). Thisstatementisprovenbythe data he compiledrepresentedin figure 3.
Figure 3: Capital split in Britain. Source: Piketty (2014)

7. There isan obviousdownwardtrendinthe value of national capital comprisedof agricultural land
withotherdomesticcapital (financial andindustrial),makingupthe majorityof itslossforthe period
underquestion. The importance of thisisthatwe can now assume all wealthandcapital data is
primarily made upof increases infinancial andindustrial capital. Inotherwords,allowingus examineto
hisdata seton wealthinequalityinBritain,underthe pretence that changesare mostlydrivenby
increasesinfinancial andindustrial capital.Duringthe laterstage of the industrial revolution the share
of wealthof the top10% increasesfrom 80% to almost90% (Piketty,2014, figure.10.3).Thisbolsters the
presumption thatonly the wealthy wereable toinvestincapital duringthisperiodandthereby
benefitedtremendouslyfromit.
Figure 4: Wealth inequality Britain 1810-2010. Source: Piketty (2014)
Researchdone by PeterLindertoveranexpansive time period,1610 - 1910, yieldedthe
conclusionthat“wealthotherthanreal estate,orgross ‘personal estate’,became more unequallyheld
duringthe industrial revolutionera”(Lindert,1986, 1130). Withall fingerspointingatan increase in
capital inequalityitissafe tosay that the industrial revolutionandthe income inequalitythatemerged
was due to barriersof entryintocapital investmentforthe lesswell off.If the inability of some toinvest
couldcreate such inequalityone wouldexpectthatthe emergence of equal accesstocapital income
wouldhelptoclose thiswideninggap.

8. III
Aroundthe same time periodthe equitymarketsinBrittanhadgone throughdevastationafter
devastation. Chief amongthemthe SouthSeaandBengal bubblesof 1720 and 1769 respectfully. Both
had a considerablyadverseeffectonthe economyasa whole andseverely damagedinvestor
confidence.Thisperiod incapital marketshoused the earliestversionof jointcharteredstock
companies.Withsuspectregulationand alack of honestybetweenthe companieslistedand investors,
speculationandfraudranwild. The eventual crashof these bubbleshurtall income classes andseverely
affectedthe Britisheconomy.Itwouldbe dubious tocall thisan equitymarket.Withall mostno
regulationand rampedfrauditcouldbe bettercharacterizedasa financing ploy benefitingfroman
unobservantinvestorbase.
Many provincial exchangesexistedupuntil 1845. The original expectationwasthattheywouldbe
more informedaboutthe local listingsandthusbe transparent.The rail roadspeculationwashedaway
all but the mostfinancial soundexchanges.This episode representedthe needforacentral exchange
governedbystandardsandprincipalsthatcouldinformthe publicandavoidthe massspeculation.
The London StockExchange whichwasoriginallyformedin1801 and represented precisely what
Britainrequired.Creatingthe LSEallowedfornew rulesandregulationtobe enforced.Theserules
forcedthe exchangesmembertobe transparentand workinthe interestof theircustomersratherthan
theirownself-interest.The LSErepresentedthe largestandmostfinanciallysoundof all the exchanges
and wasable to navigate manyfinancial stormsandemerge steadied.The LSEinauguratedaticker
systemtoallowforequal knowledgeof equityprice fluctuationsin1830. Thenaround the rail road
speculationera,officiallyin1846, theyassuredthe publicabouttheirpricingsystemby havingeach
publishedprice markedbyanofficial of the LSE to assure that all quotes inflotation were legitimate.By

9. 1853 the dominance of the LSE in Britainwasall but assuredas over70% of all rail road equity,the most
tradedand abundantduringthistime period, waslistedonthe LSE (RanaldMichie, 2001, chp.2).The
lastpiece of the puzzle,forgingfull transparency,isthe InvestorsMonthlyManual, whichwasfirst
publishedin18695
(YSM, 2016). The importance of the IMM cannot be understated. Thispublication
allowedforall investorstopeerintothe financialsof all listedcompanies. The IMMpostedchangesin
the equityanddebtof each companylistedonthe LSE and reviledpotentialthreatsoropportunities
each listingpossessed. WhichIbelieve isthe mostimportantstepincreatinganequal exchange asit
garnerstrust and transparency betweeninvestorandthe equity theyare purchasing.
Callingthe Britishequitymarketsup to1869 unjustwould seemcounterintuitive basedon the
example I gave inpart one. Duringthe period1825-1870, as I have alreadyshown,investmentinBritish
equity wouldhave beenextremely lucrative, seemingly counteringmyproposition.The problemisthat
variance inreturn was extremelyhigh duringthisperiod,representing adisparity inreturn between
investors.The standarddeviation7
intotal returnduringthisperiodwas11.73, witha max return of
53.23 and a minimumreturnof -16.93 (Acheson,Hickson, Turner,Ye,2009, Table 5).By comparisonthe
currentstandard deviation of the NYSEis0.6307 (macro axis,marketclose Nov23).The 1825-1870
variancescould be explained asknowledge gapbetweeninvestorsof differentincome classes. More
specificallythatthe higherincome classes makinggainsthroughathoroughunderstandingof the
companiesandthe poorfailingtomake the same return bynot fullyunderstandingthe company, more
oftenfallingintofraudulent traps. Once againturningto the data on wealthaccumulatedbythe top
10% from1825-1870 providedbyPiketty,itisevidentthatthe top10% increasedtheirshare.Since we
alreadyknowthischange wasdrivenby financial andindustrial wealthwe canassume the wealthydrew
mostof the gainsfrom this45 yearbull market.

10. The disseminationof companyinformationthroughthe investormanual would thenprove tobe
the keyto endunequal returnsinthe equitymarket. Thisisnottoobolda propositionas the variance in
returnpost 1870 pre WW1, droppedto constrained 3.89 whenforeignandBritishexpected return(on
equity) are setequal6
.(AndreyD.Ukhov andWilliamN.Goetzmann,2005, Table 8).
Some may findthe reliance on variance databeingthe lynchpininthisassumption suspect. To
furthersolidify myinference Iwill appraise the risksinvolvedwithinvestinginindustrial andfinancial
capital pre/post1869. In orderto do this one mustconsiderthe fieldof modernportfoliotheory more
specifically,the expectedvaluetheoremand applyingittothe twoinvestmenttype’spre/post1869.
Assumingthatinvestorsare riskadverse,theywill strive toreceive returnsthatwill payforexcess
risk. The expectedvalue isequal tothe value of aninvestmentmultipliedbythe probabilityof that
outcome.Withoutgoingtoomuch intothe actuarial side of finance andinvestmenttheorywe can
observe thatthe probabilitywill becomelessandlessaccurate asthe unknownsincrease orare harder
to quantify.From thisqualitative assumptionitiseasytosee thatcapital investmentsexpectedvalue is
much easiertoquantifyforthe pre 1869 period.Thinkingof capital investmentaspurchasingamachine
where one can examine itsproperfunctioning before the investmentismade.Thusthe onlyrisksare
businessspecifictothe industry the machine will applyto. Converselyinvestmentinequityduringthis
periodwasobviouslylesstangible,butalsoclose toimpossible toobserve the risks asthe company
financialswere not readily available.Withoutknowingthe financial healthof the companyorthe
external factorsitmaybe exposedtothere islimitedabilityto assess risk. Afterthe introductionof the
Investors MonthlyManual itbecomesmucheasierforthe investortoquantifyriskandmake informed
choices. Atthispointthe expectedvalue of investmentincapital andequityof the same outlay will
become similarlyappraisable.Nowthatthe expectedvaluesof financial andindustrial capital couldbe
calculatedinvestorswouldbe able toselectinvestmentforeithersectorwithsimilarexpectedreturns.

11. Provingthatafter1869 investorsof all incomescouldreceiveasimilarcapital income relativetotheir
investmentoutlay.
It isbecause of the progressive changesendinginthe introductionof the Investors Monthly
Manual that I wouldconsiderthe Londonstockexchange tobe fullyequal andtrustedforall in the year
1869. Allowingforall income classestoparticipate,investandreceive capital incomewithoutthe huge
monetary outlayrequiredbyinvestments inindustrial capital. One wouldthenexpectaquickand
deliberatedecreaseinwealthinequalityaround1869.
IV
Interestinglyenoughthe datacollectedbyPikettyactuallyshowedacceleration inthe capital
share ownedbythe rich from1870 to 1910. Thus increasedcapital income receivedbythe top10%,
increased income andthereby heightened income inequality.Runningcontrarytowhatwas expected,
whichbegsthe question,why?Howis itpossible thatall incomes classeshavingthe opportunityto
receive capital income widenedincome inequality? The simplestanswerwouldbe thatthe lower
income individualsdidn’ttake advantage of the newlyjustequitymarket. Toexamine the possible
explanations one mustconsultthe fieldof behavioural finance.
As previously explaineditissafe toassume that the lowerincome individualswere more often
caught infraudulent investmentsorinthe bubblesthatensnaredmuchof the workingclass.These dark
daysin the marketnegativelyaffectedinvestorconfidence makingitlesslikelyforinvestorstoreturnto
the market.The war storiesof lostfortunesinthe markettoldto childrenenshrinedthe market
fraudulence inthe mindof generationsof low andmiddle classcitizens.Thiswouldbe anexample of

12. anchoring,the tendencytothinkfroma reference point, usually illogical,inthe decision makingprocess.
For example, the childof afailedinvestormayforeversweartoavoidthe equitymarketdue totheir
familiespastmonetary loss.Theirdecisiondoesn’treflect the realitiesof the currentequitiesmarket
and wouldcause themtolose possible capital income. A second behavioural finance principle that
couldexplainthe situationisoverreaction.Inasingle securitythiswouldbe explainedbyinvestors
reactingto bad newsandpushingthe share price downtoa new low,whichshouldthennotchange
until newinformationisprovided.Thisissimilartothe reactionobservedduring bubblesandother
negative marketphenomena.Investorsseemedtodiscountthe marketasa whole decidingtowarda
waitand see approach,where onlyconstantgoodnewswouldchange theirmindsallowingthemto
investonce again. Lastlyprospecttheorymayexplainthe more emotionalside of low participation. The
theorystatesthat investorstendto have ahigheremotional response tolossesthantoa proportional
gain.Since the majorityof thisincome classreceivedlow ornegativereturnsprospecttheorywould
state these losseswouldprovide anextreme negative response, possiblycreatinganinvestorwhocould
no longerhandle the marketasa whole causingthemtoremove funds.Inall casesa psychological
tendencywouldhave compelled the marketparticipants’ actiontoremove fundsandall togetheravoid
the marketforgoingfuture capital income. Needlesstosaythose whohave lowerearningswillfind
capital lossesmore painful totheirbottomline thanthose of higherearnings.
The age oldphrase, time isthe healerof all wounds, seemstobe especiallytrue inthe case of
equitymarkets.As representedbyPikettyschartthe capital share receivedbythe top10% significantly
decreasesafterWW1 and WW2 decreasingbyabout20%. Pikettyexplainsthe final decrease in
accumulatedcapital bythe rich as due to the inaugurationof a tax on capital income duringWW1 and
the emergence of athickermiddle class,amongothers.The taxationdoesn’tseemlike areputable
answeras itwouldaffectall incomessimilarlyandforgoinganimportantsource of income simplydue to
small taxationanddoesn’tseemlikethe actionsof utilitymaximizingandrational consumer.The

13. increase inthe middle classdoeshoweverrepresentanincrease inthe numberof citizenswhocould
affordto investinequitymarkets. Workdone byMartinalsoindicatesthatduring1920 real wages
increasedrepresenting asurge indisposable income(Martin,2007, Tbl.12.3). Meaningthere wasan
increase inthe amountof Britishworkerswhocouldnow affordto investaportionof theirearnings
than inpreviousyears. Withthe tragedy’s’ of the warfirmlyplantedaheadof the fortuneslostinpost
marketfailures,one couldassume the psychological traitsthatwere previouslyhinderingmarketentry
were all butremoved.The inaugurationof the oldage pension in1908 may have also contributedto
increase investment.Withthislandmarksocial welfare reformcitizensbegantothinklongertermand
realizedthe needtoinvesttoreceiveenoughincome tolastthroughretirement,anew concept. With
an increase inthe middle classinvestorbase,theirability andthe willingnesstoenterthe equitymarket,
wealthwasswiftlyapprehended fromthe handsof the rich, as seeninfigure 4.
Figure 5: Income Share Over time. Source: The Equity Trust

14. V
Althoughthere wasasignificantlagbetween the decreaseinthe toptenpercents’ wealth
accumulationandthe emergence of ajustequitiesmarketitisassuredthatequities marketsandmore
specifically,the London StockExchange did trulyrepresentequal opportunityforall toreceive capital
income hence closingthe gapinincome inequality. Asshownin figure 5,income inequality did
significantlydecreasedfromthe 1930s up to 1979. One explanationforthisdecrease couldbe the
emergence toequal accesstoequitiesmarketsandamore inclinedandactive middle classinvestor
group.The precipitousincrease ininequalityfrom1979 to the present,formingmuchof today’spolitical
foddermayderive itssolutionfromthe pasttriumphsof capital income amongthe middleclassinvestor
from1910-1970’s.
Notes
1) It isassumedthat individuals ineachincome classare workingfulltime atthe average rate
appliedtotheirincome class. Historically,withthe exceptionof the 1990’s-2000’s, inequality
hasn’tbeendrivenbya polarizationinearnings.Bysimplyexaminingthe rate of change in
earnings,overaspecifiedperiod,thisbecomesenormouslyevident.The Earningdifferential
that tookplace in the1990’s- 2000’s can mainlybe attributedtothe lossof manufacturingand
otherlowskill middleclassworkandthe increase indemand andhoursworkedof more skilled
labour(Stewart,2016, lecture 5).
2) It isworth notingthatan increase inthe yearlyearningwill change the income of anindividual
by an equivalentratio,butoverthisperiodthere wasnosubstantial change inearningsandover
the longview, wage disparityisextremelylow.Thus itisall but assured thatonlycapital will
fluctuate andthere byalterthe individualsincome.

15. 3) It isunderstoodthe currentpoundvalue isnotthe value in2016 but in1983. Thiswas necessary
due to the timingof the release of Lindert’spaperandthere byhis“current”Values.Thusto
properlycompare the pricesIusedthe current value duringthe same period.The measuring
wealthsite usingLawrence H.OfficerandSamuel H.Williamson formulasallowingme to
provide thisvalue in1983 terms.
4) Under the pretence itseemedmostappropriatetouse the labourvalue associatedwithcost.
Thisvalue isthe cost associatedwiththe earningsaworkerwouldneedtopurchase abasketof
itemsduringthistime thenindexedandvariedforvalue of purchase.
5) Note that itonlylasteduntil 1929 butat thispointthere were significantotheroptionsto
receive newsandinformationaboutthe companyone wasinvestingin.Thatiswhyits death
wouldn’tchange the levelof opennessinthe market.
6) Settingthe expectedvalue equalallowsinvestmenttoflow througheachona level thatwould
have beenseenduringthe industrial revolutionwhenaccesstoforeignequitywastoa lesser
extentavailable
7) Variance = square root of the standarddeviation.Variance andstandarddeviationare closely
relatedandessentiallybothmeasurevariability,orthe spreadof data points.Ileftthe standard
deviationnumberforthe sake of keepingdataraw,but speakingof variance andusingstandard
deviationnumbersshouldbe understood.
8) Pikettyreferstoincome here butitisunderstoodhe istalkingaboutall non-capital income,as
he laterstates“the inequalityr > g impliesthatwealthaccumulatedinthe pastgrowsmore
rapidlythanoutputand wages” (Piketty,2014, pg.571)
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