Trickle-up, not trickle-down

In my youth I first heard of the theory of economic trickle down–that if the rich get richer, the benefits will trickle down to the poor, and so all will benefit. This was supposed to explain why, contrary to Karl Marx, it was not true that the rich got richer and the poor got poorer. On the contrary, both got richer together. The poverty line in the US has now reached the mind-numbing height of $ 11,000 per year (Rs 5 lakh per year). Historically, the poor have never been richer.

And yet the notion of trickle down always sounded implausible to me. Indeed, in my youth I found it laughably absurd. After all, I said, right through history there had always been a small coterie of rich people–kings, nobles, priests–and the riches remained with the rich. Indeed the whole purpose of feudal rule was to prevent any trickle down, and keep the riches for the rich.

Very true, I was told in my youth, but that was what happened in feudalism. It was different in modern capitalism, because the rulers could not simply grab all the wealth. Capitalism permitted people and companies to keep the gains of their work, and not have it all gabbed by the kings and aristocrats–that is what the French revolution was about. In modern times, I was told, there were rules of the economic game which protected private property and income, and in these circumstances money did trickle down from the rich to the poor.

I remained unconvinced. Capitalism after the French revolution produced little change in living standards of the poor for a century or more. Karl Marx declared- -and many of his time agreed–that the class interests of the rich were diametrically opposed to those of the poor, and that the rich would manipulate all institutions to prevent trickle-down.

Very true, I was told, but that was before the welfare state became the norm. In the last century, workers obtained the right to organise, democracy further empowered the poor, and safety nets of various kinds plus Keynesian demand–management policies helped them in times of distress. Above all, universal education ensured that the poor obtained human capital, which we now recognise is as valuable as financial capital. So, in this new welfare era, economic trickle down worked.

I accepted this thesis reluctantly. I felt instinctively that money could not trickle down in any quantity. Yet I knew it was factually true that the rich and poor were getting richer together, even if not at the same rate. So perhaps modern institutions of the welfare state had made trickle-down a reality.

Today, I know otherwise. It is indeed true that the rich and poor both benefit from growth, but this is not because money trickles down from the rich to the poor. It is because profits trickle up from the non-rich to the rich. That is a very different, and more accurate description of the way a modern economy actually works.

Consider a textile magnate. The theory of trickle-down suggests that the magnate first gets huge profits from textiles, and then a portion of this trickles down to his workers, cotton growers and others. This is simply not true.

The trickle-up theory shows what really happens. First, the cotton farmer grows his crop, pays the agricultural labour involved, and then sells the crop at a profit. Note that the agricultural worker gets his money first, the grower second. Next the cotton moves to a ginning factory to remove the seed. The transporter and ginner make their living in the process. Then the cotton moves to a mill. The staff there are paid their wages and salaries even while processing the cotton, whether or not the mill is profitable. When the cloth is ready, it is sold through agents or traders who also earn commissions or profits. Only at this final point, when the sales are made, does any profit accrue to the textile magnate. At this point, profit trickles up the top.

So, please abandon the theory of trickle down and embrace the theory of trickle-up. It is not true that money trickles down from the top to the bottom. On the contrary, every person directly or indirectly involved in textile production makes his money before the textile magnate does. The notion of trickle-down suggests that profits have first claim on business income. On the contrary, they have the very last claim, after meeting the claims of every other participant in the business. And there is no guarantee that a surplus will, in fact, trickle up–in many cases the textile magnate may suffer a loss.

This should be obvious to anybody who has ever seen a balance sheet. The balance sheet lists the income of the company. Then it lists expenses–sums paid to suppliers, to workers, to managers, to creditors, to consultants and the such. Only then does it list the profit–and in some cases there may be a loss. The profit is often called the bottomline precisely because it comes last.

The business magazine Fortune discloses that the average profit of the 500 largest companies in the world is only 3 per cent of sales. That means 97 per cent goes first to other participants in these businesses, and only 3 per cent trickles to the top.

That is how the real world works. So do not get trapped into describing the success of modern economies as the success of trickle-down economics. It is the success of trickle-up.

What do you think?