One of the profound changes in human experience from 1700 until today has been the staggering increase in technology, information, and choice. These go hand in hand. When we are able to build machines, we can print books on a large scale and spread information to the masses. People can choose between the many fictions they experience: one can sail the wild seas with Admiral Horatio Hornblower, journey back to read petitions of Emperor Tiberius, or learn valuable lessons on decision-making from Sun Tzu.

The economics of technological change itself is a complex thing. However, the economics of art investment as a function of this change is not. In response to the recently concluded India Art Summit, iTrust Financial Advisors (based out of India) weighs in on the question: “Is art a good investment?” The answer of course is “it depends.” But it’s a solid article that first lists some of the investment characteristics of art assets:

  • Uncorrelated Returns. The author suggests that the returns from investment in art are not correlated with returns in stocks or bonds. I suspect this is increasingly untrue for reasons I will explain later. Still, it would not really mitigate the author’s point that art assets could be useful diversification tools (ways to not put all of your eggs in one basket).
  • Lack of liquidity. It’s difficult to convert an art asset into more fungible form, such as cash. It takes time, especially to get fair market value.
  • Lack of income. Unlike stock ownership, art ownership does not provide income streams such as dividends.
  • Fakes and regulatory framework. There’s supposedly more risk with art, but I wouldn’t say this is a very strong point. On the other hand, gains from sales in art are subject to a higher tax than stock gains. Although no one knows what this disparity will look like after the Bush tax cuts expire, and sadly, it seems they will have to because of the suicidal spending spree recently embarked on, it is likely art gains will remain taxed at 28% while stock gains will be somewhere around 20% (according to President Obama). The consequence of this is that investment decisions between these asset classes is slightly tilted, all things being equal, in favor of stocks and that the pre-tax return from an art work must be 40% more than the return from an otherwise comparable gain in stock in order for an investor to be neutral between the two. For more, see: Internal Revenue Code s. 1(h)(4) and s. 408(m)(2).
  • Transparency. The author only means here that there seems like relatively low liquidity and therefore price signals are not as robust as in other markets– though they may be just as efficient.
  • Handling costs. Stocks don’t have them. Okay.

The interesting point is the first one. You see, I am dying to get a hold of a book recently recommended to me by a secret agent code-named Hunter called The Patron’s Payoff: Conspicuous Commissions in Renaissance Art. In a review of the book by California Literary Review‘s Judith Harris:

In The Patron’s Payoff, art historian Jonathan K. Nelson and economist Richard J. Zeckhauser have harnessed their separate disciplines into a new analytical key for understanding the linked motivations of patron and artist or architect in conspicuous commissions. . . . No less than the American financier who donates a museum wing on condition it bears his name, or the merchandiser who endows a university institute named for him, the results of Renaissance patronage had to be, first of all, highly visible.

This is an intuitive, but important microeconomic finding because it suggests that in the Renaissance era, these brilliant works of art were not created primarily as an asset class that would yield investment returns directly in currency. Rather, it would yield returns in the form of status, privilege, and indirectly perhaps in currency. This makes it a very different type of asset class than stocks. Or, at least, it did. In The Economics of Art and Culture, James Heilbrun and Charles Gray suggest that the returns on art increase through time:

“The history of art connoisseurship tells us that the main lesson imparted by the test of time is the fickleness of taste whose meanderings defy prediction.” William Baumol’s skepticism is grounded in his study of 640 arts transactions during the period from 1652 to 1961, as listed in Gerald Reitlinger’s The Economics of Taste. Baumol calculated the real rates of return associated with specific works of art and concluded that the average annual compounded rate of return was 0.55% in real terms, about one-third as high as the real return on a government security. Returns varied from a high of 27 percent to a low of -19 percent per year. […] Another study, that by Frey and Pommerehene, extended Reitlinger’s data up to 1987 and included more recent auction data from France, Germany, and The Netherlands. Taking into account inflation, commission fees, and other pertinent factors, they calculated the average rate of return to paintings over the entire period to be 1.5% per year. […] It should not be particularly surprising, then, that studies of different time periods and varying data sources reach conflicting conclusions on the investment value of art.

Actually, that’s not precisely correct. It is true that we should not be surprised studies from different time periods and data will suggest different investment values in art. However, it is not because of taste or methodological issues. The most viable hypothesis to explain these findings is that from the Pharoahs through Louis XIV, very little art was transacted for the purpose of investment returns in currency. That is not to say they didn’t expect returns, as is likely shown in The Patron’s Payoff. And this is why, except for considering artifacts that are only now perhaps categorized as art, it is not difficult to catalog the few noteworthy artists and styles of those ages.

However, when technology improved, living standards improved. Commensurate with the notion that food and shelter cost relatively less in a person’s budget, more money would now be available for those “higher pursuits” such as fine arts. Previously, there would be few buyers for spectacular art works and indeed returns would not be correlated with any market because it depends almost purely on prestige issues. Now, a market develops, and we learn that people care more about getting money — which they can exchange for all kinds of things — than mere prestige, though that is still attached in many cases. The rate of return goes up through the ages, peaking with the bubble of the 1980s but settling in the 1990s, because people are getting richer and demand for art goes up. It is no more complex than that. Ironically, even though investment in art is likely at an all-time global high (certainly still true without the useless NEA), it probably pales in comparison to the amount of art that is “consumed” through television and movie watching, to say nothing of sports.

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