I have finally gotten around to reading Thomas Piketty’s Capital in the Twenty-First Century.
Piketty is a French economist who has specialized in the study of economic inequality. He has done this by a very detailed use of historical records. For many countries and time periods, detailed records that would let you quantify inequality are just not available. But France, after the Revolution, instituted taxes on land and estates, and kept very detailed records. There is pretty decent data for other developed countries, including Britain, the U.S., and Germany, too.
There are several measures of inequality, but a couple are particularly of interest. One is inequality in income. This has pretty much always existed, but the extent of it has varied.
For a long time those in the top 1% of income were primarily rentiers. They held assets (usually land) and received income (rents) from them. Piketty refers many times to novelists such as Balzac and Jane Austin. It was common in English novels to mention something like a character having “5000 pounds a year,” and that pretty much told you everything you needed to know about their economic and social position. It meant they had a steady income from assets they owned (in 19th century Britain this was commonly land, but could also be government bonds).
Throughout the 19th century, inflation was virtually nonexistent, and there was a pretty stable relationship between wealth and income. If you bought a tract of land, it would yield about 5% of the price annually in rent.
The rate of return that owners of capital received (symbolized by r) always exceeded the overall level of growth in the economy (symbolized by g). This may seem counter-intuitive. But Piketty explains it is really a consequence of how assets are priced. When you buy a durable asset that will yield income, whether it be a business, or a tract of land, or a bond or whatever, you are giving up current money you hold for the promise of a future return. Historically, people have tended to want to receive about a 5% rate of annual return (on top of any overall inflation in the currency) in compensation for handing over the current price of the asset. (Some capitalists have received much more return on their money, but some have received less: this is an average). You could imagine a world in which so much capital was accumulated that it could no longer be effectively put to use, and so the rate of return would shrink down to the growth rate, but we aren’t there yet, and may never get there.
This inequality (termed r > g in the book) has consequences for the long-term evolution of society. If you are a capitalist, and you don’t consume all your income (and the very wealthy don’t), then you have a significant excess return, on top of inflation, that you can-reinvest. Therefore your wealth will grow, really almost without limit if this inequality persists over long periods of time. And you will be able to bequeath your accumulated wealth to your heirs, at least if punitive taxes don’t prevent that.
On the other hand, if you are a wage earner, you earn an income that generally grows no more than the economy as a whole. If that growth rate is low, you are probably not going to become wealthy from that. At least, you are not going to enter the economic stratum that the owners of capital occupy.
(Note that Piketty’s entire book can be read as a counter-argument to trickle-down economics. There is no trickle-down effect from the very wealthy. The wealthy accumulate, and the others stagnate).
Piketty also analyzes inequality in wealth. There has always been more inequality in wealth than income. At times it has been so extreme that 10% of the population possessed 90% of the wealth. This was the case for example in the late 19th/early 20th century in France (the Belle Époque). It has also been common in many historical periods for the bottom 50% of the population to own virtually nothing.
The bigger the gap between r and g, the faster capital will accumulate into the hands of those who already have some. And since some people have much more wealth than others, they will be able to build enormous fortunes. (Piketty also later details that the very wealthy in current times manage to earn above-average returns on their wealth, so that for them wealth grows even faster than for others, and they pull even farther ahead).
The 20th century, however, produced massive changes. The two World Wars, the intervening Great Depression, and several periods of massive inflation destroyed huge quantities of accumulated wealth, especially in Europe. Then, in the years following WW II, there was a very high growth rate in the overall economy, as rebuilding and recovery proceeded. So, temporarily, inequality decreased. The French refer to the years 1945-1975 as “Les Trente Glorieuses” (the Glorious 30), because in that time it seemed like everyone was getting ahead. Other countries did well, too. This period saw the emergence of a robust middle class, which wasn’t wealthy but captured a sizable share of the overall economic pie.
There have been other changes. Today, even those in the top 1% of incomes are not generally rentiers, or not exclusively. A good part of the 1% are “supermanagers,” that is, executives who earn very high compensation (often a combination of salary, bonus, benefits, and stock grants). It is only a small sliver of the top 1% — the top 0.1% or 0.01% — who aren’t working at all but are comfortably living off their investments. (Piketty dismisses though the notion that supermanagers deserve their vast incomes. Even if they head up successful companies, those companies’ successes may be due only in small part to the efforts of management. They might have done well anyway without talented management. Corporate cronyism has much to do with top managers’ high incomes).
Another change involved inheritance. Before WW I, if you were in the top stratum of wealth, you probably inherited it. Those who inherited frequently acquired in that way more wealth than a working person could acquire in even a lifetime of work. But in the wake of WW I, there was so much destruction of wealth that a whole generation in Europe at least inherited very little. And so for a time workers began to catch up to the heirs of the wealthy.
But Piketty makes plain that the middle 20th century was an anomaly. The overall economy cannot grow even at high single-digit rates forever. Countries that have had high growth rates have done so because their population was rapidly increasing (as in the U.S., when it was expanding to fill a whole continent), and/or because they were catching up to other nations from a low starting point. Over time he thinks developed countries will revert to a growth rate of no more than 1.5% annually, and it could be less.
This has consequences for inequality. The rate of return on capital may be headed down somewhat from the historical level of 5%, but it still comfortably exceeds the base growth rate (g), and is likely to do so far into the future. As the growth rate comes down, the gap between r and g increases, and this is a powerful force towards increasing inequality. So it is quite possible the middle of the 20th century was a fluke, and we are very likely headed back to a economic environment something like the late 19th century, which was a period of extreme inequality. We are already manifestly heading in that direction, especially since top tax rates were reduced starting in the 1980’s. And as the top 10% and even more the top 1% accrue more wealth, they are passing it on to their heirs again.
One of the main lessons of the book is that most humans, at least those who are not students of history and economics to the extent Piketty has been, tend to think about economics in terms of the near past, which they have experienced in their lifetimes. That can be misleading. To really understand what is happening and will happen, you need to look at longer time periods.
In the U.S., we are still having political debates about what happened to the high growth rate in incomes that we enjoyed up until 1970 or so, and how to bring it back. If you believe Piketty, there really is no bringing it back. Not unless you want another World War or Great Depression, so you can grow fast in its aftermath.
So if high growth is not returning, how can we prevent the return to an environment of extreme inequality, with a small fraction of the population doing very well and no one else?
Piketty’s proposed solution is a global tax on capital, at a high enough rate to reduce the gap between r and g and head off the otherwise inexorably widening gap between rich and poor.
Increasing the income tax will not be nearly as effective because many wealthy people have been able to structure their affairs so as to have relatively little taxable income.
A tax on capital would have to be global because at the present time there are few barriers to the wealthy moving their assets across national borders. A global capital tax implies that there is a system for international reporting of assets, so that one tax jurisdiction can discover what assets its citizens possess in other tax jurisdictions.
Lots of people will say this is unrealistic, and I do think the policy part of the book is not the strongest part. It is striking that in the aftermath of 9/11, the U.S. put all kinds of pressure on banks and other financial institutions worldwide to better track financial flows, in an attempt to cut off funds to terrorist organizations. I’m sure this has had some effect. Still, the recent Panama Papers leak shows that there are plenty of people who have practically untraceable assets, unknown to the tax authorities. I wonder too how much of this hidden wealth is actually connected to government corruption. There are quite a few countries where it is commonplace that the political elite are basically thieves, siphoning off the wealth of the country into secret bank accounts. When the government is that much a part of the problem, expecting that government to accede to financial transparency is probably not realistic. And what of our own country, where now the economic elite are free to pump vast sums of money into elections? As long as this is the case, it is going to be difficult to enact Piketty’s tax regime.
Piketty realizes at least some of the obstacles and he does say it may be possible to approach this end result in stages, maybe starting by forging something together at the EU level.
I would not dismiss his proposals entirely. If his analysis of the causes of inequality is correct, then there is currently no effective brake on its further increase from levels that already are causing alarm. Piketty clearly has in mind, and alludes to, what happened in France when over time the nobility came to concentrate wealth almost entirely into the hands of the top 1-2% of the population: heads were taken off. That is also a kind of solution, but not a desirable one: the French Revolution succeeded in redistributing wealth, but also unleashed a period of war and suffering that affected many people, not just the displaced aristocrats. And eventually, it led to the destruction of the First Republic.