Capital in the long run
Thomas Piketty's book aims to change economic thinking on inequality
By R.A. | LONDON
THOMAS PIKETTY, a French economist from the Paris School of Economics, is best known for his involvment in the joint project (with people like Emmanuel Saez and Anthony Atkinson) to build long-term series on income earned by the rich. It is thanks to these efforts that we know, for example, that the share of American income earned by the top 1% has returned to a level close to 20%, nearly matching the all-time high set in 1928. But Mr Piketty is likely to become much better known in 2014, when the English version of his 2013 book, "Capital in the Twenty-First Century", is published in March. The book aims to revolutionise the way people think about the economic history of the past two centuries. It may well manage the feat.
This week's Free exchange column examines the book. It is, first and foremost, a very detailed look at 200 years' worth of data on the distribution of income and wealth across the rich world (with some figures for large emerging markets also included). This mountain of data allows Mr Piketty to tell a simple and compelling story. Wealth as a share of income held steady at very high levels in the 18th and 19th centuries, contributing to stark inequalities in wealth and income. Rising worker wages in the late 19th and early 20th centuries stabilised growth in wealth concentrations but did nothing to reduce inequalities, which were only eliminated by the great shocks of the period from 1914 to 1950. Economists tricked themselves into thinking that the resulting compression in the income and wealth distribution was a natural feature of the maturation of capitalist economies. But as the shocks receded wealth began to accumulate again and growth in income inequality resumed. From the perspective of 2014, concentration of wealth and income begins to look like the natural state of capitalism rather than an exception.
Mr Piketty allows that this need not be the case. He sets out two "laws" to describe when and how capitalism will generate divergence rather than convergence in wealth and income:
The first explains variations in capital’s share of income (as opposed to the share going to wages). It is a simple accounting identity: at all times, capital’s share is equal to the rate of return on capital multiplied by the total stock of wealth as a share of GDP. The rate of return is the sum of all income flowing to capital—rents, dividends and profits—as a percentage of the value of all capital.
The second law is more a rough rule of thumb: over long periods and under the right circumstances the stock of capital, as a percentage of national income, should approach the ratio of the national-savings rate to the economic growth rate. With a savings rate of 8% (roughly that of the American economy) and GDP growth of 2%, wealth should rise to 400% of annual output, for example, while a drop in long-run growth to 1% would push up expected wealth to 800% of GDP. Whether this is a “law” or not, the important point is that a lower growth rate is conducive to higher concentrations of wealth.
In Mr Piketty’s narrative, rapid growth—from large productivity gains or a growing population—is a force for economic convergence. Prior wealth casts less of an economic and political shadow over the new income generated each year. And population growth is a critical component of economic growth, accounting for about half of average global GDP growth between 1700 and 2012. America’s breakneck population and GDP growth in the 19th century eroded the power of old fortunes while throwing up a steady supply of new ones.
Tumbling rates of population growth are pushing wealth concentrations back toward Victorian levels, in Mr Piketty’s estimation. The ratio of wealth to income is highest among demographically challenged economies such as Italy and Japan (although both countries have managed to mitigate inequality through redistributive taxes and transfers). Interestingly, Mr Piketty reckons this world, in which the return to capital is persistently higher than growth, is the more “normal” state. In that case, wealth piles up faster than growth in output or incomes. The mid-20th century, when wealth compression combined with extraordinary growth to generate an egalitarian interregnum, was the exception.
The twist in the story is that while technological progress can raise labour productivity and boost wages, it can also make it easier to substitute capital for labour. In that case, even rapid productivity growth may merely enhance capital's share of income, the return to capital, and the concentration of income and wealth.
As with any sweeping narrative, Mr Piketty's book occasionally tries too hard to shoehorn history into the framework, and it doesn't always deal generously with inconvenient facts. But the database on which the book is built is formidable, and it is difficult to dispute his call for a new perspective on the modern economic era, whether or not one agrees with his policy recommendations (as many will not).
What Mr Piketty conveys most powerfully, in my opinion, is the fact that economics was once centrally concerned with the question of distribution. It was impossible to ignore in the 19th century! Not least because economists of a market-oriented disposition and those more sympathetic to Marx both wondered whether capitalism was capable of generating a sustainable distribution of the gains from growth. We are all used to sneering at communism because of its manifest failure to deliver the sustained rates of growth managed by market economies. But Marx's original critique of capitalism was not that it made for lousy growth rates. It was that a rising concentration of wealth couldn't be sustained politically. Ultimately, those of us who would like to preserve the market system need to grapple with that sort of dynamic, in the context of the worrying numbers on inequality that Mr Piketty presents.
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