Thomas Piketty, Gabriel Zucman, 26 September 2013
According to many measures, inequality has been increasing in the developed world and is now approaching prewar levels. Income inequality does not tell the whole story. This column documents the increase in the ratio of private wealth to national income. This macroeconomic change, precipitated by slowing GDP growth, exacerbates the problem of wealth inequality and makes the economy more susceptible to bubbles.
Reducing inequality is one of the defining challenges of our time. In recent decades much of the discussion has centered on the need to invest in education (Goldin and Katz 2010). Fostering access to education is a powerful way to reduce the dispersion of wages in the long run, but it is not enough.
One issue is that in the US – as in many countries – the rise in income inequality has been driven by the top 1% of income earners, and not by the following 9%, although both groups have the same diplomas (Alvaredo et al., 2013).
An even more important problem is that looking at earned income is not enough. Economists used to believe that the ratio of aggregate wealth to income is constant over time, but it is not.
As we establish in a new paper, the wealth-to-income ratios of rich countries have been increasing since the 1970s (Piketty and Zucman 2013). In the top eight developed economies, according to official national balance sheets, aggregate private wealth has risen from about two to three times national income in 1970 to a range of four to seven times today (Figure 1). Capital is making a comeback. This evolution is not bad in itself, but it has far-reaching implications for inequality and calls for a whole new set of policies.
Figure 1. Private wealth / national income ratios, 1970-2010
Source: Authors’ computations using country national accounts. Private wealth = non-financial assets + financial assets – financial liabilities (household & non-profit sectors).
Because wealth is very concentrated, high wealth-to-income ratios imply that the inequality of wealth – and potentially of inherited wealth – will probably matter a lot more in the foreseeable future than it did in the postwar period. This evolution will reinforce the need for progressive capital and inheritance taxation (Piketty and Saez, 2013). This, in turn, will require a high degree of international coordination in order to prevent wealth from hiding in offshore tax havens (Zucman, 2013).
If international tax competition prevents these policy changes from happening, one cannot rule out the development of a wave of anti-globalisation and anti-capital policies.
Looking at the very long run, the postwar decades – marked by relatively low wealth – appear to be a historical anomaly. According to the best available historical estimates, high wealth-to-income ratios were the norm in Europe throughout the 18th and 19th centuries. Then the world wars, low saving rates, and a number of anti-capital policies provoked a large drop in private wealth, from six to seven times national income to about two times in the aftermath of World War II. The wealth-to-income ratios have been rising ever since, to the extent that they appear to be returning to their 19th-century levels.
In the US, the wealth-to-income ratio has also followed a U-shape evolution, but less marked (Figure 2).
Figure 2. Private wealth / national income ratios, 1870-2010: Europe vs. USA
Source: Authors’ computations using country national accounts. Data are decennial averages (1910-1913 averages for Europe). Europe is the average of UK, France and Germany.
The return of high wealth-to-income ratios has one key cause – the slowdown of productivity and population growth. In the long run, whatever the reason for saving, the wealth-to-income ratio is equal to the ratio of the saving rate by the income growth rate – what is known at the Harrod-Domar-Solow formula.
When the saving rate is 10% and growth is 3%, the long-run wealth-to-income ratio is about 300%. But if growth drops to 1.5% – for instance because population growth diminishes – then the long-run ratio rises to about 600%.
In short: capital is back because low growth is back.
Lower population growth also explains why the wealth-to-income ratio is currently higher in Europe than in the US But by the end of the 21st century, with low population and productivity growth everywhere, wealth-to-income ratios may ultimately rise globally.
Today, wealth takes many forms; not only of land as in the 18th century, but of machines, intangible assets, housing, and so on. It is increasingly easy to automate routine tasks. In such an economy, rising wealth-to-income ratios imply a rising share of capital in national income – a higher fraction of income going to capital owners. Our findings illuminate the rise of capital shares that has indeed occurred since the mid-1970s (Figure 3).
Figure 3. Capital shares in factor-price national income, 1975-2010
The capital share is still lower than it was in the 19th century UK and France. One optimistic interpretation is that human capital may be more important than it was two centuries ago. But looking forward, with low growth, high wealth-to-income ratios, and an elasticity of substitution between labor and capital even moderately larger than one, a return of the high capital shares of the 19th century seems increasingly probable.
For example, with an elasticity of substitution equal to 1.5, the capital share rises from 28% to 36% when the wealth-to-income ratio jumps from 2.5 to five. In case further capital accumulation takes place and the ratio reaches eight, the capital share could reach 42%.
Beyond inequality, the return of high wealth-to-income ratios has important implications for financial regulation. According to our computations, the wealth-to-income ratio reached 700% at the peak of the Japanese bubble of the late 1980s, and 800% in Spain in 2008-2009 (Figure 4). Bubbles are potentially more devastating when the total stock of wealth amounts to six to eight times national income rather than two to three times. Monitoring wealth-to-income ratios may help detect such bubbles and strikes us as important for designing appropriate financial and monetary policies.
Figure 4. The Spanish bubble, even bigger than the Japanese bubble
Source: Authors’ computations using country national accounts. Private wealth = non-financial assets + financial assets – financial liabilities (household & non-profit sectors.
Alvaredo, Facundo, Anthony Atkinson, Thomas Piketty and Emmanuel Saez, “The top 1 percent in international and historical perspective”, Journal of Economic Perspectives, vol. 27, n°3, Summer 2013, pp. 3-20.
Goldin, Claudia and Larry Katz, The Race Between Education and Technology, Harvard University Press, 2010.
Piketty, Thomas and Gabriel Zucman (2013), “Capital is back: wealth-to-income ratios in rich countries, 1700-2010”, CEPR Discussion Paper 9588, August.
Piketty, Thomas and Emmanuel Saez, “A theory of optimal inheritance taxation”, forthcoming in Econometrica, 2013.
Zucman, Gabriel, “The missing wealth of nations: Are Europe and the U.S. net debtors or net creditors?”, Quarterly Journal of Economics, vol. 128, n°3, pp. 1321-1364.