Capital in the Twenty-First Century
Thomas Piketty. Translated (from the French) by Arthur Goldhammer.
Harvard University Press. First published 2014.
This is one of the most talked about books of recent times, and there have been reports of it being read avidly even by school-going teenagers. It was on many best-seller lists, and maybe continues to be on one or two of them. It has been the subject of numerous essays, and has sparked numerous debates, some less learned than others, some more abstruse, in newspapers and magazines, as much as in blogs and Internet websites, in all shades of political and economic persuasion. It has, I think, introduced a large dose of egalitarianism into contemporary discourses on the political economy, though of course, not everyone agrees either with the conclusions - which say that capitalism will continue to result in gross and unacceptable inequalities in wealth distribution through the next century, as it has over the previous fifty years - or with the suggested means to prevent such inequality - a global tax on wealth, at a progressive rate. While the Occupy movement, with its call of '99% v/s 1%', focused widespread attention on inequality, it was probably Piketty's book, at once scholarly and very readable, which made it respectable for commentators from the mainstream establishment to acknowledge the existence of the problem, and try and figure out the causes and possible solutions. For example, an article by Thomas B. Edsall in the New York Times on 4 March 2015, sneeringly titled 'Establishment Populism', describes how Larry Summers, once an advocate of free market capitalism, and sometimes thought to be a key figure in causing the recent (and ongoing) global financial crisis, now believes that the currently dominant economic policy, is 'producing major distortions', which have resulted 'in gains of $1 trillion annually to those at the top of the pyramid, and losses of $1 trillion every year to those at the bottom 80 percent' (presumably in USA alone).
I thought I would read the book over the winter holiday in December-January. That didn't happen, but I finally got to read it over the past several weeks. It is easy to read, and was very accessible to me, a layman whose acquaintance with economics is marginal. I suspect however that my frequent use of graphs and tables, not to say mathematical equations, in my own quotidian professional tasks helped more than a little in easing the way.
Piketty uses copious amounts of data gathered globally from tax records, land records and such, to establish that wealth, globally, as well as within the few countries he specifically focuses on (France, UK, US, Germany, Japan), was extremely unequally distributed at the beginning of the 20th century. It evened out a bit in the middle years, coinciding with the two world wars and events like the American stock market crash of 1929, before beginning to rise again from about 1950, until now, more than sixty years later, globally wealth is almost as unequally distributed as it was 110 years ago. This U-shaped curve recurs no matter what measure of inequality is used. Having established this fact of the trajectory of inequality, Piketty then appeals to theory to make sense of it. He shows that whenever the rate of return on capital (r) is greater than the growth rate of the economy (g), i.e. whenever r > g, wealth and income inequality in a capitalist society is bound to grow. This conclusion, though at first sight reasonable enough, on closer examination raises many questions, and Piketty answers all of them, at least all that occurred to me. He also shows that this condition, of r being greater than g, existed for most of the history of the world, did not exist for a couple of centuries in the early life of the US, and also did not exist for a few decades in the middle of the 20th century in the US, Europe and the rest of the world. This condition is now again true, r is now again greater than g, and will continue to be so in the foreseeable future, thus foreshadowing increasing and extreme unevenness in the possession of wealth. Piketty finally proposes that a strong and proven measure to control this 'inflation' in wealth inequality is to levy a wealth tax, the rate of which would depend on the amount of wealth. He stipulates that to be truly effective, it would have to be levied globally, in order to negate possible flight of capital to tax havens such as Ireland, Switzerland and the Cayman Islands.
Just to let us know where he is coming from, Piketty begins the book with a quotation from the 'Declaration of the Rights of Man and the Citizen' formulated in 1789, during the French Revolution - 'Social distinctions can be based only on common utility'. In other words, inequality of wealth (or prestige or other measures of man) is only OK as long it leads to some good for everyone and helps society in general. Apart from this requirement, all other social instruments or institutions that lead to any sort of inequality are bad and must be torn down. In the rest of the book, Piketty does not dwell any further at all on the why - why inequality is bad. He only talks about the what and how of inequality, how it grew, how it grows and how it will grow.
In the introductory chapter he traces some of the main trains of thought in the area of political economy, dwelling specifically on the works of Malthus, Young and Ricardo. The three of them lived and worked well before the industrial and the agricultural revolutions, and their thoughts were full of the awful consequences of the inequality that they thought would 'inevitably' ensue when too many people chased too few resources, including such a basic resource as food. Marx, too ignored the possibilities of technological progress, and concentrated instead on how to prevent the ill-effects of the accumulation of private capital. Piketty then describes the work of Simon Kuznets in the 1950s, who showed, with the data then available to him, that inequality followed a bell curve, first rising, and then falling in the course of economic and industrial development. Piketty remarks that his own, more extensive data (as presented in the 'World Top Income Database', an online resource) shows that this is not true. In fact wealth and income inequality is a U shaped curve, being high in the 19th century and the first part of the 20th. Society then becomes less unequal in the middle of the 20th century only to grow again to current high levels. Piketty further summarizes the broad results of his studies as follows. Firstly, "the history of the distribution of wealth has always been deeply political, and cannot be reduced to purely economic mechanisms." [Double quotes indicate direct quotations from the book.] Next, there are powerful mechanisms that both increase and decrease inequality, and "there is no natural, spontaneous [economic] process to prevent destabilizing, inegalitarian forces from prevailing permanently." He does admit that the main force in favour of equality has been education, or the "diffusion of knowledge and skills". He then introduces the main idea of the book - "In slowly growing economies, past wealth [capital already in possession of the owner] will take on a disproportionate importance, because it takes only a small part of the savings to increase the stock of wealth steadily and substantially". If the rate of return on capital r is greater than the growth rate g, then wealth generates even more wealth and inequality increases. Thus, in these two paragraphs of the chapter, Piketty lays out his main conclusions. The rest of the book is a reiteration, elaboration and demonstration of the truth of these conclusions using large amounts of hard data gathered worldwide.
There are sixteen more chapters distributed into four sections. In the first section, Piketty explains his sources and defines his metrics, comparing them with other well-known economic measures such as GDP and the Gini coefficient. In the second section he presents the data in numerous graphs and tables. In the third section he interprets the data, and gives a theoretical foundation, proving his thesis that as long as r > g, then the rich will get richer and the poor poorer. In the last section he argues, strongly, in favour of his somewhat idealistic and Utopian proposal for a global wealth tax as the only sure way to bring about a fairer and more egalitarian society of mankind, and therefore a more peaceful and prosperous one. I will not here summarize each chapter in detail, for that would entail virtually transcribing the entire book. I will only present some points that struck me, arguments made by Piketty, some questions these raised in my mind, and, sometimes, possible resolutions of the dialectics. But before that, some general comments about the book.
Piketty's writing is not only accessible and smooth - the translator also needs to be commended - but also he makes frequent use of examples, anecdotes and situations from popular literature to illustrate and support his points. He refers often to the novels of Jane Austen and Honore Balzac to illustrate some point or the other about early and middle 19th century society in England and France, respectively. He also refers to many other such popular writers. I am, of course, familiar with the writings of Austen and can relate first-hand to Piketty's allusions, though not so much for the other writers he quotes. In addition, I now appreciate additional nuances in the writings of such authors as Arthur Conan Doyle and Charles Dickens. But apart from just the pleasure of reading this book, Piketty makes so many points in such a clear and non-polemical way in almost every page of the book that it can be truly appreciated only when it is fully read, not in summary, not abridged, not even when it is listened to as a lecture or a discussion. Having said that, I will in the rest of this essay describe a few points that struck me as I read the book, some of them are said by Piketty, and some are just my thoughts and reactions to them.
Piketty uses the term 'wealth' interchangeably with the word 'capital' taking both to mean the same thing, and standing in opposition to 'income'. He defines a 'national income' for a country as the sum of its domestic output (approx GDP) and its net income from abroad. National income is also the sum of income generated by capital (dividends, interest, rent) and income from labour (wages, salaries). Capital, or wealth, is all that generates income without labour on part of the owner, such as land, buildings, stocks, shares and bonds, other manner of deposits and factories and machinery. [In earlier times slaves could also be considered as wealth.] It may be argued that shareholders have to 'work' to manage their investments, and therefore dividends, etc., should be considered income from labour, not income from capital. But clearly the major portion of the money that comes from shares, comes simply from owning them. Wealth could be public wealth (roads, etc.) or private wealth, and likewise the income generated from it. He makes the point that in most countries public debt is larger than or just equal to public wealth, and thus almost the entire net national wealth will consist of private wealth. He measures wealth as a percentage of national income, and estimates that "in developed countries today, the capital/income ratio" termed β, "varies between 5 and 6", with the capital being almost entirely privately owned. The national income consists of both income from labour, and the income from capital (interest, rent, etc.), that latter termed α. He presents the "first fundamental law of capitalism" which says α = r x β, where r is the rate of return on capital. It may be in the form of profits, rents, dividends, royalties, capital gains, etc. In other words it corresponds to the income from capital, mentioned above, expressed as a fraction of that capital.
Piketty then talks about growth - GDP growth. He deconstructs this as partly due to population growth and partly due to per capita GDP growth. He shows from statistics on population that its rate of growth has already peaked worldwide, is now falling, and is projected to reach not more than 1.0% in the next century. Similarly, historically the highest per capita GDP growth rate in Western Europe was never greater than about 4% annually, and is projected, optimistically, to be about 1.5% per annum, on an average. Where do the recent growth rates of 7 to 10 % in India and China fit in this scenario? Piketty does not say, but I suspect that even now (even when China is the second largest economy) the contribution of these countries to the total world economy is too small to change the projections. In any case, considering the size of the populations and their rate of growth, the growth in per capita GDP will be small. So, Piketty used the term 'growth' to mean the annual increase in per capita GDP (or the per capita national income) of a country.
Next, Piketty uses all the data sources mentioned earlier to show that national capital in Britain, as a percentage of the national income was about 700% (i.e. 7 times) from about 1700 to 1900, then fell rapidly to 200% by 1950, only to rise again to 500% in 2010. Most of this capital was, and remains, privately owned, since public capital was/is more or less cancelled out by public debt. This U-shaped curve, and this private/public distribution is seen again in France and in Germany. In the US, capital, again principally privately held capital, increased from about 300% in 1770 to about 400% now, without the large mid 20th century fall seen in Europe. Net public capital in US was, and is, close to zero. Almost as a digression, Piketty here discusses 'human capital'. He is not in favour of using that term for labourers (whether manual or intellectual, including the denizens of the cubicle farms in Silicon Valley, and in the wanna-be Silicon Valleys around the world), but agrees that it makes sense when speaking of slaves. Fortunately for our conscience, we need not consider that in our calculations, since slavery by and large does not exist anymore except, perhaps, in some dark corners of Asia and Africa.
Piketty here introduces what he calls 'the second fundamental law of capitalism'. In the first law, stated above, the capital/income ratio β was expressed as the the income from capital α, divided by the rate of return on capital r. In the second law, β is equal to the savings rate s divided by the growth rate g. In other words, if, for example, a nation saves s% of its national income every year for about 30 years, and has a rate of growth of the national income of g% a year for a similar period, then over this period of time, the capital income ratio will reach β = s/g (x100)%. To quote Piketty: "in a quasi-stagnant society [low growth rate], wealth accumulated in the past will inevitable acquire disproportionate importance". He notes very carefully that this is a long term law, and represents the equilibrium state to which the capital/income ratio tends, over a few decades at the least, and cannot be applied on an annual basis. Nevertheless, it is a rigorous law, that can be mathematically derived from basic principles and definitions, as shown, for example by Dan Kervick at https://ruggedegalitarianism. wordpress.com/a-derivation-of-pikettys-second-fundamental-law -of-capitalism/. Piketty uses these laws then to interpret what the data shows, namely the distinct and "strong comeback of private capital (wealth) in the rich countries since 1970", i.e. "the emergence of a new patrimonial capitalism", where inherited wealth is more and more important. The interpretation of this fact is that it is due to three factors - most importantly, low long term per capita growth rate and a high saving rate (rich people have much more money than they can spend); the "gradual privatisation and transfer of public wealth into private hands since the 1970s" (the era of Thatcher and Reagan); and the increase in stock market and real estate prices. He then uses the data to show that all three factors are fully supported by the empirical data. He extrapolates the data to project that the global capital/income ratio (for all countries together) would go from about 450% now to about 650% in 100 years - assuming, of course that there are no global revolutions and so on, and that it is 'business as usual' everywhere. There follows a long discussion about income from labour and income from capital. Piketty estimates an average long term "pure" rate of return on capital (after deducting portfolio management costs) at about 3 to 4% today, increasing maybe to 5% in a hundred years.
Having presented and analysed the data with regard to the growth of capital as against the growth of income, Piketty next turns his attention to the most interesting part of the analyses, namely the structure and dynamics of economic inequality in, chiefly, the rich societies. As a measure of inequality he concentrates on the percentage of wealth accruing to the top 10% (decile) or the top 1% (percentile) of the population. Likewise, he considers the top centile and deciles in income, which are not the same groups as for wealth. Using income tax records and such like, he shows that, in France, of the people in the top 1% of income, the total income of people who get their incomes solely from capital, i.e. the "rentiers", is less now, in the early 21st century, than the total amount of money earned by people whose income is from 'labour' - managers and executives and such like. However, even now, the major share of the income of the top 1%, rising to more than 60% of the income of the top 0.01% (i.e. about 5000 people in France) comes as income from capital. He makes the point that inequality (the share of the top 10% or top 1% in the national income) tends move in the same direction as the economy. In economic boom times the share of profits (rents, interest, dividend, capital gains) all tend to increase as compared to the average increase in income from labour. Also, at the same time, labour income at the top end of the scale (executive salaries) will increase faster than at the lower ends (clerical salaries or worker wages). Thus, economic growth, will not automatically lower inequality. However, during economic slowdowns, also, inequality does not necessarily decrease, since other, political factors, come into play. He shows, again backed up by solid data, that inequality, and especially income inequality in the US has risen hugely from 1980. The share of the total income of the top 1% has gone from 10% to about 20% now. The share of the top 10% has gone from about 30% of the total income to about 50% now. He then poses the question: Did this income inequality cause the financial crises of 2007? And he answers: Yes, it did. He further shows that in Europe and Japan, the share of the top decile or top centile in the total income has barely changed from less than 10%. In India, Piketty notes, the share of the top percentile of the total income is about 12% now, having grown from about 6% in 1980.
The inequality in ownership of wealth is far larger than inequality of income, though the former has not changed as much as the latter. It reached heights of 80% of the total national wealth for the richest 10% in the US in 1910, only to drop down to about 65% in 1970 to about 70% now, with similar behaviour in Europe, though at different levels - 90%, 60%, 65%.
Piketty now elaborates on his core thesis - that the reason for the "divergence" in wealth is principally the fact that the rate of return on capital was/is greater than the growth rate of the economy (i.e. growth of the national income), or r > g. He illustrates this with an example, which I quote here. "If g = 1% and r = 5%, saving [just] one fifth of the income from capital (while consuming the other four-fifths) is enough to ensure that capital inherited from the previous generation grows at the same rate as the economy. If one saves more, because one's fortune [initial capital] is large enough to live well while consuming somewhat less of one's annual rent, then one's fortune will increase more rapidly than the economy, and the inequality of wealth will tend to increase, even if one contributes no income from labour". Though intuitively obvious, this can be also be established by mathematically rigourous arguments. Thus, in a capitalist society, where there are no other means to redistribute the wealth, when r > g, the inequality is bound to increase. QED. It is therefore "an illusion to think that something about ... the laws of a market economy ensures that inequality of wealth will decrease and harmonious stability will be achieved". Later on in the book, Piketty points out that r > g specifically also implies that more and more of the money of the people in the lower fractions is transferred to people in the higher fractions of the economy, since more money is generated as rent than as wages/salaries. So not only is the gap between the rich and poor widened, but also the rich get richer, and poor, poorer, if the rate of return on capital is greater than rate of growth of he economy.
Next Piketty examines the relative importance of inheritance over merit (or labour) in generating capital. He shows from data that "in the nineteenth century, the living standards that could be attained by the top 1% inheritors were a lot higher than those that could be attained by the top 1% labour earners". This difference reduced in mid 20th century. However late in the 20th century the importance of inherited wealth in being able attain the top 1% again grew, and is set to increase again. However, the difference now is that there is a class of 'labourers', the supermanagers and entrepreneurs, whose enormous salaries and earnings takes them into the class of the top 1% or even higher, ostensibly due to their own merit. Piketty's analysis makes the defense of such a 'meritocracy' hard to support. He points to the weirdness of the argument that unless these supermanagers are paid the obscene salaries they now get, only those with inherited capital would occupy the top echelons of wealth. In other words, we pay these salaries in the interest of 'social justice'! "Meritocratic extremism can thus lead to a race between supermanagers and rentiers, to the detriment of those who are neither." Piketty examines the arguments about wealth, enormous wealth, being rewards for innovation and risk-taking. He concludes that "the inequality r > g, when it combines with inequality of returns (r) as a function of initial wealth, can lead to excessive and lasting concentration of capital: no matter how justified inequalities of wealth may be initially, fortunes can grow and perpetuate themselves beyond all reasonable limits and beyond any possible rational justification in terms of social utility".
Piketty here remarks, as an aside, on the lack of any moral or economic merit of the astronomical wealth of 'innovators' and 'entrepreneurs' like Bill Gates. He makes two points here. First, while the initial wealth of the Microsoft founder might have come as a reward for his vision and entrepreneurship, his capital has increased even more rapidly since he stopped working. Second, even his initial efforts would not have been so spectacularly successful without the work of countless computer scientists, mathematicians and electronics engineers. A similar point has been made, repeatedly and with much empirical support, by Noam Chomsky, who has pointed out that all the Internet billionaires, whom we admire so much, would not be around but for the publicly funded work on DARPANET and WWW. Larry Page and Sergei Brin would not have made so much money from their much touted page-ranking algorithm that underlies Google, but for their single minded pursuit of ways to monetize it, while throwing out several conventions of decent behaviour with regard to other people's privacy and so on. Piketty uses such examples, including Laxmi Mittal and Arcelor, and an African dictator living in Paris, to illustrate the fact that the return on capital often inextricably combines elements of "true entrepreneurial labor (an absolutely indispensable force for economic development), pure luck (one happens at the right moment to buy an asset at a good price), and outright theft." In order to estimate true returns on capital, he therefore concentrates on University endowments which are invested in the market, and represent pure capital returns, separated from labour or theft. He shows that Universities with large endowments, such as Harvard and Princeton make greater than 10% annually on their endowment, while less well-endowed Universities, those with less than $ 100 million to invest, make about 6%. Thus, the richer you are, the greater is the rate of return. And inflation does not reduce this return (unless you have just deposited money in the bank), since asset prices rise at least at the same rate as inflation. He then talks about sovereign wealth funds, i.e. moneys invested by a country in the assets of another. The same rule applies, and these countries end up owning more and more of the others.
Piketty analyses China and India, and concludes that, for various political and demographic reasons, it is unlikely that either of them would end up 'owning the rest of the world'. He also mentions studies confounding the idea that rich countries are actually poor since much of their wealth is owned by others like China, Qatar and Saudi Arabia, since the citizens of the rich countries have huge amounts, more than 10% of the world's wealth, held in tax havens such as Switzerland.
And so we come to the last section of the book, in which Piketty suggests a solution to the problem of inequality. Of course, many people would not recognize differences in wealth distribution as a problem to be solved, but only something that happens in the natural course of evolution of a society, people for whom words like 'social justice' are swear words. Piketty does not address such people. He simply assumes that everyone will agree that a solution has to be found. The title of the thirteenth chapter, 'A Social State for the Twenty-First Century', signals his own inclination to the left. In this chapter he considers how the social welfare state that was created in the mid 20th century in the rich countries, with emphasis on universal education, healthcare and retirement, can be carried over to the 21st, especially in the face of a relentless attack on it in the last three decades. He shows that the social welfare state was possible because the population agreed to pay for it with high taxation rates, the rich paying a greater percentage of their income than the poor. In poor countries, like India, the taxes were (and are) low, leaving no money for social welfare. Since generally taxes are coming down, the social support will also come down, thus exacerbating inequality. The obvious remedy is to raise taxes, with a progressive taxation rate so that the rich will pay more than the poor - tax and spend, in other words. Not in such a facile and pejorative manner, though. Piketty is serious about a global tax on wealth that will redistribute money not only within the country, but also between countries. He admits this is Utopian, that large conceptual and political barriers exist to it, worldwide. However, after carefully considering all other measures, he concludes that if we are to save the social state that now exists in many rich countries (with Denmark being a supreme example), and if we are to extend its reach both within the countries in which it now exists, and to all other countries of the world, the hard logic of capitalism points to no other solution.
The book is part scholarly treatise, part layman's guide to an aspect of macroeconomics, part political tract. It reads well at all levels, and will probably be influential in future discussions on the political economy. It does however seem to preach to the converted, and I can imagine that it will change too few minds that need to be changed. It is too limited in its focus, and also a little bit too abstruse to serve as a 'Bible' for any popular movement, new or existing. It will probably be a reference book for finance ministers of left-wing governments, of whom there are too few anyway. I cannot see the 'Masters of the Universe' at the World Bank or on Wall Street spend any time on it, except to try and drown it in scorn and mud.
Placed in the context of my own larger reading about saving the world (!), the book does not consider some important future events that could, potentially remake the world and society, even to the extent of making it extinct. For example, climate change. There are simply no market-driven solutions for this problem. It will probably have a far greater effect on economic inequality within and between countries than r being greater than g. A second such 'externality' that market forces cannot deal with, and which Piketty does not consider, is the possibility of a 'singularity' where machines will be able to do everything that humans do, including designing and making other machines. If that happens, those who own the machines, the capitalists at the top of the heap, will be OK. What about the rest? This is already happening - Facebook employs a far small smaller number of people to make much greater amounts of money than General Motors. Jobs are now shifting to the service industry, but machines could replace people in that as well.
