Reflections on Piketty’s inequality argument

The novels of Jane Austen, Honore de Balzac or Henry James, in which civilized life was confined to a small percentage of the population and the only way most people could acquire significant wealth was to inherit it or marry it.

According to Thomas Piketty’s Capital in the Twenty-First Century, there is nothing to stop that kind of world from coming back.

1_percent_decomposed_2.png.CROP.promovar-mediumlargePiketty’s basic argument goes as follows:
•    If the rate of return on investment is a higher percentage than the rate of economic growth, which he expresses as r > g,  the owners of investment property will get an ever-larger share of national income.
•    R > g is the normal state of affairs.
•    Ownership of wealth is distributed even more unequally than income.   The higher the share of income that comes from wealth, the more unequal it will be.
•    The larger the amount of wealth you own, the faster it is likely to compound.   So not only do the rich become richer at a faster rate than ordinary people, the super-rich become richer at a faster rate than the ordinary rich.
•    At some point the process levels off, but the leveling-off point may not come until inequality reaches a point that we associate with 18th century Europe or the Third World

The economic prosperity and relative equality during 1945-1975 were made possible by the destruction of capital during the Great Depression and the two World Wars, according to Piketty.   Of course war and depression left everybody worse off, not just rich people, but when economic growth resumed, a lesser share went to the economic elite.

Piketty’s conclusions are backed up by archival research that traces income and wealth distribution in France, Britain and the USA for two centuries and many other countries for shorter periods of time.  That research shows that r > g is the typical state of affairs in most countries and most periods of history for which information is available.

One striking finding is that there is just as much inequality among the elite as there is among the public at large.  In the USA, the top 10 percent have about half the wealth, the top 1 percent have about half the wealth of the top 10 percent, and the top 0.1 percent have about half the wealth of the top 1 percent.

Another finding, based on comparisons of American university endowment funds, is that the larger the amount of wealth you have to invest, the higher your rate of return is likely to be.   This is probably because the richer you are, the better financial managers you can hire, the better able you are to diversify your investments and the better cushion you have when you make high-risk, high-return investments.

chart_2.png.CROP.promovar-mediumlargePiketty proposes to deal with inequality by means of a graduated tax on wealth to go along with graduated taxes on inheritance and income.  But there are other ways.

You could figure out ways to increase the rate of economic growth, for example.  Or you could figure out ways to achieve a wider distribution of wealth, such as through employee stock-ownership plans or worker-owned enterprises.   Or you could strengthen labor unions, increase minimum wage or take other measures to increase the incomes of the middle class, working people and the poor.

It’s important to keep in mind that Piketty only deals with one specific issue, the concentration of income and wealth in a small elite—an important issue, but not the only one.   Piketty does not tell us how to raise people out of dire poverty, nor how to achieve better productivity, or economic growth, or better education, or a cleaner environment, or any other goal.

And taking money away from the economic elite will not in and of itself make anyone any better off.   A lot of financial wealth was destroyed during the Great Depression and and a lot of tangible wealth was destroyed during World War Two, but this did help anybody at the bottom of the economic scale.  Piketty thinks that destruction of wealth cleared the way for the prosperity of the 1950s and 1960s, but I don’t think anybody who lived through the 1930s and 1940s would have said it was worth it.

     Critics of Piketty say that r > g will be self-correcting.   Take, for example, rental property as an example of income-producing wealth.   As rents go up, the law of supply and demand says that more people will build or acquire rental property.  Eventually this will cause rents to level off or to go down.  Piketty admits this is so, but he says the historical record shows that society can grow extremely unequal before this leveling-off process takes place.

There is a moral argument, which is that the accumulation of wealth should not be questioned because people get rich through their superior intelligence, harder work and important contributions to society.

10economix-sub-wealth-blog480Piketty agrees that it requires intelligence and effort to getrich, but not necessarily to stay rich and certainly not to inherit riches.  Once you reach a certain level, your gains become almost automatic, unless you are reckless or foolish.  Someone as rich as Bill Gates does not need the talents of a Bill Gates in order to get even richer.   That is why Piketty thinks that, unless something changes, the world is moving toward an era of “patrimonial capitalism” based on inherited wealth.

Some critics question his research.   Chris Giles, a reporter for the Financial Times of London, says Piketty makes adjustments in his figures based on subjective judgment, which is true.  He says Piketty asserts that the richest 10 percent in the United Kingdom own 70 percent of the wealth, while they in fact only own 44 percent; Piketty’s reply is that Giles’ figure comes from a government survey while his own figures are based on income tax and inheritance tax records, which he thinks are more accurate.

the-top-01-of-americans-get-a-near-record-amount-of-income-at-around-10I expect Piketty’s figures will be challenged further as economists delve deeper into the data.  The important thing is not whether his figures are off, but whether his conclusions are off.   He said that over the long run, the rate of return on investment is about 5 percent, and the rate of economic growth is about 1 or 2 percent.   If further research shows that the rate of return is only about 3.5 or 4 percent, then Piketty will have been wrong about the rate of change, but not about the direction of change—the rich steadily increasing their share of national income.

The title of Piketty’s book invites comparisons to Karl Marx, but Piketty’s Capital is very different from Marx’s Capital.  Where Piketty wrote of the returns to capital vs. the returns to labor, Marx wrote of the class struggle between the capitalists and the workers.

chart_1.png.CROP.promo-mediumlargePiketty is an academic economist whose aim is to save the capitalist system from its excesses.  Marx was a self-taught economist, political scientist, journalist and revolutionary leader whose aim was to overthrow the capitalist system.

Marx wanted to expropriate the rich.  Piketty does not object to people being rich.  He is content to live in a capitalist economy.   He just wants to prevent the rich as a class from throwing society out of balance.   That shouldn’t be seen as threatening.

LINKS

Why We’re In a New Gilded Age by Paul Krugman in the New York Review of Books

Thomas Piketty Is Right: everything you need to know about ‘Capital in the Twenty-First Century’ by Robert Solow in The New Republic.

Capital in the Twenty-First Century: Introduction by Thomas Piketty.

Inequality & Capitalism in the Long-Run by Thomas Piketty

Q&A: Thomas Piketty on the Wealth Divide, an interview by the New York Times.

Thomas Piketty on capital, labor, growth and inequality, an interview by the Institute for Public Policy Research.

Inequality in the Long Run by Thomas Piketty and Emmanuel Saez in Science. [Added 6/21/14]

Should We Count Out Piketty Due to “Sum” Math Errors? by Stephen Pressman for Triple Crisis.

Plutocracy without end: Why the 1 percent always defeats the middle class by Thomas Frank for Salon.

Piketty answers David Brooks: The best-selling economist sounds off to Salon [Added 6/21/14]

Thomas Piketty’s Capital in the 21st Century by Cory Doctorow for Boing Boing.  Excellent!  [Added 6/26/14]

Capital Eats the World by Suresh Naidu for Jacobin [Added 6/26/14]

Note: All the charts in this post show income and wealth distribution in the United States.

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