The big idea
Thomas Piketty is set to become a star. “Capital in the Twenty-First Century” – the new book from the founder of the Paris School of Economics – has received gushing praise from the New York Times and the Economist, even before the official publication of the English translation next month. The massive production, 577 pages of text plus voluminous supporting material, posits that economic inequality is a major social problem which is likely to get worse. Piketty’s arguments, however, fail to persuade.
The theoretical centrepiece is a simple claim. Whenever return on capital is greater than a nation’s GDP growth rate, the existing owners of capital end up with an increasing proportion of the capital stock. Piketty argues that returns are usually around 4 percent to 5 percent, while growth in demographically mature and economically advanced societies is unlikely to be much above 1.5 percent. Since capital ownership is highly concentrated, the result is an ever higher concentration of wealth.
The problem with this argument is that the mathematical claim is faulty. Higher returns only lead to an increased concentration of wealth if capital owners invest enough of their income. If they spend it all, as for example landed aristocrats have often done, they gain no ground. Piketty does acknowledge this on a few occasions, but provides no evidence that the combination of the reinvestment rate and returns is currently high enough to widen the gap between rich and poor.
That lacuna pretty much invalidates roughly a quarter of his analysis. It does not, however, damage the main statistical argument, which is that incomes have been rising much faster for top earners than for everyone else. Historical statistics are Piketty’s special expertise. He is a leader in the relatively new effort to use tax records to quantify historical income distributions in different countries.
This leads to a series of graphs showing that in most developed economies the share of total income garnered by the economic elite, the top 1 percent and 0.1 percent of earners, fell through much of the 20th century, started rising again in the 1980s and has now reached or surpassed the previous peaks. Piketty identifies a similar pattern in the ownership of capital, although his conflation of financial assets, residential property and industrial infrastructure into a single category is more confusing than illuminating.
He may well be right about the trend, although a new “Chartbook of Economic Inequality” from the Institute of New Economic Thinking at the Oxford Martin School finds a less universal and dramatic separation of the rich from the rest. However, in “Capital” Piketty largely ignores the economic context.
A narrow focus on top cash incomes, as reported to tax authorities, is misleading. Whatever the statistics suggest, the pre-Depression arrangement of mansions and servants was fundamentally different from today’s bourgeois society in which most important goods – electricity, heat, transport, the internet, basic education and advanced medical care – are nearly universally available.
Piketty’s prediction of even greater inequality relies on a dubious historical claim, that the social cataclysms which led to an increasingly equal distribution of wealth through much of the 20th century were anomalies which are now being reversed. The widespread interest in inequality, including in Piketty’s own work, shows this is false. The welfare state may become more or less redistributive, but it is here to stay.
All that said, a good short book lurks within Piketty’s sprawling tome. His discussion of the social difference between inherited and self-made wealth is stimulating, as is his commentary on the newest source of ultra-high incomes, the “supersalaries” given to distinctly average managers. More important, his big policy ideas – higher taxes on high incomes and on capital – are fairly persuasive. The suggestion of a one-off capital levy to pay down government debts is intriguing. Higher estate taxes, which he mentions only fleetingly, would fit well into this package.
Piketty deserves praise for his social concern and for his enthusiastic revival of a largely dormant economic question, namely the just relationship between labour and capital. His book, though, is too unreliable a guide to inequality to deserve a laudatory reception.