Thursday, May 15, 2014

Piketty: Merit and Inheritance in the Long Run

The ownership of capital is getting more unequal every day, and may end up as bad as the years before World War I writes Thomas Piketty in Capital in the Twenty-First Century. But how do people get to own capital?  By savings or inheritance?  In Piketty's view it is mostly by inheritance.  So nothing has changed since Jane Austen and Balzac.

Here is his argument:
Whenever the rate of return on capital is significantly and durably higher than the growth rate of the economy, it is all but inevitable that inheritance (wealth accumulated in the past) predominates over saving (wealth accumulated in the present).  
So, "the inequality r > g in one sense implies that the past tends to devour the future". (See Discussion in Inequality of Capital Ownership where Piketty gets to this position by whiffing the measured phenomenon of time preference as "theory" "tautology" and "simplistic").

On this view "inheritance will... probably again be as important as it was in the nineteenth century", provided that demographic and economic growth slow, as Piketty expects.  Of course it won't be quite the same, because there will be more medium rentiers and supermanagers to reduce the share of the very wealthy, although this won't help the "low- and medium-wage workers".

Piketty now produces another chart, of inheritance and gifts in France as a percent of national income from 1820 to 2010.  Inheritances amounted to about 20% of national income in 1820, rose to 24% in 1880 to 1900 and plunged to 8% in 1920 after World War I.  After World War II inheritances collapsed again to 4% of national income and then began a slow rise to about 14% today.  Piketty has two ways of computing this, by "fiscal flow" and "economic flow"; economic flow comes in a little higher than fiscal flow.

Now Piketty comes up with another identity to show what is going on with inheritance.
Annual flow of inheritance = (average wealth at death)/(average wealth of living) * (mortality rate) * (capital/income ratio)  
For instance, if the dying are twice as wealthy as the living, and two percent of the living die each year, then four percent of the national wealth gets transferred each year.  If you factor in Piketty's capital/income ratio at 600% then you get 24% of the national income transferred by gift and inheritance per year.

In Modigliani's life-cycle theory of wealth the average wealth at death would be almost zero because the aged would all live on "annuitized wealth" from pension funds or insurance.  But they don't.  The chart shows that people are not turning their wealth into annuities, as people thought they would do in the mid 20th century.  They are saving it and giving it to their children.

Another reason people give for discounting the importance of inheritance is that people live longer: that should reduce the size of legacies.  In fact it doesn't seem to make much difference.  When people die later they leave more to their legatees.  In fact people do not save just for retirement.  They also save to leave wealth to their children both in death and with gifts during life.  Gifts made during life, in France, have increased substantially since 1980.

Piketty shows us an interesting table showing the age-wealth profile by decade in France.  Under normal conditions people get richer the older they get, right up into their 80s.  In 2010 twentysomethings in France owned about 25% of the average 50-60 year-old.  By their 80s they were worth 134% of the average fiftysomething!  The only exception to this rule was the "rejuvenation of wealth" from the shocks to capital and owners in 1914-45.  The war years cleaned out the capitalists, so that in 1947 in France the average 80-something owned 67% of the wealth of the average fiftysomething.

So what about inheritance in the future? This is where Piketty's inequality r > g comes in.  If the rate of return on capital is low he expects the inheritance level to flatten out at 16% of national income.  But if the rate of return on capital is high then his chart shows that the inheritance level could climb back up to the level at the end of the 19th century.

Piketty's numbers allow him to come up with a chart of the cumulated value of inherited wealth as a percent of the total wealth of the living.  It's about 85% in 1850 and rises to nearly 90% by 1910.  The inherited share of wealth collapsed to 45% in 1970, but now it is climbing again, back up to 67% in 2010.  Piketty forecasts it leveling out at 80% by 2100 if the rate of return on capital is low, or 92% if the rate of return on capital is high.

Piketty takes a look at what the mid-century collapse in inheritance has meant to actual people in a chart of inheritances for each age cohort.  Basic advice: don't be born between 1900 and 1920, because you won't get to inherit much.  (This rings true, because my father's family in Russia was wiped out by World War I and the Bolshevik Revolution, and my mother's family in Japan was wiped out by World War II).  Thus, in another chart, Piketty shows that the best way to succeed in life for those born between 1890 and 1970 was to get a job.  For the rest of us, Piketty shows that it pays to follow the criminal Vautrin's advice to the young penniless aristocrat de Rastignac in Père Goriot and marry a rich heiress!

Thus, Piketty can say, if the capital/income ratio goes much above 300% you will get a society in which "top incomes from capital will predominate over top incomes from labor by a wide margin."  And you will get a Jane Austen/Balzac/Henry James world where ambitious people are looking for inherited money to marry rather than a greasy career pole to climb.

Even though inheritance is returning to its 19th century importance the culture still celebrates a "hierarchy of labor and human capital", as in TV programs like House, Bones, and West Wing, celebrating a "just inequality, based on merit, education, and the social utility of elites."  This cultural meme is based on two misunderstandings.  First, inheritance has not disappeared; inheritance is back.  Second, there is r > g, that capital growth overwhelms income growth.  Human capital will get overwhelmed by non-human capital.

So much for inheritance in France.  What about the rest of the world?  Piketty shows that inheritance is up in Germany, but not as much, perhaps, in Britain.  In the United States the data is not too good, and demographic growth means that inheritance must be a lower factor than in Europe.  But don't be fooled: "inheritance also plays an important role in the United States."

Discussion

Piketty's picture of inheritance shows that, when you use up all of a nation's capital in war and revolution everyone has to get to work and rebuild what was destroyed.  That, you'd think, would be obvious.

But Piketty affects to be shocked that people are still people.  They work to provide for their families, and when they die they want a chunk of wealth to go to their children.  After a disaster, like 1914-45 people work to rebuild what was lost.  No kidding!

The invidious part of his analysis is the unspoken assumption that the top 1% of 1810 that passes on fortunes to their heirs is the same 1% that passes on wealth to their heirs in 1910.  I doubt it.  If we take, e.g., the Churchills, we see the warrior of 1700 raised to great wealth.  But 200 years later Lord Randolph Churchill had to marry a Wall Street heiress, Jenny Jerome, in order to stay in politics.  Today, the Churchill family has reverted to the mean.  The fact that the capital/income ratio has returned roughly to the level it showed back before 1914 is probably not a scandal.  It is probably just the way that advanced capitalism (aka free enterprise) works.

Piketty's model also contradicts the findings of sociologists that Thomas J. Stanley and William D. Danko popularized in The Millionaire Next Door. Millionaires are typically people that have built up a few nondescript businesses by luck and hard work and modest living.  But they worry about their children; they don't want them to become wasters.  So they push them through school into the professions, because they know that a professional life supported by a salary is not as risky as a business life supported by an ever evanescent profit.

Introduction

Part One: Income and Capital

Income and Output

End of Growth

Part Two: The Dynamics of the Capital/Income Ratio

Changes in Capital

New World Capital and Slavery

Capital/income Ratio in the Long Run

Capital's Share of Income

Part Three: The Structure of Inequality

Inequality and Its Concentration

Two Worlds: France and the US

Inequality of Labor Income

Inequality of Capital Ownership

Merit and Inheritance in the Long Run

Global Inequality of Wealth in the 21st Century

Part Four: Regulating Capital in the Twenty-First Century

A Social State for the 21st Century

Rethinking the Progressive Income Tax

A Global Tax on Capital

The Question of the Public Debt

Conclusion

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