Piketty: Global Inequality of Wealth in the 21st Century

Mostly, under advanced capitalism, people get rich by inheritance, writes Thomas Piketty in Capital in the Twenty-First Century.  In other words, inequality of wealth is perpetuated by inheritance. Now he turns to the question of global wealth inequality.  "Is there a danger that the forces of financial globalization" will lead to an unprecedented "concentration of capital"?  Unfortunately we lack global wealth data equivalent to the French record-keeping inspired by the French Revolution, so Piketty will examine global wealth through proxies, like magazine rankings of rich businessmen and fragmentary data on sovereign wealth funds and US university endowments.

You would think that capital is capital, and that "the return on capital is the same for all owners".  But Piketty will show that there are economies of scale in wealth, and that richer capitalists get a bigger return than small capitalists, and that "such a mechanism can automatically lead to a radical divergence in the distribution of capital."  Piketty appeals once again to his r > g inequality.

According to Forbes magazine's annual list of billionaires published since 1987 there were "over 140 billionaires in 1987" but "more than 1,400" in 2013.  A Japanese billionaire led the list in the late 1980s, an American in the late 1990s.  Since 2010 the richest billionaire has been a Mexican.  And those billionaires have been making billions on their billions. Piketty shows a table in which the top wealth holders have made a post inflation 6.8% per year on their money while the average world wealth per adult has gone up 2.1% a year.  So the share of the global richest has been going up.  Where could this end?  How about "impoverishment of the middle class", "explosive trajectories and uncontrolled inegalitarian spirals."

In his analysis of the Forbes rankings Piketty intuits that "all large fortunes" grow at extremely high rates.  Entrepreneur Bill Gates went from $4 billion to $50 billion, and L'Oréal heiress Liliane Bettencourt -- "who never worked a day in her life" -- went from $2 billion to $25 billion.  That's 11% rate of return after inflation.  Beyond a certain size "capital grows according to a dynamic of its own", maybe for decades and "nearly all the income on this capital can be plowed back into investment."

There isn't much data for global wealth, but Piketty estimates that "inherited wealth accounts for more than half of the total amount of the largest fortunes worldwide."  Regardless of "sterile debate about merit and wealth" "fortunes can grow and perpetuate themselves beyond all reasonable limits" and justification in "social utility." An entrepreneur may have amazing ideas at 40, but hardly any at 90, and forget the children.  So a "progressive annual tax on the largest fortunes worldwide" would control a "potentially explosive process."  The return on capital comes partly from "true entrepreneurial labor... pure luck... and outright theft" as suggested by examples from Carlos Slim, Bill Gates, and Lakshmi Mittal.   It is arbitrary.  "[P]roperty sometimes begins with theft, and the arbitrary return on capital can easily perpetuate the initial crime."

It's not just big businessmen that get outsized returns on capital.  The endowments of US universities averaged a real rate of return of 8.2% from 1980 to 2010.  And the biggest earned the most, with Harvard, Yale and Princeton coming in at a return of 10.2%.  The reason the biggest do the best seems to be that they employ more sophisticated investment strategies, "such as shares in private equity funds and unlisted foreign stocks... hedge funds, derivatives," etc. Harvard, with an endowment of $30 billion, spends $100 million a year managing its portfolio.  Of course, the very high returns of 1980-2010 may not continue. But, for Piketty, the institutions have one up on family wealth because of the "ability to choose the right managers."  Families end up sooner or later with the prodigal son.

How does inflation enter into all this?  Probably by helping the people that can afford professional help on their investments, so inflation probably works against the small investor.  But not enough to justify "a return to the gold standard or zero inflation."

Today there are a number of sovereign wealth funds generally in oil-rich states, from Norway with $700 billion in assets to less transparent funds in the Persian Gulf.  According to estimates there is $5.3 trillion in these funds, compared with $5.4 trillion owned by the Forbes billionaires. It is natural to worry that these sovereign wealth funds might end up owning the world, and it is natural for people to fear this, particularly as today's $100 a barrel oil "could rise as high as $200 a barrel by 2020-2030." But these funds have already "begun to limit their foreign investments" and spend money at home.

What about China and India?  Could they end up owning the world?  Probably not, because they "have large populations whose needs... remain far from satisfied."  But imagine China saving 20% of national income until 2100!  Then a large part of the world "could be owned by enormous Chinese pension funds."

Really, the specter of oil and China owning the world is less threatening than "oligarchic" divergence, with countries owned by their own billionaires as the rich pull ahead of the rest.  People in Paris think that "rich foreign buyers" are buying up all the real estate in the city.  Actually, it is rich French buyers.  So it is the spending of the domestic rich that creates a sense of "dispossession" and "helplessness" that could be tapped by the government of the EU.  And don't forget that a substantial fraction of global wealth is hidden away in tax havens.

Discussion

The problem with Piketty's notion of "divergence," of the rich making money hand over fist forever, is that it fails the sanity test. Capitalists make money by financing world-beating innovations that billions of people want to buy.  When they stop coming up with world-beating innovations they stop making money. Bill Gates became rich because PCs running his operating system on a $2,000 computer could do financial spreadsheets incomparably better than a minicomputer costing $30,000.  But now Microsoft is struggling because people are migrating from the desktop computer to the smartphone and the tablet and Microsoft is left playing catch-up.  There is no rate of return on capital when it is used to finance an idea that fails to deliver.

And as for the idea that university foundations and sovereign wealth funds have a leg up on the rest of us with their top-notch professional managers, what about the geniuses at Fannie and Freddie?  What about the big banks that went bust in 2008?  What about the state government pension funds that lost half a trillion dollars in 2008-09?  And what about a middling sort of capitalist like me?  I just ran the numbers on Quicken and my net worth has increased at 8.75% after inflation from 1987 to 2013.  So I'm doing better than Forbes' loser billionaires and their paltry 6.8%!

The bottom line is that the only way for billionaires to make tons of money -- other than by cronying up to governments -- is by coming up with brilliant ideas that people want to buy. What is Piketty's problem with that?

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

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

Piketty: Inequality of Capital Ownership

Labor income inequality is on the rise again, according to Thomas Piketty in Capital in the Twenty-First Century. Now he looks at capital inequality since the turn of the 19th century.  This is important because the compression of inequality in the 20th century came from a "collapse of high incomes from capital."

Wealth is always more concentrated that income. Down the ages the "least wealthy half... own virtually nothing".  Generally the top 10% own 60% or more of the wealth and the folks in the middle from 5% to 35%.  The significance of the modern era is the emergence of a "patrimonial middle class" owning between 25% and 33% of national wealth.  How did this middle class emerge?

Of course, it is difficult to estimate historical wealth trends because France only started to record property transfers after the Revolution and Britain and the US a century later after the shock of World War I.  Piketty shows the wealth of the top 10% and 1% in France from 1810 to the present in a chart. It shows wealth inequality going up in France throughout the 19th century.  The top 10% owned 80% of wealth in 1810 and 89% of wealth by 1910.  The top 1% owned 46% of wealth in 1810 and 60% by 1910.

Now, of course, the content of wealth was totally transformed over this period, with land being replaced by "industrial and financial capital and real estate" -- not to mention vast political changes -- but the capital/income ratio stayed pretty constant throughout.

Then came the world wars and the top 10% wealth share in France declined from 89% in 1910 to 62% in 1970 and then started a slow recovery.  For the top 1% wealth declined from 60% to 22% over the same period, recovering to about 24% by 2010.

Wealth inequality in Britain and Sweden followed a similar path, but the US started with less inequality and ended up with more as you can see in the following tables from Piketty's charts.

Wealth Share of the Top 10%

Country	1810	1910	1970	2010
France	80%	89%	62%	63%
Britain	83%	92%	64%	70%
Sweden	83%	88%	54%	59%
United States	58%	81%	65%	71%

So you can see that the US started out more equal and ended up more unequal.  Now let's look at the top 1%.

Wealth Share of the Top 1%

Country	1810	1910	1970	2010
France	46%	60%	22%	24%
Britain	55%	69%	22%	28%
Sweden	57%	61%	18%	21%
United States	26%	45%	29%	33%

Piketty wants to ask why wealth inequality was so extreme before World War I, and why is it today significantly below its high.  Is this "irreversible?"  In any case, we clearly see the emergence of a "patrimonial middle class" with about 33% share of the wealth.

Now we come to the center of Thomas Piketty's argument.

The primary reason for the hyperconcentration of wealth... prior to World War I... is that these were low-growth societies in which the rate of return on capital was markedly and durably higher than the rate of growth.

Or, as Piketty likes to show in the following inequality: r > g.

In a world of low growth, say 0.5% to 1% per year, the rate of return on capital is much higher, say 4% to 5% per year. If the capitalist saves a good part of his income, his capital can grow faster than the economy.

For example, if g=1% and r=5%, saving one-fifth of the income from capital... is enough to ensure that the capital inherited from the previous generation grows at the same rate as the economy.  If one saves more... then one's fortune will increase more rapidly than the economy, and inequality of wealth will tend to increase[.]

Piketty shows a couple of charts here and here to show the history of r and g in France in the 19th century. They shows that the rate of return on capital is typically "10 to 20 times greater than the rate of growth of output (and income)."  He shows a chart of r and g since antiquity that forecasts r and g through 2100.  In another chart, Piketty forecasts that the return on capital, which collapsed in the 20th century, will return by 2200 to near historical levels while economic growth declines.  This is not a "plausible hypothesis, precisely because its inegalitarian consequences would be considerable and would probably not be tolerated indefinitely."

But what about "time preference"?  Isn't the rate of return on capital mostly time preference, "that measures how impatient they are and how they take the future into account"?  Well, yes, but this "theory" is "somewhat tautological".

[A]ssuming a zero-growth economy, it is not surprising to discover that the rate of return on capital must equal the time preference[.]

The problem is that the time preference theory "is too simplistic and systematic" because we can't reduce all savings behavior to one parameter.  And it requires that during rapid growth the gap between r and g should be greater than during zero growth. There are a lot of other things to consider, including "precautionary savings, life-cycle effects" and the prestige of wealth itself.

On the validity of Piketty's ideas, that the inequality r > g allows the capitalists to increase their share of wealth without limit, and that time preference is just one of many factors in the rate of return on capital, hangs the entire argument of Capital.  See the Discussion below.

Of course, Piketty admits, if the capitalists save without limit, the only thing that can avoid "an indefinite inegalitarian spiral" is that eventually, the rate of return on capital would go down.  But this could "take decades to operate."  Alternatively "shocks of various kinds" whether demographic or economic, can deplete capital.  No doubt that's why many aristocratic societies were based on primogeniture "to conserve the family's wealth."  Since 1800, of course, western societies have progressively abandoned primogeniture.

Primogeniture was abolished in the French Revolution, but inequality in France continued for another century.  That's where the inequality r > g comes in.  When the rate of return of capital is as high as it was in France in the 19th century you can expect an increase in inequality.  And beyond a certain threshold "inequality of wealth will increase without limit".

In the event, though, inequality today is still less that the peak at the end of the 19th century.  Why is that?  Piketty admits that he doesn't have a good answer to this.  Obviously the shocks of 1914 to 1945 destroyed a lot of wealth, and probate records show that many rentiers failed to reduce their expenditure to match their reduced income.  And many of the largest fortunes were plundered by expropriation, as with the nationalization of the Renault fortune after World War II and the French "national solidarity tax" of 1945.

One answer is that "governments in the twentieth century began taxing capital and its income at significant rates" and also taxed estates.  The highest estate tax in Germany is "15-20 percent, compared with 30-40 percent in France" and 50 percent in the United States.

Piketty does not expect inequality to return to the level of the Belle Époque, principally because he expects the return on capital to come down and the rate of growth to stay high compared to pre-modern rates.

But if there are no shocks from war and if the taxation of capital and high incomes continue to come down then there is a "high risk" of inequalities of wealth returning to the extremes of the Belle Époque at the turn of the 20th century.

Discussion

Piketty argues that his inequality r > g means that when the rate of return on capital is a lot bigger than the rate of growth then inequality can increase without limit, because if the capitalists save a decent part of their capital income their share of wealth keeps going up.  But this is belied by his own numbers.

1. He shows that the return on capital was about 4.5% for centuries before the modern growth spurt.  This implies, according to his way of looking at things, that it takes more than 4.5% return to spark any growth at all.
2. If you look at the history, the aristocracy didn't see wealth as something to be increased by savings.  They saw their wealth as a necessary support of their political power and they typically used their wealth for that purpose.  Savings was something you did in the generational tournament of acres where the fortunate increased their land ownership by an arranged marriage.  The idea was to combine the acres of the eldest son with a rich heiress.  She could be a young woman with a large dowry or she could be the beneficiary, like Trollope's Lady Glencora, of a family without a male heir.

Piketty rather carelessly brushes off time preference as a tautology and a "theory," and simplistic to boot.  In fact researchers have studied time preference not just theoreetically, but empirically in actual human experiments.  Here is Nicholas Wade in A Troublesome Inheritance introducing the idea.

When inflation and risk are subtracted, an interest rate reflects the compensation that a person will demand to postpone immediate gratification by postponing consumption of a good from now to a future date.

This business of time preference is extreme in young children, a demonstrated in Walter Mischel's marshmallow test, where young children were offered a choice between "one marshmallow now or two in fifteen minutes."

[T]hose able to hold out for a larger reward had higher SAT scores and social competence in later life... American six-year-olds, for instance, have a time preference of about 3% per day, or 150% per month; this is the extra reward they must be offered to delay instant gratification.

According to Wade, society's time preference has been about 10% per year down to 1400 AD. "Interest rates then entered a period of steady decline, reaching about 3% by 1850." Note that Piketty's chart asserts that the rate of return on capital was 4.5% from antiquity until 1800.

Obviously Thomas Piketty must brush aside the notion of time preference.  Otherwise his entire thesis collapses.

Introduction

Part One: Income and Capital

Income and Output

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

Piketty: Inequality of Labor Income

After a look at the income of the top 10% and top 1% in France and the US, in Capital in the Twenty-First Century, Thomas Piketty now analyzes inequalities in labor income.  He wants to know "what caused the explosion of wage inequalities and the rise of the supermanager in the United States after 1980."

What is it that drives inequality?  First Piketty looks at the "widely accepted theory" of "a race between education and technology." It does not explain the rise of the supermanager, but it has its uses, resting on the two ideas that a worker's wage depends on his "marginal productivity" and the supply and demand for his "skill in a given society."

Naive as it is, this theory does point up the importance of two factors: "the state of the training [and/or education] system... and the state of technology".  New technology enables innovation, but if "the supply of skills does not increase at the same pace as the needs of technology, then groups whose training is not sufficiently advanced will earn less... and inequality... will increase."  It's up to the education system to remedy this deficit, "especially for the least well educated."

But what really happened in the last century?  In France, while the "average wage increased enormously" the inequalities remained because everyone moved up a notch, with the children of grade school graduates finishing high school etc.  That is not ideal, but if everyone had stayed where they were educationally, inequalities would have increased "substantially."  In the US, according to researchers, the wage gap between high school and college graduates "which decreased fairly regularly until the 1970s" suddenly began to increase after 1980.  This, in the view of the researchers, was "due to a failure to invest sufficiently in higher education."

So what's needed is to "invest in education" because output increased fivefold in the century in which skills were improved by universal education.  This would increase wages at the low end and cut the upper decile's income share.  However, "theoretical discussion of educational issues and meritocracy is often out of touch with reality."

The education-and-technology theory may explain the long term, but not the short term, for it fails to explain the rules and regulations that drive the labor market.  Wage compression in World War II was caused by government freezing wages for managers and thereafter by increases in the minimum wage (see chart).  For Piketty, the setting of a minimum wage and/or administratively establishing wage scales with union bargaining is the way to deal with inequalities at the low end of the income scale. Piketty does not discuss here the effect of welfare and labor market regulation on off-the-books economic activity.

The education-and-technology theory also cannot explain the explosion of upper centile labor income in the United States.  Increased productivity didn't do it, and doesn't explain why the "supermanager" income explosion is an Anglo-Saxon phenomenon and cannot be seen in Continental Europe and Japan (charts here and here).  Inequality has now reached, in the United States, the "record levels observed in 1910-1920".  But not in Europe and Japan, although inequality in the Belle Époque was higher in Europe than the US.

It was "concentration of capital" that caused the inequality a century ago in Europe, but why?  The answer lies in "low demographic growth".  That's how you get "greater accumulation and concentration of capital."

Piketty then looks at inequality in emerging economies.  The pattern is similar to the developed nations. Inequalities were high a century ago, declined in mid century, and have climbed since 1980.

But let's get back to the supermanagers in the United States!  Obviously their high compensation cannot be justified by "individual 'productivity'" and Piketty does some math to prove it.  So the high compensation must be the result of "hierarchical relationships" and the natural tendency of people "to treat themselves generously."  It's also a question of "social norms"; high compensation that is "shocking" in Europe and Japan is tolerated in Britain and the US, perhaps as a result of the "'conservative revolution' that gripped" the US and the UK in the Reagan/Thatcher era.  Or maybe it's a form of "meritocratic extremism" that wants to reward "winners".  Who knows where it might end?

Right at the end of the chapter, Piketty raises the question of marginal tax rates.  Maybe the "very large decrease in the top marginal income tax rate" in the US and UK may have encouraged top executives to shoot for higher pay.  You think?

Discussion

Thomas Piketty believes as an article of faith that it is the job of the ruling political class to ride herd on the ruling economic class and provide a guiding hand for the lesser mortals that work to create products and services.  Education must be provided; experts must tinker with minimum wages and wage schedules.  Corporate executives must be tamed and disciplined.  But what if the experts don't have a clue what they are doing?

Introduction

Part One: Income and Capital

Income and Output

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

Piketty: Two Worlds: France and the US

Thomas Piketty now takes a look at the fortunes of the top ten percent in two countries, France and the US, in Capital in the Twenty-First Century. First he looks at his native France.

A couple of figures here and here tell the story.  The top ten percent were doing fine from 1910 until the 1930s, taking about 40-45% of national income.  Then, starting in 1936 their share plummeted to 30%.  From 1945 to 1965 the top ten percent clawed their way back to a 37% share, but this dissipated back to 30% in 1968-83, only recovering to 25% gradually after the economic U-turn of the Mitterand presidency in 1983.

If you look at the 1% the trend is even more drastic.  The top 1% took about 20% of total income in 1920 and the share declined to about 17% by 1929.  Then its share declined to 15% in the 1930s and collapsed to 8% by 1945 due to war and invasion.  Basically its income share has been flat ever since.

This collapse is in capital income, because the top ten percent has been getting about 26-27% of wage income all along and the top 1% about 6-8% of wage income all along.  Piketty calls it the "fall of the rentier." (In France, government bonds are called rentes).

The decline in top 10% income came in a series of shocks during the interwar period "when social tensions ran very high."  The top 1% income "plummeted during the Depression" but for the managers in the lower tranche of the top 10% the deflation increased their share of income.  But when the Popular Front came to power in 1936 "workers' wages increased sharply" and franc devaluation and inflation decreased income shares for the top 10%.

After World War II the top 10% did well "in a context of rapid economic growth" but in the riots of 1968 economic policy was reversed and the minimum wage was increased and indexed.  The share of the top 10% declined until the U-turn of the socialist Mitterand government in 1983: "wages were frozen, and the policy of annual boosts to the minimum wage" terminated.  Profits "skyrocketed" and inequalities increased, including the "stunning new phenomenon" of very high top salaries for "top executives of the largest companies and financial firms".

The story of inequality in the United States since 1910 is different from France, and the charts here and here show.  Top 10% income starts at 40% and rises to 45% right through the Depression until World War II.  Then the top 10% share collapses to 33-35% by 1945 and stays there until 1980.  After 1980 the top 10% share steadily increases to 40% by 1990, 45% by 2000 and about 47% in 2010.  The main story is in the top 1%, which took about 17% of total income in 1910-1940 with a peak in the late 1920s boom.  Then the top 1% share dropped to 12% in the 1940s, and 10% in 1950-1970, and to 9% in the 1970s inflation.  But since 1980 top 1% income share has kept increasing, punctuated by troughs after market declines, settling at 20% in 2010.

What about the Crash of 2008?

In my view, there is absolutely no doubt that the increase of inequality in the United States contributed to the nation's financial instability.

You can blame it on the "virtual stagnation of the purchasing power of the lower and middle classes... which inevitably made it more likely that modest households would take on more debt" provided by "unscrupulous banks" that "offered credit on increasingly generous terms."  There is nothing in Piketty's analysis that recognizes the contribution of left-wing politics to the real-estate boom, forcing the financial system to issue mortgages to "sub-prime" borrowers.  But still, "a potentially more important cause of instability is the structural increase of the capital/income ratio... coupled with an enormous increase in aggregate international asset positions."

What about wages?  In the US wage inequality rose in the 1920s, was stable in the 1930s and experienced "severe compression during World War II" when the government "generally approved raises only for the lowest paid workers."  But from the mid 1970s onward, top salaries increased faster than the average wage.  This increase primarily reflects very high salaries and bonuses, including stock options, paid to "supermanagers" at top corporations and financial institutions.

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

Piketty: Inequality and Its Concentration

After discussing capital and income, and the share of capital income and labor income under modern capitalism Thomas Piketty now dives into the third part of Capital in the Twenty-First Century. He investigates The Structure of Inequality.  Piketty will show that, after recovering from the shocks of the world wars, the developed world has returned to the low-growth, high inequality society of the late 19th century.

In this third part of his narrative Piketty will show that the low inequalities of the mid 20th century issued from the world wars "and the public policies that followed from them," that the rise in inequality since the 1970s and 1980s again suggests "that institutional and political differences played a role."  He will also show the "rising importance of inherited wealth versus income from labor" in the 21st century.

But first a three part definition of the inequality that he will investigate:

1. Inequality in income from labor
2. Inequality in the ownership of capital and its income
3. Inequality in the interaction between labor and capital income

To dramatize the lesson to come, Piketty retails the convict "Vautrin's Lesson" to the penniless young noble Rastignac in Balzac's Père Goriot, published in 1835.  You wanna get ahead? says Vautrin. Forget getting ahead in your career; it's too hard and requires too much toadying and compromising. Marry a rich young heiress and kill anyone in the way.

So any young man on the make back then had to make a choice between work and inheritance.  But has anything changed since the early 19th century?  Has the importance of labor income vs. capital income improved since then?  And if it did, what happened and can it be reversed?

In discussing these inequalities, what mechanisms are at work?  For labor it would include supply and demand for skills, the education system, and rules and regulation of the labor market.  For capital it would include savings and investment behavior, gifting and inheritance, operation of the real-estate and financial markets.  Notice that Piketty will not include the effects of welfare state income redistribution, at least not yet.

Inequality in capital is always and everywhere much bigger that inequality in income, and this is not explained by life-cycle needs of saving against fluctuations in labor income or against retirement.  It is explained "mainly by the importance of inherited wealth and its cumulative effects".  Piketty shows three tables showing shares of income across four income classes: the 1%, the next 9%, the middle 40% and bottom 50%.  The top 10% in the US gets 35% of labor income against 20% in Scandinavia. The top 10% in the US gets 70% of capital income against 50% in Scandinavia.

But there is an upside to this: the creation of the "Patrimonial Middle Class" in the 20th century.  A century ago the middle class owned about 5% of the wealth; today it ranges from 25% in the US to 40% in Scandinavia.  But since labor income is about two-thirds of total income, the total income inequality picture isn't much different from the labor income inequality.

Piketty ends with a riff on whether "those at the bottom will accept the situation permanently."  It's not merely a question of the "repressive apparatus" but more important the "apparatus of justification."  The current justification, of course, is that the high labor earners sort of deserve it.  Instead of the "hyperpatrimonial society" of the 19th century we now have a "hypermeritocratic society" of "superstars" or "supermanagers."  The question is to what extent labor income inequality in the US really follows a "meritocratic logic".

Piketty also wants to tell us that he doesn't want to use the common measure of inequality, the GINI coefficient, because it's really not up to the task.  And most official reports on inequality decorously hide the incomes of the very rich behind a discreet veil.  Piketty's method puts more flesh and blood on the skeleton of inequality.

Introduction

Part One: Income and Capital

Income and Output

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

Piketty: Capital's Share of Income

We now return to Thomas Piketty's First Fundamental Law of Capitalism.  It is the equation that Piketty introduced in his chapter on Income and Output.

(Share of national income from capital) = (rate of return on capital) x (capital/income ratio)

The idea is to tease out the share of capital and labor in the national income.  The question is: how do you compute the rate of return on capital?

But first, Piketty wants us to look at the history of capital's share of national income in Britain since 1770 and France since 1820.  His chart of capital income in Britain shows a capital share of about 34% in 1800 that rises to a peak of 43% in 1850.  Then it declines to about 33 percent in 1890, before collapsing after World War I to 22%.  Since then capital income has jogged along between 20% and 30% of national income with a nadir in 1970 at 20% and highs in 1940 and 2000 at 27%.

In France, capital's share of national income starts at 30% in 1820, rises to a peak of 43% in 1850-60, and declines sharply to 26% in 1890 and bouncing to 34% in 1910.  Capital share declines to 29% after World War I and collapses to 13% in 1940.  Since then it has jogged along between 20% and 30% of national income with a nadir in 1980 at 20% and a high of 26% in 2010.

Piketty doesn't discuss it, but I find myself fascinated by the peak in capital income in the mid 19th century.  What was really going on then?  Was it railroads?  Here's my thought.  Railroads meant that small-scale farmers went to the wall.  Before railroads, when grain was transported by horse and cart, the cost of the grain would double with a single day's travel.  After railroads, midwestern US grain could compete with farmers everywhere, as Zola showed in La Terre.  So the farmers migrated off the land to the mines and the factories, and all they could earn was the Marxian subsistence wage --  until the migration eased and wages started to climb in the later 19th century.

But Piketty's calculation of capital's "share" of national income depends on a calculation of a national rate of return on capital.  He computed it by

adding various amounts of income from capital included in national accounts regardless of legal classification (rents, profits, dividends, interest, royalties, etc., excluding interest on public debt and before taxes) and then dividing this total by... the national capital stock (which gives the average rate of return on capital, denoted r).

In Britain the average rate of return on capital starts at about 5% in 1800, rises to a peak of 6.3% by 1860 and declines to 5% by 1890.  After World War I the rate of return climbed erratically up to a peak of 11% in 1950 before declining to about 5-6% after 1980.

France shows a similar pattern only more abrupt.  Rate of return on capital starts at 6% in 1820 and rises to 7.5% in 1850, declining abruptly after 1870 to a little over 4%.  Rate of return peaks at 10% in 1920, troughs at 6.4% in 1940, peaks again at nearly 11% in 1950 before declining to under 5% by 2010.

Piketty thinks that his numbers are pretty solid: he refers back to Jane Austen and Balzac.  Back then the rentier class more or less assumed a 5% return on land or on government debt.  But I am not so sure.

A middling sort of capitalist like me does not compute rate of return from income and dividends.  He computes it from comparing net worth last year with this year.  In Piketty's terms, this means combining income from capital with savings.  In my terms it means combining interest and dividends with the capital gain from a stock rising in price.  Why does a stock rise in price?  Because, e.g., Apple just came out with a new iPhone that every consumer wants to buy and does buy.  On this basis, I suspect, the share of income from capital appreciation over the last 200 years would dwarf the income from interest and dividends.

Picketty now embarks on a discussion of the marginal productivity of capital, "defined by the value of the additional production due to one additional unit of capital."  Of course, when capital becomes abundant the "marginal productivity of capital decreases as the stock of capital increases."  The question is by how much, and "everything depends on the vagaries of technology" and the ability to substitute capital for labor and vice versa.  But this leaves out the basic fact of every decision to change production.  Every decision is a bet on the future which might, or might not work out.

Economists have been arguing over the question of the capital income share since World War II.  In mid century economists thought that the capital share would remain about constant, but in the last 40 years it has been going up.  That, according to Piketty is because the substitution of capital from labor tends to increase capital's share of income, a trend that also reflects capital's "increase in bargaining power vis-à-vis labor".

But what about "human capital", the notion that knowledge and skills represent a growing share of wealth creation that has crowded out capital? For Piketty this represents "mindless optimism: capital... is still useful"!

And what about Marx's prediction that the bourgeoisie would "dig its own grave" as capital accumulated and the rate of profit fell, according to Marx's analysis?  Piketty applies his two Fundamental Laws of Capitalism and finds a logical contradiction, with a positive savings rate accumulating more and more capital.  If growth is zero then the capital/income ratio tends towards infinity. But this is rubbish, and shows the weakness of using the "savings" notion.  If growth is zero it means that the increase in wealth is zero and therefore the savings, the increase in wealth from year to year is zero, and that capital investments don't add to wealth.  Is is possible that Piketty's Second Fundamental Law of Capitalism is meaningless?

But economists have been arguing over this.  In Britain economists argued that growth was "entirely determined by the savings rate" while in the US economists argued that the savings rate and the capital/income ratio could adjust to each other.  But if you reject the accumulationist theory and argue that growth comes from innovation and surprise then the argument is all about counting angels on the head of a pin.  And you say that savings is a result of an increase in wealth.

Piketty wants us to think that a return to low growth, economic and/or demographic, means a "return of capital."  For, "in stagnant societies, wealth accumulated in the past naturally takes on considerable importance."

Or maybe in a stagnant society the upper crust keep spending and mortgaging themselves until the whole thing collapses.  As often happens in 19th century novels.

One last point at the end of the chapter. One should not think that technology will save us.

If one truly wishes to found a more just and rational social order based on common utility, is not not enough to count on the caprices of technology.

But the problem is that the lefty answer to that is to count instead on the caprices of political power -- in the right hands, of course.

Introduction

Part One: Income and Capital

Income and Output

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