This post originally appeared at The American Prospect.
Thomas Piketty’s Capital in the Twenty-First Century is a monumental book that will influence economic analysis (and perhaps policymaking) in the years to come. In the way it is written and the importance of the questions it asks, it is a book the classic authors of economics could have written if they lived today and had access to the vast empirical material Piketty and his colleagues collected.
Piketty’s key message is both simple and, once understood, almost self-evident. Under capitalism, if the rate of return on private wealth (defined to include physical and financial capital, land and housing) exceeds the rate of growth of the economy, the share of capital income in the net product will increase. If most of that increase in capital income is reinvested, the capital-to-income ratio will rise. This will further increase the share of capital income in the net output. The percentage of people who do not need to work in order to earn their living (the rentiers) will go up. The distribution of personal income will become even more unequal.
The story elegantly combines theories of growth, functional distribution of income (between capital and labor), and income inequality between individuals. It aims to provide nothing less than the description of a capitalist economy.
Two questions can be asked: Why didn’t this model hold during the period of “the golden age” of capitalism (between approximately 1945 and 1975), when functional income distribution was stable and income inequality declined? Why does it matter for the 21st century? The answer to the first question is that the “short 20th century” was special. The physical destruction associated with two world wars led to a significant destruction of the advanced world’s capital stock. In addition, the advent of the welfare state, motivated by the Great Depression and strong socialist movements, imposed a need to heavily tax capital. The 20th century was thus different from the 19th. Through the action of wars and social movements, capitalism appeared to most social scientists to have been “tamed.” Piketty argues that this view turns out to have been wrong. The fundamental nature of capitalism was not altered — the external circumstances were different.
Why does Piketty’s model herald the return of “patrimonial capitalism” (the term he introduces to mean that an important part of the upper class receives income from property) in the 21st century? The reasons are the reverse of the ones that drove developments during the short 20th century. The period of prosperity after the end of World War II saw the rebuilding of large fortunes (owned, of course, by different people today); the capital-to-output ratio in advanced countries gradually rose back to the higher levels of prewar years. The Reagan-Thatcher revolutions of the 1980s reduced the taxation of capital and of high incomes in general and further increased the share of capital in net output. If this process continues, the return to features of 19th-century capitalism is inevitable.
The return is all the more likely since the rate of growth — at the technological frontier where most rich countries operate today, that rate is equal to the sum of “pure” technological progress and population growth — is decreasing. Once the convergence of Europe and Asia to US-like levels of income is achieved, the rate of growth cannot exceed more than, say, 2.5 percent per annum (a combination of about 1.5 percent in technological progress and 1 percent in population growth). Piketty writes: “Decreased growth — especially demographic growth — is thus responsible for capital’s comeback.” If the rate of return on private wealth is higher than 2.5 percent, then the 19th-century-like effects of “pre-tamed” capitalism will reappear.
Or will they? There are significant differences between the 19th century and ours that Piketty does not fully acknowledge, although he mentions them. First, it is not obvious that the rate of return on private wealth will remain high enough to sustain Piketty’s prediction. Even if we look at the admittedly transitory situation of today, the rate of return is stuck barely above zero percent, less than the rate of growth of the rich world’s economies. The tendency toward a decreasing rate of return, possibly lower than the rate of growth, cannot be ruled out.
Second, the role of labor incomes has changed since the 19th century. As Piketty acknowledges (he writes about it in both this and earlier works), extraordinarily high labor incomes play a larger role in society today than in the past, even if they concern mostly the richest 1 percent through 5 percent of income recipients — not the top 0.1 percent, where “capital is still king.” A dose of “meritocracy” has been introduced into the distribution. The overlap between being rich and owning capital so evident in the 19th century will be less prominent in the 21st.
Third — the convergence of China and even more that of India and even more that of Africa — may take a century or longer to complete. As long as the convergence is still ongoing, global growth will be higher than the steady-state rate of 2.5 percent due to the faster growth rate of “infra technological frontier” countries such as China, India, Nigeria and Indonesia. This is an aspect of the problem that Piketty neglects. The former Third World might end up playing the same role in the 21st century that Europe, Japan, South Korea and others played in the past 50 years — maintaining upward global growth as they were catching up with the United States.
So these are possible problems with Piketty’s analysis. But if we take it at its face value, what are the remedies he suggests? A global tax on capital — needed to curb the tendency of advanced capitalism to generate a skewed distribution of income in favor of property holders. The high taxation of capital and of inheritance in particular, is not something new, as Piketty amply demonstrates. It is technically feasible since information on the ownership of most assets, from housing to stock shares, is available. (Piketty, by the way, provides lots of specific information on how the tax could be implemented. He also gives some notional rates: no tax on capital below almost $1.4 million, 1 percent on capital between $1.4 million and $6.8 million and 2 percent on capital above $6.8 million.) For such a global tax to be effective, however, a huge amount of coordination would be required among the leading countries — a task to whose challenges Piketty is not oblivious. Implementation by one or two countries, even the most important economies, could lead to capital flight. The main offshore tax havens would also have to cooperate, although they would lose hugely lucrative business. But an agreement across the Organisation for Economic Co-operation and Development on the uniform taxation of wealth, however farfetched it might seem today, should be put on the table. This is, in Piketty’s view, the only way to “regulate capitalism” and make both capitalism and democracy sustainable in the long run.
In a short review, it is impossible to do even partial justice to the wealth of information, data, analysis and discussion contained in this book of almost 700 pages. Piketty has returned economics to the classical roots where it seeks to understand the “laws of motion” of capitalism. He has re-emphasized the distinction between “unearned” and “earned” income that had been tucked away for so long under misleading terminologies of “human capital,” “economic agents,” and “factors of production.” Labor and capital — those who have to work for a living and those who live from property — people in flesh, are squarely back in economics via this great book.