Unlike most economists, Piketty makes extensive use of historical sources from the 17th century onwards to argue that unbridled capitalism generates an endless inegalitarian spiral always when the return on capital is higher than economic growth (which seems to be most of the time, as periods of high economic growth are exceptional).
In the 19th century, economic inequalities were at their historic high, because despite unprecedented economic growth, wages stagnated and nearly all the profit went to the owners. Marx's Communist Manifesto with its predictions of the inevitable fall of capitalism was born out of this reality.
However, Marx's prophecy never came to realize. Even though extreme inequalities persisted, wages started to increase. Piketty concludes that capital accumulation is finite, but can be still destabilizing for societies.
Whereas in the nineteenth-century economists tended to give in to the feeling of doom and gloom, in the twentieth century they manifested unrealistic optimism with regard to capitalism's self-regulating mechanisms. After the second world war, economic inequality was at its historic low. Capital was wiped out during the two world wars and as a result of post-war anti-capitalist policies.
But income inequality is on the rise again, which is at odds with 20th-century optimistic theories.
Forces of Convergence and Divergence
Piketty argues that the economy is deeply political and should be studied in context, without making assumptions about universal laws that are supposedly immune from the forces of history. Piketty shows that the reduction of inequality in the 20th century was the result of the adopted policies rather than the economy's capacity for mysterious self-regulation.
There are some semi-spontaneous forces of convergence, which, over a very long time period can reduce inequalities, such as the diffusion of knowledge and skills. But they also depend on educational policies and access to higher education.
But the forces of divergence tend to be stronger, as the fruits of growth aren't distributed equally. If the return on investment is higher than economic growth, the top earners get rich much quicker than the rest of society, simply because their capital yields a profit at a faster rate than wages grow.
The Force of Divergence r (Return on Capital) > g (Growth)
Inequalities arise when the return on capital is higher than growth.
In the 19th century, the capital/income ratio was high in most Western countries – private wealth hovered at about 6 or 7 years of national income. This means that the economy was capital-intensive. This ratio dropped to just 2 or 3 after 1945, which was the result of shocks to capital after World War II. Now private wealth is returning to 5 or 6 years of national income.
What Is National Income?
National income is the sum of all available income to the residents of a country in a year. It includes both worker wages and profit going to stakeholders.
National income = capital income + labour income
What Is the Capital/Income Ratio?
The capital/income ratio (β) is the total value of assets owned by the residents of a given country divided by the total income from labor and capital for this country in a given year. In most developed countries today, capital is equal to 5 or 6 years of national income. The capital/income ratio measures the importance of capital in a society.
The comeback of capital is caused by a very low growth rate, which means that inherited wealth takes on disproportionate importance and reproduces itself at a higher rate than the growth of wages. This is the principal force of divergence r (return on capital) > g (growth).
Income and Output
The split between labor and capital, or what share of output goes to wages and what to profit has always been at the heart of the conflict between the owners and the workers. Capital's share is often as large as one quarter and sometimes even half.
Contrary to what most economic textbooks maintain, the capital-income split has varied widely since the eighteenth century. For instance, capital's share of national income fell dramatically in the wake of the shocks of the two world wars and anti-capitalist policies adopted in their wake. Conversely, capital's share has increased since the 1980s, which was partly due to Margaret Thatcher and Ronald Reagan's conservative revolution
Growth is made up of population and economic growth (per capita output). Growth has been slow over the centuries –1.6% between 1700 and 2012, (economic growth makes up 0.8%, and demographic grow accounts for the other 0.8%).
Even though these figures are small, growth accumulates over a very long time. The demographic growth of 0.8% between 1700 and 2012 saw an increase in population from 600 million to 7 billion.
Population growth reached its heights in the twentieth century (1.9% between 1950 and 1970), but it's forecasted to fall considerably in the twenty-first century (0.2% - 0.4%).
Rapid Growth Is a Force of Convergence
Rapid demographic growth promotes a more equal distribution of wealth, as inherited wealth loses its importance. Rapid economic growth favors income from labor over income from capital (the increase in wages might be higher than the return on capital).
Conversely, slow economic growth favors capital over labor, which tends to increase wealth inequalities.
Double Bell Curve of Growth
Fast growth of 3-4% occurs only when a poorer country catches up with more developed countries and has never been sustained over a long time. 1-1.5% growth is much more common in the long term.
Growth is forecasted to slow down considerably in the advanced countries to between 0.5% and 1.2%.
Even though fast growth renders inherited wealth less important, it isn't enough to eliminate inequalities in itself; income inequalities might become more prominent than capital inequalities.
Over the past three centuries, global growth can be illustrated as a bell curve with a high peak in the twentieth century.
Inflation Over the Centuries
Up to World War I, inflation was non-existent. It was invented in the twentieth century to rid the advanced countries of high public debts after the world wars. In pre-twentieth century literature, authors tend to dwell on exact income and prices, which were stable over the years. In the twentieth century, these considerations were practically erased from literature, as inflation renders exact prices meaningless.
The Structure of Capital
Whereas in the 18th century, capital was mostly made up of government bonds and agricultural land, it was largely replaced by buildings, business capital, and financial investment in the 21st. The value of agricultural land collapsed, the value of housing skyrocketed.
National wealth is made up of private and public wealthy, which is the difference between assets and liabilities. Britain and France own almost as much as they owe, which amounts to public wealth close to zero.
Private wealth in Britain and France is far larger than public wealth and has been since the 18th century, although it has varied over the centuries. Faith in private capital was shaken by the financial crash of 1929. However, the 1980s saw a wave of privatization.
Britain's public debt reached extreme heights after the Napoleonic wars, and it never got rid through direct (by repudiating it) or indirect (inflation) methods – the British government insisted on paying it off, which is why it took so long. High public debt benefitted the rich who claimed interest from the rest of the population.
The Ancien Regime in France, on the other hand, defaulted on two-thirds of its debts and pumped up inflation to get rid of the rest.
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In the 20th century, however, when public debt in Britain reached 200% of GDP, the government resorted to inflation and managed to reduce it to 50%. Germany was the country that resorted to inflation most freely in the 20th century, but it also resulted in the destabilization of society and the economy.
High inflation is a crude instrument to control debt, as it's difficult to control it or predict who will become the biggest victim.
The Fall of the Capital/Income Ratio in the 20th Century
The fall of the capital/income ratio in 20th century Europe can only partially be explained by the physical destruction caused by the two world wars. The main reasons were lower saving rates, a decline in foreign ownership (the fall of colonialism) and low asset prices caused by the post-war regulation of capital. In short, the reduction of the capital/income ratio was the result of conscious policies to reduce inequalities
The Comeback of the Capital/Income Ratio in 1970
The capital/income ratio depends on the savings rate (s) and the growth rate (g). The higher the savings rate, the higher the capital/income ratio. Conversely, the higher the growth rate, the lower the capital/income ratio.
β = s/g
For example, if a country saves 12%, and the growth is 2%, the capital/income ratio is 600% (or wealth worth 6 years of national income). Wealth acquires disproportionate significance in low-growth regimes.
The capital/income ratio has been on the rise in developed countries since 1970, which is down to lower growth rates and higher savings rates and a wave of privatization of public assets.
The Capital/Labour Split
In Britain and France, capital's share of income was 35-40% in the late 18th and 19th century, it fell to 20-25% in the late 20th century, and was at 25-30% in the early 21st century.
In both France and Britain, the return on capital has averaged between 4-5% a year over the centuries, but there is a lot variation between high-risk assets (tend to yield a higher return on investment) and low-risk assets (lower return on investment). Generally, real estate yields a return on investment on the order of 3-4%.
No self-correcting economic mechanism exists to prevent a steady increase in the capital/income ratio or capital's share of national income, which means that inequalities could rise significantly in the future.
The Structure of Inequality
Income inequality can result from an unequal distribution of income from labor, income from capital, or the mix between the two. Inequalities of income from capital are usually the biggest – the upper 10% of society always owns as much as 50% of total private wealth, and sometimes as much as 90%. In comparison, labor inequality tends to much smaller with the upper 10% receiving around 25-30% of total labor income.
Inequalities of Labour
In the most egalitarian countries, like Scandinavian countries in the 70s and 80s, the top decile (10%) received 20% of total income from labor, and 35% went to the bottom 50% of society. In average countries, such as most European countries today, the top 10% claims 25-30% of total wages, and the bottom half about 30%. The United States has the biggest wage inequality; the top decile receives 35%, and the bottom half only 25%.
Inequalities of Capital
These are much more extreme than wage inequalities. In the most egalitarian countries (the Scandinavian countries in the 1970s and 1980s), the top 10% owned 50% of total wealth. In most European countries today it's usually 60%. The bottom half of society usually owns around 10% or even 5% of total capital. In the United States, the top 10% owns as much as 72% of total wealth, and the bottom half only 2%.
Inequality Has Been on the Rise Since the 1980s
After the relatively egalitarian years following the second world war, Europe and the United States turned towards austerity policies, freezing the minimum wage, and giving incredibly generous pay packages to the top managers.
Top salaries in France reached astonishing heights at a time when other workers' wages were stagnating.
Inequalities in the United States have become even more pronounced than in France and elsewhere in Europe. The upper decile's share of national income increased from 30-35% in the 1970s to 45-50% in the 2000s
Whenever the rate of return on investment is durably higher than the growth rate of the economy, inherited wealth acquires disproportionate importance. The 21st century is poised to go back to a low-growth regime, which means that inheritance will again play an important role.
In the 19th and early 20th centuries, inherited capital accounted for 80 – 90% of all private wealth. In the 70s, it was at its historic low, accounting just for 40% of all wealth, but in 2010 it represented two-thirds of private wealth in France.
Global Wealth Inequality
For wealthier people, the return on investment tends to be higher than for the less well off because the super-rich have the means to hire financial advisors, take more risks, and be patient when waiting for the results. This effect amplifies the wealth gap significantly.
Since the 1980s, global wealth has increased faster than income on average, and the largest fortunes grew more rapidly than the smaller ones. All large fortunes tend to grow at an extremely high rate, regardless of whether they were inherited or not. Bill Gates's wealth, for instance, increased from $4 billion to $50 billion between 1990 and 2010. Entrepreneurial fortunes tend to perpetuate themselves beyond social utility, even though their source might be justified.
Progressive taxation partly explains why we never went back to the extremely high inequality levels of the Belle Epoque, even though we are clearly heading in this direction.
Many governments have exempted capital from the progressive income tax due to the rise of global tax competition; countries want to set their taxes as low as possible in the hope of attracting new businesses.
Although a tax on various forms of capital already exists in many countries (for instance, the real estate tax), it usually isn't as progressive as the tax on income from labor. In addition, assets that generate the biggest profit (such as financial assets) are not taxed at all.
After World War II, Britain and the United States led the world in progressive taxation. Some of the highest incomes (both from labor and capital) were taxed at extremely high rates (the absolute historical record was 98% on unearned income in Britain). These taxes only applied to less than 1% of the population and were designed specifically to reduce inequalities.
However, in the 1980s, tax rates in Britain and America fell short of those in France and Germany.
A Global Tax on Capital
Introducing a global tax on capital, albeit a utopian idea, would be the best way to halt rising inequalities. This would fill in the gaps in the current tax system and redistribute the fruits of progress in a more egalitarian way. The global tax on capital would be calculated based on the amount of wealth that each person owns.
Reducing Public Debt
There are usually three main ways of reducing public debt – a tax on capital, austerity, and inflation. Austerity is by far the worst in terms of efficiency and social justice, and yet this is the course that most European countries are taking. The best approach would be a tax on capital.
Levying an exceptional tax on private wealth on the order of 15% would yield almost a year's worth of national income. This would be enough to pay off Europe's public debt in 5 years.
In contrast, austerity would eliminate the public debt only after a few decades. In the 19th century, austerity in Britain had to last a century before the country managed to get rid of its debt. Taxpayers at that time were spending more on interest than on education.
Patty Florence from Illinois on December 27, 2018:
It kind of seemed like a pattern of wealth diverges.