Pocket Piketty

Jesper Roine

• Publisher: Zed Books
• Year: 2017
• Print ISBN: 9781786992338
• eBook ISBN: 9781786992352
• Edition: 1
• Topic: Economics
• Subtopic: Taxation
• Index: Economics

Thomas Piketty's Capital in the Twenty-First Century has been hailed as a masterpiece, making a powerful case that wealth inequality is not an accident, but rather an inherent feature of capitalism. But how many of us who bought or borrowed the book have read more than a fraction of its 700+ pages? And how many of Piketty's groundbreaking ideas have gone unappreciated, all for want of intellectual stamina? In this handy volume, Jesper Roine – whose own work was relied upon by Piketty – explains in clear and accessible prose the key concepts behind, and controversies surrounding, Piketty's landmark work.

II

SUMMARY OF CAPITAL IN THE TWENTY-FIRST CENTURY

STRUCTURE OF THE BOOK

In addition to an introduction and a short concluding summary, Capital in the Twenty-First Century comprises sixteen chapters, split into four sections, plus almost a hundred pages of endnotes, references, digressions and clarifications. Piketty also published an extensive technical appendix online in which he explained and expanded on his arguments. The first part, Income and Capital, introduced a few basic concepts and relationships that then reoccur throughout the book. This first part is split into two chapters. Chapter 1 defines concepts such as gross domestic product, national income, capital and the basic ratio of capital to income. The chapter also introduces an important formula called the first fundamental law of capitalism. This expresses how capital’s share of national income can be described as the product of the rate of return on capital and the capital/income ratio. This relationship is neither controversial nor surprising, but rather an accounting identity. It is nevertheless a relationship that proves useful in illustrating several later points. The second chapter presents nothing less than the broad history of the global economy, in terms of economic growth and demographic change over the past two thousand years, with a particular focus on developments since the Industrial Revolution. The purpose of all this is to provide some background to the rest of the book.

The second part of the book, The Dynamics of the Capital/Income Ratio, then outlines what we know about the aggregate relationship between the capital stock and the flow of income over time. This part explains how the nature of capital has changed since the eighteenth century in terms, for example, of the relative size of its components, such as agricultural land, housing, and other domestic capital. It also discusses the effect of state expansion on the relationship between public and private capital, and the role that international capital flows have played. Part Two is comprised of four chapters (3–6). In terms of empirical analysis, the different chapters have a slightly different geographical and temporal focus. Chapter 3 presents what we know about the growth of the capital stock and its relation to income in France and the United Kingdom since the eighteenth century. These are the countries for which we have most detailed historical data. Chapter 4 examines similar trends in Germany and the United States, but over a slightly shorter time period. Chapters 5 and 6 then expand the horizon to include other countries for which we only have data from the latter part of the twentieth century to the present day.

In Chapters 5 and 6, Piketty also presents a theoretical framework he thinks useful for understanding what we observe in the data. In Chapter 5 he introduces the second fundamental law of capitalism, which relates savings and economic growth to the level of the capital/income ratio over time. In contrast to the first “law,” which is an identity, the second formula only holds in the long run and under certain, but general, circumstances. Underlying the second fundamental law is a standard abstraction of the economy in which production takes place through combining capital (in a broad sense) with labor. These so called factors of production then in some way share the value of what is produced in the form of return on capital and labor income. Some of the value is consumed, while some is saved and contributes to the future capital stock. Over time—decades rather than years—and for a given amount of saving and a given rate of growth, this process leads to a particular ratio between capital and income in the economy given by the so-called second fundamental law. The relationship says nothing, however, about what form the savings take, who saves, or why. It also says nothing about what drives the growth or why it reaches a given level. In reality it might of course be the case that growth changes with savings or vice versa. If, for example, the capital stock is very large and growth small, it is likely that savings would fall rather than remaining constant. Nonetheless, Piketty believes the formula is useful in understanding why the capital/income ratio has changed the way it has. In Chapter 6, this newfound understanding of the development of the capital/income ratio is linked to the effect such development has on capital’s share of national income.

Part Three of the book (Chapters 7–12) then moves from the aggregate relationships to the distribution of capital and income among individuals in society. The focus here is on what we know about income and wealth distribution, how it has developed and also on the significance of wealth as a source of income for certain groups and how that has changed over time. In addition, Piketty showed why it is so important not just to look at the overall distribution, but also to follow changes within the top of the distribution and also why it is important to distinguish between different sources of income. The presentation of all these facts is followed by a discussion of how best to understand the long-running inequality trends based on the book’s most central relationship—that between the return on capital, r, and the rate of growth in the economy, g. Based on data over the very long run Piketty noted that, with the exception of most of the twentieth century, the return on capital, r, has been larger than the economic growth rate, g, that is r > g. This implies that wealth accumulated in the past grows faster than output and wages. Chapter 11 explains how the inheritance flow has changed in relation to national income over time in France (the only country studied in detail so far, although projects are ongoing in Sweden and the United Kingdom) and how this development can largely be understood in terms of changes in the capital/income ratio. Finally, Chapter 12 discusses how global wealth may develop over the coming decades, and also how the fact that the return on large fortunes appears to be greater than the average return may be an additional factor in reinforcing the effect of the inequality represented by r > g.

In contrast to the earlier parts, the fourth and final part of the book (Chapters 13–16) does not focus on data and historical trends, but is instead an outline of what Thomas Piketty sees as possible policy measures. He begins with a brief overview (Chapter 13) of how taxation, redistribution and pension systems developed in the twentieth century, before moving on to discuss progressive income tax (Chapter 14), the possibility of a global tax on capital (Chapter 15), and what approach should be taken with regard to public debt and the accumulation of public capital.

INTRODUCTION

The starting point for the book Capital in the Twenty-First Century is the assertion that the distribution of wealth is one of today’s most widely discussed and controversial issues. But, asks Piketty, what do we actually know about the distribution of capital over the long run? Will the accumulation of private capital inevitably lead to a concentration of wealth among the few, as Karl Marx believed in the nineteenth century? Or might it be that the balancing forces of growth, competition, and technological progress lead to harmonization and greater equality, as Simon Kuznets believed in the twentieth century? What conclusions can we draw from the knowledge and the data to which we now have access?

The aim of the book is to try to answer these questions although the answers are bound to be imperfect and incomplete. Nevertheless, they have to be taken seriously, since they are based on a much larger set of historical and comparative data than was available to researchers of previous generations—data that stretch across three centuries and cover more than 20 countries. This represents a major improvement on what was possible in the past, when much of the discussion was, as he puts it, a debate without data.

The introduction mainly consists of a summary of the key results in the book. Since this text is in itself a summary, it may seem superfluous to spend time on summarizing the summary. It is, however, interesting to see which of the many conclusions can be drawn from the book Thomas Piketty chose to focus on.

First, according to Piketty, we should be cautious about applying a deterministic approach to economics when looking at the distribution of wealth and income. Historically, economic distribution in society has always had a political dimension and cannot simply be reduced to economic mechanisms. For example, the levelling out of income inequalities as seen in many of the countries studied in 1910–1950 was largely a consequence of the two world wars, and of political decisions taken in connection to these. Piketty also thinks the rising inequalities seen in most countries since around 1980 are also attributable to political decisions, primarily deregulation of the financial sector and changes in taxation.

The second conclusion, which Piketty presents as the most significant, is that there are powerful mechanisms in the economy which, under certain circumstances, tend to increase inequality over time. There are, of course, forces that act in the opposite direction, but Piketty believes that these alone are insufficient to balance a future increase in inequality.

The core mechanisms that promote increased equality are the diffusion of knowledge and investments in education. These are key both to productivity growth and to reducing inequality, within countries as well as between countries. In addition to education and diffusion of knowledge, there are other potential mechanisms that could reduce inequality, although Piketty sees these as theoretical possibilities rather than anything discernible from the data. One such idea is that as workers acquire knowledge and skills, they also increase their share of total income. Piketty calls such a development the rising human capital hypothesis, where economic rationality automatically gives rise to democratic rationality and a more equal society—in line with Kuznets thinking. Another optimistic belief is the idea that, in modern societies with greater life expectancy, we will increasingly work when young and then live off saved capital in older age. The tension between labor and capital is thus less divisive, since we all begin young and become old and therefore (on average) have an equal interest in both labor and capital. Piketty asserts both these optimistic scenarios are possible and to some extent correct, but that their influence is much less than one might think. There are few signs of the workforce seeing an increased share in national income over an extended period of time. “Nonhuman” capital appears almost as indispensible in the twenty-first century as it was three hundred years ago (even if, as we will see, its form has radically changed), and there is nothing to suggest that the trend will not endure. In addition, as has always been the case, the inequalities in wealth distribution occur primarily within age groups, with inherited money continuing to play an important (and possibly growing) role.

So what are the forces that increase inequality over time? Piketty highlights two issues. First, there appears to be a tendency (particularly in certain countries) for those with the very highest labor income to pull away from others, which leads to labor income being concentrated in the hands of fewer people. Secondly, and more importantly according to Piketty, there are processes related to the way in which capital accumulates over time that, in a world where return on capital, r, is higher than the growth in the economy, g, result in increasing inequality over time. The basic inequality represented by r > g lies at the heart of the book and can thus be said to encapsulate the logic of Piketty’s argument. When the return on capital is higher than economic growth (which has been the case throughout history, and is likely to be the case in the future), accumulated capital increases more quickly than income. Someone with inherited wealth only needs to save a fraction of the income from this capital for its size to grow more quickly than the economy as a whole. Under such conditions, it is, according to Piketty, almost inevitable that inheritance will dominate what a person can generate through work over his or her lifetime and the concentration of wealth in society will become much higher—potentially reaching a level incompatible with meritocratic values and social justice.

PART ONE: INCOME AND CAPITAL

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Table of contents

• Cover
• Title
• Copyright
• Contents
• Preface
• I The Underlying Research
• II Summary of Capital in the Twenty-First Century
• III Is Thomas Piketty Right?