History shows that growth alone won’t stop vast economic inequality.
Capital in the Twenty-first Century
by Thomas Piketty
translated by Arthur Goldhammer
Belknap Press, 696 pp.
In his annual address, the president of the American Economic Association, Irving Fisher, sounded the alarm about the issue he described as “the great peril today”—the “striking inequality of capital,” which, he argued, was “perverting” American democracy. It was “distressing,” he said, that wages were “actually decreasing while profits have been increasing.” “Something like two-thirds of our people have no capital,” said Fisher, while “the major part of our capital is owned by less than 2 percent of the population.” Moreover, “half of our national income is received by one-fourth of our population.”
In the year 2014, the theme of Irving Fisher’s address is resonant—which is why you may be surprised to learn that he gave it in 1919. Fisher, moreover, was a mainstream economist, very much in the neoclassical tradition. Milton Friedman called him “the greatest economist the United States has ever produced.” Today, the overriding concern of most mainstream American economists is what it has been for decades: economic efficiency. Questions of equity, on the other hand, have fallen by the wayside. But as Fisher’s address vividly demonstrates, concerns about distribution were once seen as vitally important.
In his important new book, Capital in the Twenty-first Century, French economist Thomas Piketty asserts that one of his chief goals is “putting the distributional question back at the heart of economic analysis.” As he notes, today the concentration of wealth has soared to levels that have not been seen in over a century. In recent years, the issue of economic inequality has moved out of the seminar rooms to become an issue of broad public concern. We’ve heard it in the rallying cry of the Occupy movement—“We are the 99 percent!”—and in Pope Francis’s thundering denunciations of capitalist excess and “trickle-down” economics. We’ve seen it in the surprising electoral success of economic populists like Elizabeth Warren and Bill de Blasio. Late last year, President Barack Obama gave a speech devoted to the subject, and the Democratic Party is pushing economic inequality as its major campaign theme for the 2014 midterm elections.
Inequality is on the political map, all right, and without question, the economist most responsible for putting it there is Thomas Piketty. Beginning in 2003, Piketty, along with his colleague and frequent coauthor Emmanuel Saez, published a series of ground-breaking studies documenting the dizzying rise of income inequality in the United States. Piketty’s innovation in this empirical work was his use of tax returns, rather than household surveys, to measure inequality. Tax returns give a more accurate picture of inequality than household surveys, which frequently fail to capture what is going on at the top of the income distribution. Partly this is because of nonresponse bias (rich people are far less likely to participate in such surveys) and partly it is due to the practice of “top-coding,” which caps the reported top incomes at a maximum value and thus prevents the exact amounts from being disclosed.
Piketty and Saez have demonstrated that while groups at the top of the income distribution have increasingly reaped disproportionately large economic rewards, in recent decades it is those with incomes at the very top—the top 1 percent and, even more, the top 0.1 percent—where the gains have been truly spectacular. And when Piketty and his colleagues examined inequality in other rich countries, the pattern held: since the 1970s, inequality has risen sharply in every developed economy, with the gains concentrated among the richest 1 percent. Saez’s most recent report found that in 2012, the top 1 percent of U.S. earners took in over a fifth of all income—among the highest levels ever recorded since the enactment of the income tax in 1913.
In Capital in the Twenty-first Century, Piketty sums up his research, tracing the history and pattern of economic inequality across a number of countries from the eighteenth century to the present, analyzing its causes, and evaluating some policy fixes. Spanning nearly 700 densely packed pages, it’s a big book in more than one sense of the word. Clearly written, ambitious in scope, rooted in economics but drawing on insights from related fields like history and sociology, Piketty’s Capital resembles nothing so much as an old-fashioned work of political economy by the likes of Adam Smith, David Ricardo, Karl Marx, or John Maynard Keynes. But what is particularly exciting about this book is that, due to advances in technology, Piketty is able to draw on data that not only spans a substantially longer historical time frame, but is also necessarily more complete and consistent than the records earlier theorists were forced to rely on. As a result, his analysis is significantly more comprehensive than those of his predecessors—and easily as persuasive.
Another of Piketty’s strengths is his enthusiastically interdisciplinary approach. One of the pleasures of this book is the way Piketty draws on sources as varied as the classic economic theorists, the great nineteenth-century social novelists like Jane Austen and Honoré de Balzac, recent research by historians and sociologists, and popular movies and TV shows like Titanic and Mad Men. He prefers the richness of these sources to the sterile mathematical models that are prevalent in contemporary academic work in economics. Indeed, he is scathing about much contemporary work in the economics field, condemning its “childish passion for mathematics and for purely theoretical and often highly ideological speculation, at the expense of historical research and collaboration with the other social sciences.”
Capital is a consistently engrossing read, encompassing topics including the stunning comeback that inherited wealth has made in today’s advanced economies, the dubiousness of the economic theory that a worker’s wage is equal to his or her marginal productivity, the moral insidiousness of meritocratic justifications of inequality, and more. But the book’s major strength lies in Piketty’s ability to see the big picture. His original and rigorously well-documented insights into the deep structures of capitalism show us how the dynamics of capital accumulation have played out historically over the past three centuries, and how they’re likely to develop in the century to come. From his analysis he’s derived several important lessons, none of them particularly comforting.
The first of these is that, contrary to widely held economic theories, there is no “natural” tendency of inequality to wane in advanced capitalist societies. In the 1950s, economist Simon Kuznets famously argued that in advanced economies, inequality looks like an inverted U curve, with inequality increasing during the early stages of industrialization, then decreasing as economic development spurs growth that benefits all. But as Piketty demonstrates, Kuznets’s inequality theory was based on fatally incomplete data—he only dealt with one country (the United States), from the years 1913 to 1948.
Economic inequality in the U.S. and Europe experienced a precipitous decline between World War I and World War II, but the causes were hardly natural. Inequality fell due to a series of shocks that included the physical destruction in Europe left by two massive wars, the bankruptcies of the Great Depression, and, he says, “above all” to “new public policies”—policies that included rent control, nationalizations, steeply progressive income taxes, and “the inflation-induced euthanasia of the rentier class that lived on public debt.”
The decline in inequality that began between the wars and continued for decades afterward was a historical anomaly that is unlikely to repeat itself—something that many American liberals, still mired in New Deal and Great Society nostalgia, need to hear. Left to its own devices, capital begets capital, wealth becomes increasingly concentrated, and inequality spirals. Piketty warns us that “[t]he consequences for the long-term dynamics of wealth distribution are potentially terrifying, especially when one adds that the return on capital varies directly with the size of the initial stake, and that the divergence in the wealth distribution is occurring on a global scale.”
Piketty’s second major lesson is that, contrary to the fervent hopes of advocates ranging from supply-side economics’ true believers to many left-leaning economists, growth will not save us. As Piketty explains, economic growth does indeed tend to decrease economic inequality. Demographic growth, which is one component of economic growth, tends to decrease the influence of inherited wealth. For example, if families are larger, the average inheritance per child will be smaller, everything else being equal. In addition, high-growth economies tend to increase social mobility, because they provide greater opportunities for those whose parents weren’t part of the old economic elite. During the late 1990s—the last period of sustained, relatively high growth we saw in the U.S.—workers experienced a nearly full employment economy, which increased wages and caused inequality to decline, albeit only slightly and temporarily. But Piketty argues that the sustained, high rates of economic growth we saw in advanced economies in the twentieth century are very likely a thing of the past. He emphasizes that “there is no historical example of a country at the world technological frontier whose [inflation-adjusted] growth in per capita output exceeded 1.5 percent over a lengthy period of time” (one hundred years or so).
Piketty’s central insight is that inequality is an increasing function of the gap between r, the net rate of return on capital, and g, the rate of economic growth. Throughout most of history, the rate of return on capital has been durably and significantly higher than the rate of economic growth, and this trend is likely to continue, particularly given the likelihood of slower growth rates in advanced economies. The ratio of capital to income—as good a measure as any of the influence of wealth in society—peaked at about 700 percent in Europe in the nineteenth century, then plummeted to between 200 and 300 percent in the 1950s and ’60s. Currently it hovers around 600 percent and shows every sign of returning to its nineteenth-century peak. Indeed, plugging highly plausible assumptions into Piketty’s model yields predictions that Europe and America will experience rates of inequality and wealth concentration that will not only match but exceed their nineteenth-century peaks.
This dystopic scenario is deeply disturbing, but it doesn’t have to be our destiny. Piketty notes that “the history of income and wealth is always deeply political, chaotic, and unpredictable.” This brings us to Piketty’s third major lesson, which is that, happily, there is, in theory at least, a solution to the problem of soaring economic inequality, and a surprisingly simple one at that: taxes. Specifically, Piketty advocates a steeply progressive income tax and a global tax on wealth. He estimates that the optimal top marginal income tax rate is approximately 80 percent. Such a rate, he says, “not only would not reduce the growth of the U.S. economy but would in fact distribute the fruits of growth more widely while imposing reasonable limits on economically useless (or even harmful) behavior.”
Piketty’s proposed global tax on wealth would be progressive, annual, and applicable to all forms of capital, from real estate to financial and business assets. He advocates that the tax be based on bank information that is automatically shared, a move that would enable governments to manage banking crises more efficiently and would also promote financial transparency. Even a modest wealth tax could bring in significant revenue, and it would minimize the “substantial risk that the top centile’s share of global wealth will continue to grow indefinitely.”
Piketty admits that such a tax is “utopian.” International cooperation would be a formidable challenge, particularly given our globalized banking system with its vast panoply of seductive tax havens for the 1 percent. But precisely since our economy is now global, solutions to economic problems need to be global as well. More fundamentally, Piketty lacks a theory of politics that tells a persuasive story about how such changes might come about in the real world. In the twentieth century, it took the economic shocks of two world wars and the Great Depression to compel governments to adopt aggressively redistributionist tax policies. Absent such traumas, and given the declining power of institutions like labor unions that built support for such measures, what would make governments adopt such far-reaching reforms today?
Even in social-democratic Europe, many governments, including the party that Piketty supports, the French Socialists, are strongly supporting lower taxes and fiscal austerity. In the U.S., while Democrats have adopted economic inequality as a major campaign theme, in substance their anti-inequality political agenda is, sadly, less than meets the eye. It appears to consist mainly of supporting a long-overdue increase in the minimum wage, a modest expansion of food stamp benefits, and, perhaps, tax cuts for lower-middle-class families. Yes, last year Congress implemented far tougher financial reforms than expected. But among most mainstream Democrats, there appears to be little appetite for enacting policies that would seriously upset Wall Street or challenge the entrenched power of the 1 percent. No one is talking about returning to an 80 percent marginal tax rate.
So are we doomed to a dystopic future after all—a Hunger Games-like society where a tiny but powerful elite lives in luxury and splendor while the masses toil and starve? Hardly. As Piketty argues, history suggests that the levels of inequality we are approaching tend to be politically unsustainable. As Piketty notes, there is an odd yet widely accepted idea that the U.S. is significantly more inegalitarian than Europe because we like it this way. Certainly, many U.S. conservatives appear highly invested in persuading their fellow Americans—and perhaps themselves—that this is the case. But recent opinion polls tell a rather different story.
Moreover, as Piketty rightly emphasizes, equality is our American birthright. We Americans are, after all, a proudly democratic people whose signature achievement—ridding ourselves of kings, queens, and a titled aristocracy—marked a revolutionary step forward in human progress. In the early years of the American republic, the U.S. truly was a more egalitarian society than Europe—
Piketty’s historical data confirms this. During the Gilded Age of the late nineteenth century, when economic inequality soared and wealthy elites began to exercise unprecedented power over our society and our political system, many Americans—even free market economists like Irving Fisher—expressed alarm.
The inequality crisis America faced in the early twentieth century was a profoundly serious one, but in the end we rose to the challenge. After all, as Piketty points out, America is the country that, after World War I, literally invented “confiscatory” taxes—the type of progressive tax that is designed not so much to yield revenue but to “put an end to” large incomes and estates, because they are regarded as “socially unacceptable and economically unproductive.” Even an ardent apostle for capitalism like Fisher felt that the best solution to the early-twentieth-century inequality problem was a steeply progressive tax on the largest estates—with a rate that could climb as high as 100 percent for an estate that was more than three generations old. America’s twenty-first-century inequality crisis is, if anything, even more daunting and complex than the one we experienced a century ago. But as Piketty reminds us, the solutions to this problem are political, and they lie within our grasp. Should Americans choose to deploy those solutions, not only would we be doing the right thing, we’d be living up to our deepest traditions and most cherished ideals.
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