Thursday, July 24, 2014

Capital in the 21st Century, by Thomas Piketty

Staff Review by Chris Saliba

In this groundbreaking book, French economist Thomas Piketty investigates the historical data on inequality and finds that the capitalist system is structured in such a way that, over time, capital accumulates aggressively in the hands of the few.

Thomas Piketty is a French economist who has for over a decade been studying the hard historical data (where it is available) on income, capital, wealth accumulation, and most importantly of all, inequality. His 2013  book, Capital in the 21st Century, which has only recently been translated into English, could just as easily have been called Inequality in the 21st Century.

For the lay reader and non-economist, you may have presumed that the argument over inequality had been already been settled. The world is subsumed in facts, figures, statistics and official financial reports. Surely the inequality question had been answered? Amazingly, this is not the case. Thomas Piketty is the first economist to have seriously studied the available records, going back as far as 1700. (France and Britain’s national accounts provide the richest records historically, so much of the analysis covers these two countries).  In the debate on inequality there has mostly been opinion or a “dialogue of the deaf, in which each camp justifies its laziness by pointing to the laziness of the other”; Piketty now provides the facts.

Before going to the substance of Capital in the 21st Century, it is worth noting a few things about Piketty himself. He moved to America at the age of twenty-two after finishing his doctorate and worked for a Boston university. Dissatisfied with the intellectual culture there, he moved back to Paris at the age of twenty-five. The problem was that Piketty thought economists were too revered in the US. His own work was praised, but he felt it lacked enough rigorous data. In France, economists were taken less seriously, and this suited Piketty fine, as he thought economics should work with other disciplines such as politics, history and sociology. Economics on its own was not enough. Piketty’s criticism of economists is quite stark:

“To put it bluntly, the discipline of economics has yet to get over 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.”

Piketty shows himself to have broader intellectual and cultural interests; he likes to illustrate his economic theories by reference to classic works of literature. The novels of Jane Austen, rich in economic data, come in for much discussion. Sense and Sensibility (1811) is held up for especially close scrutiny, examining the cruel circumstances of the disinheritance of Elinor, Marianne and Margaret Dashwood. As Piketty notes, “Jane Austen, herself disfavored by inheritance and left a spinster along with her sister, knew what she was talking about.” This method of fusing different intellectual disciplines with economics is explained:

“Indeed, the novels of Jane Austen and Honore de Balzac paint striking portraits of the distribution of wealth in Britain and France between 1790 and 1830...These and other novelists depicted the effects of inequality with a verisimilitude and evocative power that no statistical or theoretical analysis can match.”

A lot of the text also employs examples from cinema and television. For example, when discussing how the top centile of the population in France owned 70 percent of the wealth in 1913, there is this reference to Disney’s The Aristocats:

“The reality was so striking that it even found expression in an animated cartoon, The Aristocats, set in Paris in 1910. The size of the old lady’s fortune is not mentioned, but to judge by the splendor of her residence and by the zeal of her butler Edgar to get rid of Duchesse and her three kittens, it must have been considerable.”

The basic economic theory behind Capital in the 21st Century is quite simple. Capital (stocks, land etc.), over the long period, have a natural tendency to accumulate in the hands of the already rich. In the 21st century, the common thinking is that we live in a meritocracy, and that the rich deserve their wealth. Piketty says the picture is more complicated. Talent and hard work do count, but fundamentally the capitalist system is structured so as to make capital accumulate in the hands of the few. When the historical rate of return on capital is 5 percent, and you’re Bill Gates, with a net worth of $80 billion, then in just one year of doing absolutely nothing you’re going to make millions.

“Regardless of whether the wealth a person holds at age fifty or sixty is inherited or earned, the fact remains that beyond a certain threshold, capital tends to reproduce itself and accumulates exponentially.”

This theory is set out in quite a bit of detail, with the first 200 or so pages devoted to explaining basic economic concepts.  Piketty explains that historically, the rate of return on capital has been about 5 percent. But the growth rate for economies over the same time has been very low, almost zero  (a major component of economic growth is population growth). Hence  those with capital have seen their fortunes compound at 5 percent a year, while for the rest of the population, their incomes have barely moved. The few at the top find their wealth, if you were looking at it on a graph, shooting upwards; those at the bottom flatline, barely moving up at all. This disparity between rich and poor only gets bigger and bigger as time goes on.

This economic theory is summed up in the quote below, where r stands for the return on capital, and g for growth. The formula r > g means that, over time, the return on capital is always greater than the growth of the economy:

"To sum up: the inequality r > g has clearly been true throughout most of human history, right up to the eve of World War I, and it will probably be true again in the twenty-first century. Its truth depends, however, on the shocks to which capital is subject, as well as on what public policies and institutions are put in place to regulate the relationship between capital and labor."

In the 20th century, however, massive amounts of wealth were blown away by the two world wars. This massive erosion of wealth caused a reduction in inequality as the rich lost much of their capital. Piketty’s graphs (the book is chock-a-block full with graphs, all pointing in the one direction) show that since the end of the Second World War, inequality is growing again. According to Capital’s central thesis, this is just the system returning to normal. The long period between the two world wars and after have lulled economic thinkers into believing the world had entered a new age of reduced inequality. But as the book’s graphs clearly show, inequality keeps steadily climbing in the post-war years.

In short, because the growth rate is slowing (to around 1.5 percent) and the rate of return on capital is greater than that figure, it means that inequality is returning to the historical norm. Piketty’s worry is that capital accumulation will return to nineteenth century levels. As mentioned above, all of his graphs show inequality dipping during the two world wars, then since the 1950s steadily climbing.

Of course that is simplifying a complex and very nuanced seven hundred page book. Piketty doesn’t claim to have all the answers. He makes predictions, but acknowledges there are always unforeseen events that could again destroy large amounts of capital. His work presents overarching trends, but then counter trends as well. He notes that while capital has continued to grow and concentrate in the hands of a few, the progressive tax system has helped to rein in inequality and create a powerful middle class. Education and training have also been a vital key to reducing inequality.

Capital in the 21st Century has been a massive hit in America. Indeed, it seems some parts were specifically written for an American audience. Piketty takes especial note of American inequality and argues that the high salaries awarded to senior company executives and CEOs are not merited.

“It may be excessive to accuse senior executives of having their ‘hands in the till’, but the metaphor is probably more apt than Adam Smith’s metaphor of the market’s ‘invisible hand’.”

A lot of doubt is also cast on the notion of the very rich deserving their wealth, an idea that Americans are especially enamoured of. He suggests that many other factors come into play. The poor can remain poor due to the structure of capitalism, while the rich  may attain wealth not through any special skills but the simple fact of luck or inheritance.  The dominant economic mantra that market forces direct capitalism in a beautifully perfect system is overly simplistic. Writes Piketty, “The dynamics of the global distribution of capital are at once economic, political, and military.”

What solutions does Capital in the 21st Century propose to these problems of inequality? Basically, tax excessive wealth to keep it in control. Tax is not a strictly economic issue, but rather a moral one, about the kind of fair society we all want to live in.

"Taxation is not a technical matter. It is preeminently a political and philosophical issue, perhaps the most important of all political issues"

Capital in the 21st Century is a book that shakes preconceived ideas about the fairness of the market to their very core. Its author is a mild mannered and earnest man who believes in morality, democracy and social cohesion. Thomas Piketty’s book is a non-ideological and serious work of political economy, written for a wide audience. The book at all times strives to make itself understood in the clearest possible terms, despite much of the detail and complexity of the arguments. The many graphs in the book all point in one direction: growing inequality in the 21st century. One of the starkest findings of the book is that inequality is built into the system. It’s something we all probably intuited, using our common sense. Capital in the 21st Century weaves this historical data into an economic, political, philosophical and moral argument with a gravitas far beyond the reach of other contemporary authors.

Capital in the 21st Century, by Thomas Piketty. Translated by Arthur Goldhammer. Published by The Belknap Press. ISBN: 9780674430006  $59.95

To sign up for our monthly newsletter, featuring new releases, book reviews and favourite articles from around the web, click here.