[Sorry, just one more on Piketty... *RON*]
by Justin Fox, Harvard Business Review, April 24, 2014. Justin Fox is Executive Editor, New York, of the Harvard Business Review Group and author of The Myth of the Rational Market. Follow him on Twitter @foxjust.
It was only published in English a few weeks ago, but French economist Thomas Piketty’s Capital in the Twenty-First Century has already become inescapable. The reasons start with the confluence of subject matter and author. There’s a lot of interest in economic inequality these days, and research conducted over the past 15 years by Piketty, a professor at the Paris School of Economics, is a big reason why. In the U.S., Piketty and UC Berkeley’s Emmanuel Saez transformed a tame discussion of income quintiles and deciles into a sharp debate about the skyrocketing incomes of the 1% — and the mind-boggling gains of the 0.1% and 0.01% — by gathering and publishing income tax datathat nobody had bothered with before. Piketty was behind similar projects in France, Britain, Japan, and other countries.
And now this book. It is massive (696 pages) and massively ambitious (the title is a very conscious echo of Karl Marx’s Das Kapital). It came out in France last year to great acclaim, which meant that those in the English-speaking world who pay attention to such matters knew that something big was coming. Over the past few weeks it has become one of those things that everybody’s talking about just because everybody’s talking about it. That, and it really is important.
Is it worth reading? Martin Wolf of the Financial Times called it “enthralling”; a couple people I know have described it as “a slog.” I’d liken it to a big river — muddy and occasionally meandering, but with a powerful current that keeps pulling you along, plus lots of interesting sights along the way. There are endless numbers and (ugly but generally understandable) charts, but also frequent references to the novels of Balzac and Austen, and even a brief analysis of Disney’s The Aristocats. Regular people can read this thing; it’s just a matter of the time commitment. You should definitely buy it, if your place on the income distribution allows it. It looks good on a bookshelf, plus every copy sold makes Piketty wealthier, allowing us to discover whether this alters his views about inequality. At the moment those views involve a lot of alarm about the growing income divide and a decided equanimity about raising taxes. Unlike most economists who write for a general audience, though, Piketty makes it quite easy for readers to separate these views from the evidence he assembles. When he writes at the end of the book that “all my conclusions are by nature tenuous and deserve to be questioned and debated,” one gets the feeling that he actually means it.
Still, chances are you won’t get to the end of the book, so here is a not-all-that-brief guide for the busy:
The argument. Capital (which by Piketty’s definition is pretty much the same thing as wealth) has tended over time to grow faster than the overall economy. Income from capital is invariably much less evenly distributed than labor income. Together these amount to a powerful force for increasing inequality. Piketty doesn’t take things as far as Marx, who saw capital’s growth eventually strangling the economy and bringing on its own collapse, and he’s witheringly disdainful of Marx’s data-collection techniques. But his real beef is with the mainstream economic teachings that more capital and lower taxes on capital bring faster growth and higher wages, and that economic dynamism will automatically keep inequality at bay. Over the two-plus centuries for which good records exist, the only major decline in capital’s economic share and in economic inequality was the result of World Wars I and II, which destroyed lots of capital and brought much higher taxes in the U.S. and Europe. This period of capital destruction was followed by a spectacular run of economic growth. Now, after decades of peace, slowing growth, and declining tax rates, capital and inequality are on the rise all over the developed world, and it’s not clear what if anything will alter that trajectory in the decades to come.
The method. Piketty does not offer his own theory of what drives economic growth, or what the optimal ratio of capital to labor income might be. In fact, a recurring theme of his book is that the theory-first approach of modern economics is a dead-end. After starting out his career as an economics professor at “a university near Boston” (MIT), Piketty writes that he returned to France in part because “economists are not highly respected” there — so he’d need to amass convincing evidence, not just spout scientific-sounding theories, to have an impact. This evidence-first approach is the great strength of his book, but it’s also why I described it as “muddy.” Piketty just isn’t really sure how economically useful capital is, or what the right level of inequality is, or how high taxes ought to be.
The evidence. The richest source of data for the book is France, thanks to the country’s long tradition of excellent record-keeping and an estate tax that was enacted a couple of years after the 1789 Revolution. What the French numbers show is that the ratio of capital to income remained steady at about seven-to-one for centuries, plummeted around the start of World War I, and began recovering after World War II. It’s still not back to pre-World War I levels, but it seems to be headed there. Income inequality in France probably peaked right before the Revolution, stayed very high for the entire 19th century, then also plummeted starting in 1914. Over the past few decades it has made a modest recovery that Piketty believes is just beginning. Less-complete data from Britain and other European countries show a similar trajectory, although in Britain income inequality has made a much stronger comeback than on the continent.
The prognosis. Piketty’s main worry seems to be that growing wealth in Europe will bring a return to 19th century circumstances in which most affluent people get that way through inheritance. That’s why he spends so much time describing characters from the novels of Honoré de Balzac and Jane Austen who see inheriting money or marrying into it as the only path to a comfortable life. Things haven’t gotten anywhere near that bad yet in the 21st century, and at least judging by the novels of Anthony Trollope (not cited by Piketty), in which British heirs and wannabe heirs interact with wealthy industrialists and ambitious professionals on more or less equal terms, I’m not sure they even remained that bad in the 19th. But the basic message from Piketty’s data, that the ravages of the World Wars and the high taxes that followed put a big damper on wealth and inheritance that has now been lifted, seems irrefutable. His assumption that most of these heirs and heiresses won’t squander their fortunes can of course be questioned, but he does offer evidence for his contention that the bigger the fortune, the faster it will grow in the future: the performance of university endowments in the U.S., where the largest endowments have earned dramatically higher percentage returns than the rest.
Inequality in the U.S. On this side of the Atlantic, wealth and income were less concentrated in the 19th century than in Europe. After a spike in top incomes that topped out in the late 1920s, the income distribution flattened out here again, albeit in less dramatic fashion than in Europe. Since the 1970s, though, the U.S. has seen a sharp and unparalleled increase in the percentage of income going to the top 1% and especially 0.1%. This has not been driven by the capital and inheritance dynamics at the heart of Piketty’s story. He attributes it instead to the rise of what he calls “supermanagers.” Piketty cites recent research that shows managers and financial professionals making up 60% of the top 0.1% of the income distribution in the U.S., and proposes that their skyrocketing pay is mainly the product of sharp declines in top marginal tax rates that made it worth managers’ while to bargain harder for raises. This isn’t the only explanation available, and Piketty’s discussion of U.S. inequality doesn’t carry the same historical authority as other parts of the book. But it surely is interesting that, as he and several co-authors report in a new article in the American Economic Journal: Economic Policy, the rise in the top-percentile income share in 13 countries was almost perfectly correlated with declines in top marginal tax rates in those countries. It’s also interesting that this huge rise in relative income inequality has brought no discernible economic benefit. Yes, the U.S. economy has grown a bit faster than those of other developed economies, but that’s purely because of population growth. Per-capita economic growth has been almost identical in the U.S. and Western Europe since 1980, and because of the skew towards the top here, U.S. median income has actually lost ground relative to other nations.
The solution. As you may have already heard, Piketty proposes a progressive global wealth tax — at one point he suggests that it could start at 0.1% a year for small nest eggs and rise to 2% for fortunes of above 5 billion euros ($6.9 billion) — as the best response to the current dynamics of inequality. He also describes this idea several times as “utopian,” but then goes on to explain why it’s more practical and fair and unlikely to disrupt the wealth-creating properties of capitalism than other possible remedies. The policy section is probably the least satisfying part of the book, but it’s still thought-provoking. When Piketty describes a one-time European tax on wealth as a simpler, fairer, more growth-friendly solution to the Eurozone’s debt problems than anything else currently on the table, he’s got a point. When he writes that central banks are redistributing wealth all the time, just not in a transparent, democratic manner, he’s got a point there, too. And when he argues that the U.S. should consider a return to a “confiscatory” (his word) 80% top marginal tax rate even though it wouldn’t bring in much money (he basically agrees with Arthur Laffer on that), well, that provokes some thoughts, doesn’t it?
The impact. To accompany an article last week on the rapturous reception the book has received,The New York Times ran an online graphic that put Capital in the Twenty-First Century in the company of Adam Smith’s Wealth of Nations and John Maynard Keynes General Theory. That seems premature. But even before the book, Piketty and his co-researchers had already helped set off a global debate on income inequality. With Capital in the Twenty-First Century, it is possible that Piketty will succeed in shifting the burden of proof within economics and perhaps outside of it from one side of that debate to the other. No longer will one be able to simply assert that rising inequality is a necessary byproduct of prosperity, or that capital deserves protected status because it brings growth. From now on, those who say such things may be expected to provide evidence that they’re actually true.