To sum up: modern growth, which is based on the growth of productivity and the diffusion of knowledge, has made it possible to avoid the apocalypse predicted by Marx and to balance the process of capital accumulation. But it has not altered the deep structures of capital — or at any rate has not truly reduced the macroeconomic importance of capital relative to labor. I must now examine whether the same is true for inequality in the distribution of income and wealth. How much has the structure of inequality with respect to both labor and capital actually changed since the nineteenth century?
I've been writing about Piketty's work for more than a year, as the first inklings of his French-language publications began to trickle into the Anglosphere. With the explosive publication of the English edition of Capital in the 21st Century last March, the trickle's turned into a flood of Piketty commentary, which I've followed as I made my way through the text, a process that took a lot longer than I expected.
Piketty has come in for a lot of praise for the clarity of his writing, and I think it's deserved. There's very little math in this book, and it assumes very little prior knowledge of economics. In part, this is because Piketty is offering something fresh in the discourse: an unimaginably massive data-set that traces the ebb and flow of wealth and productivity around the globe for three centuries. Piketty's been very transparent about the assumptions he and his team made in pulling together the data, offering more than 100 pages of endnotes that explain the logic behind each assumption (the data itself is online, too).
If there was one word I'd use to sum up the structure of Capital, it's "careful." Piketty is offering up an inflammatory thesis (more on that in a minute), but his presentation is almost plodding. He retraces and reiterates his arguments again and again, which is helpful for those of us who don't trade in economics in our daily lives, and also is set to head off lazy critics who want to dismiss him out of hand. Indeed, one of the most entertaining episodes in the debate so far has been The Financial Times affair, where the FT's Chris Giles pointed out a bunch of "errors" in Piketty's work, only to have the normally even-keeled Piketty come back with a long, detailed rebuttal that boiled down to "Hey, asshole, if you'd bothered to look, you'd see that I documented every one of the decisions you're characterizing as an error, and if you want to disagree with me, then argue with my explicit, detailed assumptions instead of sloppily assuming I didn't even realize I was making them."
Piketty's thesis has been shorthanded as r > g: that the rate of return on capital today — and through most of history — has been higher than general economic growth. This means that simply having money is the best way to get more money. Piketty uses examples from English and French literature (Austen, James and Balzac) to illustrate just how unimaginably weird this situation is by modern standards. The literature of the pre-modern era is full of people who understand that the being rich is a hereditary condition, and no matter what you create, or where you work, or how important you are, or how great you are, the only way to get rich is to be rich or marry someone rich.
The most striking fact is that the United States has become noticeably more inegalitarian than France (and Europe as a whole) from the turn of the twentieth century until now, even though the United States was more egalitarian at the beginning of this period. What makes the US case complex is that the end of the process did not simply mark a return to the situation that had existed at the beginning: US inequality in 2010 is quantitatively as extreme as in old Europe in the first decade of the twentieth century, but the structure of that inequality is rather clearly different.
In the US (and Canada), this is a more remote memory, because the European colonists who came to the "New World" generally arrived without much capital, and notwithstanding the occasional land-baron or rail tycoon, have not had the opportunity to set up the kind of enduring, centuries-long dynasties that characterized the world they'd left. But for Piketty, this extreme wealth disparity is a central fact of history, and it is supposed to be the thing that modernity — and capitalism — conquered, through a "meritocratic" system that rewards people who do amazing things with amazing fortunes, and that recognizes that merely being the kid of someone who did something amazing is not, in itself, amazing, and should not entitle you to the exalted heights that your storied forebears attained.
The estate tax became progressive in France in 1901, but the highest rate on direct-line bequests was no more than 5 percent (and applied to at most a few dozen bequests a year). A rate of this magnitude, assessed once a generation, cannot have much effect on the concentration of wealth, no matter what wealthy individuals thought at the time. Quite different in their effect were the rates of 20–30 percent or higher that were imposed in most wealthy countries in the wake of the military, economic, and political shocks of 1914–1945. The upshot of such taxes was that each successive generation had to reduce its expenditures and save more (or else make particularly profitable investments) if the family fortune was to grow as rapidly as average income. Hence it became more and more difficult to maintain one's rank. Conversely, it became easier for those who started at the bottom to make their way, for instance by buying businesses or shares sold when estates went to probate.
Piketty challenges the idea that modernity somehow led to "merit" asserting itself as the new determinant of wealth. Instead, he makes a very convincing case that the increasing size of the capital class — which expanded comfortably during the period of colonial expansion — created a hunger for wealth that turned the aristocracy on itself in a squabble over who got to loot the colonies, which was World War I. This war was incredibly destructive of capital, and left many of the aristocracy holding onto potentially worthless government bonds issued by states that had nearly bankrupted themselves during the Great War. These states were so beholden to the rich that they couldn't contemplate inflating or taxing or defaulting their way out of debt, and so they took heroic and improbable measures to keep bondholders whole, which led to the economic chaos of of which WWII was born.
WWII destroyed so much accumulated wealth that in its aftermath, a raft of previously unimaginable policies became the norm. Trade unionism, progressive taxation, tenants' rights and other rules that spread out access to economic privilege and mobility became the norm, and the growth of fortunes was dramatically slowed all over the world. But by the 1980s, there was a big and important enough class of very rich people that they were able to exert serious political pressure, and the neoliberal era began, with Reagan and Thatcher. From then on, the return on capital has mounted even as growth has slowed, and the gap between the rich and poor has widened to the point where we are teetering on the brink of a society with such entrenched hereditary inequality that it can make no claim to "meritocratic" virtue.
In my view, there is absolutely no doubt that the increase of inequality in the United States contributed to the nation's financial instability. The reason is simple: one consequence of increasing inequality was virtual stagnation of the purchasing power of the lower and middle classes in the United States, which inevitably made it more likely that modest households would take on debt, especially since unscrupulous banks and financial intermediaries, freed from regulation and eager to earn good yields on the enormous savings injected into the system by the well-to-do, offered credit on increasingly generous terms.
This is a crisis. The reason for capitalism is that it is supposed to allocate reward based on "merit" — it is supposed to move capital into the hands of the people who can do the most with it — and if all our policy decisions are made in service to a class of supermanagers whose wealth comes from squatting on a fortune managed by some green-eyeshade quants who grow it without its owner ever doing a notable thing apart from being born to dynasty, there is no more reason for capitalism. Piketty darkly hints that the last time this happened, the world tore itself to pieces, twice, in an orgy of destruction that left millions dead and whole nations in ruin.
The main purpose of the health sector is not to provide other sectors with workers in good health. By the same token, the main purpose of the educational sector is not to prepare students to take up an occupation in some other sector of the economy. In all human societies, health and education have an intrinsic value: the ability to enjoy years of good health, like the ability to acquire knowledge and culture, is one of the fundamental purposes of civilization.
Piketty's controversial prescription for this is to impose a global wealth tax. Not a very big one, mind — he talks at length about how a couple of percentage points per year would be more than enough. But just enough that every squillionaire would have to account for his wealth, disclosing its particulars and its disposition (laying bare the world's tax-havens), and that there would be enough redistributive pressure in the system to keep dynastic fortunes from growing, thus allowing for a middle-class to flourish (Piketty convincingly shows that even at the peak of "meritocratic" redistribution, the poor's share of the world's wealth has not changed appreciably — rather, that the loosened control of the rich has made room for a middle-class).
A global tax on capital is a utopian idea. It is hard to imagine the nations of the world agreeing on any such thing anytime soon. To achieve this goal, they would have to establish a tax schedule applicable to all wealth around the world and then decide how to apportion the revenues. But if the idea is utopian, it is nevertheless useful, for several reasons. First, even if nothing resembling this ideal is put into practice in the foreseeable future, it can serve as a worthwhile reference point, a standard against which alternative proposals can be measured. Admittedly, a global tax on capital would require a very high and no doubt unrealistic level of international cooperation. But countries wishing to move in this direction could very well do so incrementally, starting at the regional level (in Europe, for instance). Unless something like this happens, a defensive reaction of a nationalist stripe would very likely occur. For example, one might see a return to various forms of protectionism coupled with imposition of capital controls. Because such policies are seldom effective, however, they would very likely lead to frustration and increase international tensions.
There are lots of reasons for this to be controversial. First, as Piketty admits, it's impractical. Getting all the countries of the world to agree to this scheme is implausible. But, he says, we don't need everyone to cooperate to realize some immediate benefit:
To reject the global tax on capital out of hand would be all the more regrettable because it is perfectly possible to move toward this ideal solution step by step, first at the continental or regional level and then by arranging for closer cooperation among regions. One can see a model for this sort of approach in the recent discussions on automatic sharing of bank data between the United States and the European Union. Furthermore, various forms of capital taxation already exist in most countries, especially in North America and Europe, and these could obviously serve as starting points.
There's something ineluctably European and scholarly in Piketty's willingness to treat redistribution as legitimate. "Redistribution" is political poison in the USA, though it wasn't always thus:
In 1919, Irving Fisher, then president of the American Economic Association, went even further. He chose to devote his presidential address to the question of US inequality and in no uncertain terms told his colleagues that the increasing concentration of wealth was the nation's foremost economic problem. Fisher found King's estimates alarming. The fact that "2 percent of the population owns more than 50 percent of the wealth" and that "two-thirds of the population owns almost nothing" struck him as "an undemocratic distribution of wealth," which threatened the very foundations of US society. Rather than restrict the share of profits or the return on capital arbitrarily — possibilities Fisher mentioned only to reject them — he argued that the best solution was to impose a heavy tax on the largest estates (he mentioned a tax rate of two-thirds the size of the estate, rising to 100 percent if the estate was more than three generations old).
Indeed, an unwillingness to tax creates all kinds of evils. For starters, if a state can't fund its core programs out of tax, it has to borrow. And when it borrows, it borrows from the rich. So instead of taxation — which weakens the fortunes and political influence of the wealthy — we get bonds, through which the wealthy are paid interest out of the funds extracted from those who lack the political clout to escape taxation. The wealthy get more wealthy, and exert more political pressure. Piketty illustrates this beautifully with a couple of well-chosen examples — for example, take the sky-high CEO salary. Why weren't the CEOs of the post-war period paid tens of millions, while their financialized descendants bring home the makings of a hereditary dynasty? It's all down to an unwillingness to have real progressive taxation:
…Lower top income tax rates, especially in the United States and Britain, where top rates fell dramatically, totally transformed the way executive salaries are determined. It is always difficult for an executive to convince other parties involved in the firm (direct subordinates, workers lower down in the hierarchy, stockholders, and members of the compensation committee) that a large pay raise — say of a million dollars — is truly justified. In the 1950s and 1960s, executives in British and US firms had little reason to fight for such raises, and other interested parties were less inclined to accept them, because 80–90 percent of the increase would in any case go directly to the government. After 1980, the game was utterly transformed, however, and the evidence suggests that executives went to considerable lengths to persuade other interested parties to grant them substantial raises. Because it is objectively difficult to measure individual contributions to a firm's output, top managers found it relatively easy to persuade boards and stockholders that they were worth the money, especially since the members of compensation committees were often chosen in a rather incestuous manner.
It's a rare thing to see economists, especially pro-capitalist economists, praising taxation itself, but Piketty — careful, unemotional Piketty — dares:
Without taxes, society has no common destiny, and collective action is impossible. This has always been true. At the heart of every major political upheaval lies a fiscal revolution. The Ancien Régime was swept away when the revolutionary assemblies voted to abolish the fiscal privileges of the nobility and clergy and establish a modern system of universal taxation. The American Revolution was born when subjects of the British colonies decided to take their destiny in hand and set their own taxes. ("No taxation without representation"). Two centuries later the context is different, but the heart of the issue remains the same. How can sovereign citizens democratically decide how much of their resources they wish to devote to common goals such as education, health, retirement, inequality reduction, employment, sustainable development, and so on?
Picketty has little patience for economic doctrine in general, and gets some serious digs in:
Among the members of these upper income groups are US academic economists, many of whom believe that the economy of the United States is working fairly well and, in particular, that it rewards talent and merit accurately and precisely…Some economists have an unfortunate tendency to defend their private interest while implausibly claiming to champion the general interest.
Besides, he says, the thing every red-blooded entrepreneur wants to see is people getting rich by their wits and deeds, not by the birthright of kings. Consider the heiress to the L'oreal fortune and Bill Gates:
All large fortunes, whether inherited or entrepreneurial in origin, grow at extremely high rates, regardless of whether the owner of the fortune works or not. To be sure, one should be careful not to overestimate the precision of the conclusions one can draw from these data, which are based on a small number of observations and collected in a somewhat careless and piecemeal fashion. The fact is nevertheless interesting.
Take a particularly clear example at the very top of the global wealth hierarchy. Between 1990 and 2010, the fortune of Bill Gates — the founder of Microsoft, the world leader in operating systems, and the very incarnation of entrepreneurial wealth and number one in the Forbes rankings for more than ten years — increased from $4 billion to $50 billion. At the same time, the fortune of Liliane Bettencourt — the heiress of L'Oréal, the world leader in cosmetics, founded by her father Eugène Schueller, who in 1907 invented a range of hair dyes that were destined to do well in a way reminiscent of César Birotteau's success with perfume a century earlier — increased from $2 billion to $25 billion, again according to Forbes.
In other words, Liliane Bettencourt, who never worked a day in her life, saw her fortune grow exactly as fast as that of Bill Gates, the high-tech pioneer, whose wealth has incidentally continued to grow just as rapidly since he stopped working. Once a fortune is established, the capital grows according to a dynamic of its own, and it can continue to grow at a rapid pace for decades simply because of its size. Note, in particular, that once a fortune passes a certain threshold, size effects due to economies of scale in the management of the portfolio and opportunities for risk are reinforced by the fact that nearly all the income on this capital can be plowed back into investment. An individual with this level of wealth can easily live magnificently on an amount equivalent to only a few tenths of percent of his capital each year, and he can therefore reinvest nearly all of his income. This is a basic but important economic mechanism, with dramatic consequences for the long-term dynamics of accumulation and distribution of wealth. Money tends to reproduce itself.
(A dry postscript on those who say that feckless descendants correct this problem on their own: "It would in any case be rather imprudent to rely solely on the eternal but arbitrary force of family degeneration to limit the future proliferation of billionaires.")
But how does money increase itself? It turns out that if you have a lot of money to invest, you get a lot more in return, as Piketty demonstrates by picking apart the investment returns of the Ivy League university endowments, which are the only privately invested fortunes whose investment strategies are subject to public scrutiny:
If we look at the investment strategies of different universities, we find highly diversified portfolios at all levels, with a clear preference for US and foreign stocks and private sector bonds (government bonds, especially US Treasuries, which do not pay well, account for less than 10 percent of all these portfolios and are almost totally absent from the largest endowments). The higher we go in the endowment hierarchy, the more often we find "alternative investment strategies," that is, very high yield investments such as shares in private equity funds and unlisted foreign stocks (which require great expertise), hedge funds, derivatives, real estate, and raw materials, including energy, natural resources, and related products (these, too, require specialized expertise and offer very high potential yields). If we consider the importance in these various portfolios of "alternative investments," whose only common feature is that they abandon the usual strategies of investing in stocks and bonds accessible to all, we find that they represent only 10 percent of the portfolios of institutions with endowments of less than 50 million euros, 25 percent of those with endowments between 50 and 100 million euros, 35 percent of those between 100 and 500 million euros, 45 percent of those between 500 million and 1 billion euros, and ultimately more than 60 percent of those above 1 billion euros. The available data, which are both public and extremely detailed, show unambiguously that it is these alternative investment strategies that enable the very largest endowments to obtain real returns of close to 10 percent a year, while smaller endowments must make do with 5 percent.
In other words, if you're a normal person with a 401(k), you'd be lucky to clear inflation with your nest egg. If you're a gazillionaire, you can hire financial talent who'll get you 10 points even in the worst market, and you can pay them hundreds of millions out of chump change.
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The low point was attained in the 1970s: after several decades of small inheritances and accumulation of new wealth, inherited capital accounted for just over 40 percent of total private capital. For the first time in history (except in new countries), wealth accumulated in the lifetime of the living constituted the majority of all wealth: nearly 60 percent. It is important to realize two things: first, the nature of capital effectively changed in the postwar period, and second, we are just emerging from this exceptional period. Nevertheless, we are now clearly out of it: the share of inherited wealth in total wealth has grown steadily since the 1970s. Inherited wealth once again accounted for the majority of wealth in the 1980s, and according to the latest available figures it represents roughly two-thirds of private capital in France in 2010, compared with barely one-third of capital accumulated from savings. In view of today's very high inheritance flows, it is quite likely, if current trends continue, that the share of inherited wealth will continue to grow in the decades to come, surpassing 70 percent by 2020 and approaching 80 percent in the 2030s.
Piketty says that the "normal" state of affairs in which anyone has a crack at fame and fortune is a blip in the long run of human history that has been largely characterized by a self-serving, greedy hereditary aristocracy whose comfort was only possible because of the enmiseration of nearly everyone else. Absent some kind of extraordinary intervention, hereditary wealth will reassert itself as the primary political mover in our world. The people at the top have always convinced themselves that they live in a meritocracy, because hey, they're the best people they know, and they're at the top of the pyramid. QED. But this story is impossible to square with the data:
The fact that income inequality in the United States in 2000–2010 attained a level higher than that observed in the poor and emerging countries at various times in the past — for example, higher than in India or South Africa in 1920–1930, 1960–1970, and 2000–2010 — also casts doubt on any explanation based solely on objective inequalities of productivity. Is it really the case that inequality of individual skills and productivities is greater in the United States today than in the half-illiterate India of the recent past (or even today) or in apartheid (or postapartheid) South Africa? If that were the case, it would be bad news for US educational institutions, which surely need to be improved and made more accessible but probably do not deserve such extravagant blame…
…Since it is impossible to give a precise estimate of each manager's contribution to the firm's output, it is inevitable that this process yields decisions that are largely arbitrary and dependent on hierarchical relationships and on the relative bargaining power of the individuals involved. It is only reasonable to assume that people in a position to set their own salaries have a natural incentive to treat themselves generously, or at the very least to be rather optimistic in gauging their marginal productivity. To behave in this way is only human, especially since the necessary information is, in objective terms, highly imperfect. 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." In practice, the invisible hand does not exist, any more than "pure and perfect" competition does, and the market is always embodied in specific institutions such as corporate hierarchies and compensation committees.
…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. The logic of r > g implies that the entrepreneur always tends to turn into a rentier. Even if this happens later in life, the phenomenon becomes important as life expectancy increases. The fact that a person has good ideas at age thirty or forty does not imply that she will still be having them at seventy or eighty, yet her wealth will continue to increase by itself. Or it can be passed on to the next generation and continue to increase there. Nineteenth-century French economic elites were creative and dynamic entrepreneurs, but the crucial fact remains that their efforts ultimately — and largely unwittingly — reinforced and perpetuated a society of rentiers owing to the logic of r > g.
This inequality of access also seems to exist at the top of the economic hierarchy, not only because of the high cost of attending the most prestigious private universities (high even in relation to the income of upper-middle-class parents) but also because admissions decisions clearly depend in significant ways on the parents' financial capacity to make donations to the universities. For example, one study has shown that gifts by graduates to their former universities are strangely concentrated in the period when the children are of college age. By comparing various sources of data, moreover, it is possible to estimate that the average income of the parents of Harvard students is currently about $450,000, which corresponds to the average income of the top 2 percent of the US income hierarchy. Such a finding does not seem entirely compatible with the idea of selection based solely on merit. The contrast between the official meritocratic discourse and the reality seems particularly extreme in this case. The total absence of transparency regarding selection procedures should also be noted.
Remember, hereditary wealth isn't just unfair, it's also an invitation to laziness. Just as competition disciplines firms, so to does taxation discipline dynasties:
A classic argument in favor of a capital tax should not be neglected. It relies on a logic of incentives. The basic idea is that a tax on capital is an incentive to seek the best possible return on one's capital stock. Concretely, a tax of 1 or 2 percent on wealth is relatively light for an entrepreneur who manages to earn 10 percent a year on her capital. By contrast, it is quite heavy for a person who is content to park her wealth in investments returning at most 2 or 3 percent a year. According to this logic, the purpose of the tax on capital is thus to force people who use their wealth inefficiently to sell assets in order to pay their taxes, thus ensuring that those assets wind up in the hands of more dynamic investors.
There have been a number of critcisms leveled at Piketty since the English translation of Capital, and, like the Financial Times broadside, most of these have been unserious — coming from people who clearly haven't read the book carefully enough. But there's one criticism I have a lot of time for: Suresh Naidu's critique of the politics of Piketty's analysis. Piketty treats the rate of return on capital as largely financial, while Naidu argues (convincingly) that it's political. The rules of property and the willingness of the state to support those rules through everything from guard labor to anti-default/anti-inflationary policies are political decisions, not laws of nature, and they are the crux of the rate of return. And since the relative positions of the rate of return versus the rate of growth (r > g) is at the crux of his theory, this is a significant challenge to his analysis.
Piketty, in Naidu's view, is limited by his unwillingness to challenge capitalism itself. As Naidu says:
This is where Piketty’s Walrasian conventions dampen his contribution: he discusses the first, but not the second. It’s like saying slavery is an inequality of assets between slaves and slaveholders without describing the plantation.
Even Adam Smith suggested measuring a person’s income by the “quantity of that labor which he can command.” This has normally been taken to mean income of the rich relative to the wage. But it also means looking at “command”: what privileges and obligations can one demand from the soul purchased (or rented)?
An economy that allows indentured labor means that wealth can purchase more power over people; an economy with robust union contracts means that capital is trammeled in its control over the shop floor. From sexual harassment on the job to the indignities of gentrification and nonprofit funding, a world of massive inequality is a world where rich people get to shape environments that everybody else has to accept.
Piketty repeatedly announces that politics plays a large role in the distribution of income. But he neglects that the distribution of income and wealth also generates inequalities of larger privileges and prerogatives; wealth inequality together with a thoroughly commodified society enables a million mini-dictatorships, wherein the political power of the rich is exercised through the market itself.
Piketty is locked in a curious dance with Marx — there is a spectre haunting Capital in the 21st Century and it is Kapital — the Marxist critique of power-dynamics themselves. Piketty wants desperately to salvage capitalism, even if that means proposing something that every capitalist will hate: a global wealth tax.
(Image: Piketty in Cambridge, Sue Gardner, CC-BY-SA)
-Cory Doctorow
