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Book Review, Capital in the Twenty-First Century

By       Message Reza varjavand       (Page 1 of 2 pages)     Permalink

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Numerous books have been written about economic inequality, especially in the aftermath of the Great Recession; however, none of them has received as much attention from the academic community as Capital in the Twenty-First Century by Professor Thomas Piketty. The book was initially published in France in 2013 and translated into English and published in the U.S. in 2014. It is a comprehensive voluminous book of 685 pages and it is destined to become a classic. The depth and the breadth of analyses and the detailed data on income inequality since the 18th century that the author has presented in this book are mesmerizing.

In essence, Dr. Piketty argues, along with many other economists, that inequality is not bad per se as long as it is not intense and works for the common good of the economy. However, the extreme inequality that often stems from unfettered capitalism is not only an economic problem; it is also a social, moral, and political problem.

Needless to say, economic inequality is a global phenomenon that has followed a U-shaped pattern since the early 20th century. Before the Great Depression, the share of income going to the top 10% of the U.S. population was 45%; this percentage then declined to an average of less than 30% between 1940 and 1980 and climbed back up in post-1980 to that of the pre depression era. A similar pattern can be observed in other wealthy countries. As a result, we may be moving toward a "patrimonial capitalism" in which the super-rich muster an immense controlling power. The author classifies the forces that influence the distribution of income into two groups: the convergence forces and the divergence forces. The convergence forces are those that help to alleviate inequality. They include technological advancements that weaken the concentration of economic power, the dissemination of information and knowledge, investment in education and training, the increasing economic ties among nations, as well as a favorable transparent system of public policy. On the other hand, there are forces of divergence reinforcing inequality and causing the concentration of wealth and capital resources in the hands of few. Under such a system, capitalists become rentiers who can amass a larger share of the national income without contributing much to it.

The salient feature of this book is its worldwide approach and the comprehensive data on distribution of wealth and income since the 18th century based on tax records for major industrialized nations including France, England, Germany, Japan, and the United States. Dr. Piketty believes that examination of historical episodes such as wars, the Industrial Revolution, and changes in political ideology are also crucial to his investigation because they have actually had deep impact on income distribution.

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Dr. Piketty argues that inequality has two dimensions, inequality in distribution of income for labor and inequality in distribution of income for capital, and the total inequality is equal to labor inequality plus capital inequality. Although a substantial portion of income goes to labor, earnings from capital has been a dominating force. Its rate of return (r) has been rising much faster than the overall growth of the economy (g). That is, r>g. The disproportionate distribution of capital income is especially worrisome because of "savings and investment behavior, laws governing gift giving an inheritance, and the operation of real estate and financial markets." He writes that the distribution of wealth is more egalitarian today than it was a century ago in Europe. In comparison to Europe, when it comes to income inequality in the United States, some very rich individuals gained their fortune from hard work and utilizing their talent rather than from inheritance or cronyism as may be true of other countries. In other words, inequality in the U.S. was partially driven by the advent of "super salaries." Historically, there has been a dynamic shift in the long term trajectory of the share of income that goes into capital and labor. Noteworthy, despite the Great Recession of 2008, the share of capital did not drop as one may expect because of the many factors that are examined meticulously throughout this book.

Dr. Piketty points out that he uses the word capital and wealth interchangeably, and he has devoted an entire chapter to the definition of wealth and ownership of capital, including intangible and financial assets. He has devoted an entire chapter to the description of and the sources of capital, different types of wealth including the endowment of natural resources as well as man-made resources, and inheritances and their historical evolution.

The author demonstrates how the ratio of capital to income has remained steadily high at 5 to six times the value of the national income in industrialized nations where most of the stock of capital is owned by the private sector. Specifically, he shows that while the per capita national income for industrialized countries ranges from 30,000 to 35,000 Euros, the ownership of capital is six times as high, 180,000 Euros per person. He declared that if the capital income ratio of 600% and historical rate of return on capital is 5%, as he believes they are, then the return on capital of 30% (5 x 6) "For example, in the wealthy countries around 2010, income from capital (profits, interests, dividends, rents, etc.) generally hovered around 30% of national income."

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The extent of global inequality can be seen at a glance in Table 1.1 on page 63 of the book. This table shows that the amount of monthly income ranges from 200 to 300 Euros for poor countries and 2,500 to 3,000 Euros for North America and Europe. Wealthy countries typically receive higher income than their level of output because they earn additional income from capital invested in other countries. Essentially, low income countries can benefit from participating in globalization that helps them to catch up with the rest of the world. Dr. Piketty strongly supports the participation in international trade as an effective tool to ease inequality. "Autarky [he emphasizes] has never promoted prosperity."

As an alleviating factor, many emerging countries have been growing at a much faster rate than developed nations in recent decades; China is at the top with an annual average growth rate of nearly 8%. Additionally, because of this gap, these countries will eventually catch up to the developed nations, but it will take several years for that to happen. The catch up process will no doubt be facilitated by investment in emerging nations, especially by rich countries, and the international exchange of knowledge, technology transfer, and access to financial resources.

In chapter two, Dr. Piketty focuses mainly on the growth of population, especially in poor countries. Increase in population is unpredictable, he says, and the fertility rate changes in various countries with the African continent having the highest rate. Not only is quantitative change in population an important factor in inequality, but also qualitative changes play a role, such as increasing life expectancy, changes in the proportion of the elderly population, and the extent of migration. Given the fact that the cost of raising a child is skyrocketing, the decision, of especially younger couples, to have children is now becoming an economic issue, particularly in rich countries. The disproportionate increase in population in poor countries results in declining per capita income and output, further aggravating the problems of income gap and poverty. He makes no attempt to project the population of the world for the next century nor makes a gloomy prediction as Thomas Malthus did; however, he has thoroughly examined the impact of population explosion on inequality and standard of living. Understandably, a family with 10 children will leave poorer offspring than a family with three because as the number of children increases, the limited supply of food and other resources would need to be spread over a larger number of children.

In chapter three, Dr. Piketty examines distribution of income and wealth and the dynamics of capital and its evolution since the 18th century, from old fashion forms like ownership of land and government bonds to modern varieties, in an attempt to explore the sources and the consequences of inequality and its impact for the 21st century. Primarily in industrial nations, the so-called divergence and convergence forces have been identified and their impact on income and wealth distribution has been examined from an historical perspective. Even though the diffusion of knowledge and information and increasing international economic connections have resulted in the amelioration of inequality during our modern history, the divergence factors have worked in the opposite fashion and in favor of owners of capital. This is a serious problem that poses a threat to the cohesiveness of a nation by creating divisions and compartmentalization in a society.

The author insists that inequality results from a high rate of return on capital, which has been steadily above the growth rate of income and output (r>g) in industrialized nations. Such a development, and he expects this to be continued in the next century, could be potentially threatening to the world economy. Even though the world economy will continue to grow, the outcome of this growth will be mostly reaped by the top 10% of income earners. He projects that the world economy cannot grow more than 1.5% in the 21st century, but the same lopsided distribution of income and wealth will continue as long as the rate of return on capital, which he believes will continue to be between 4 to 5%, is above the projected rate of gross output, which is about 1 to 1.5%.

Economic inequality and its continuation in the long term can lead to more concentration of economic power in fewer hands and the eventual breakdown of the system unless countervailing forces weaken the inequality. The repeated theme of this book is that as long as r>g, the inequality will not only persist, it will also threaten democratic values. To avoid this appalling likelihood, we need to gain control of capitalism through tax and regulation.

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People in wealthy countries seem to have been unconcerned about inequality and the growing income gap. They simply invoke some social and political norms to justify it. They believe, for example, that high income is the reward for hard work, risk taking, and talent; or, taxing the wealthy kills jobs because rich people are "job creators." Even though undue income inequality is a threat to the fabric of capitalism, it seems economists have not paid serious attention to the distribution of income and wealth for a long time, expecting that the doctrine of balanced growth, which was proposed by Simon Kuznets earlier in the 20th century, would materialize. It did not. Although the author does not predict an apocalyptic consequence as predicted by Karl Marx or Thomas Malthus--their predictions did not fully take shape either simply because of countervailing powers and the built-in system of checks and balances inherent in a market economy--Dr. Piketty reminds us that the destabilizing consequences of inequality, nonetheless, should not be overlooked.

Even though after WWII the tax rate on capital increased in the U.S., it quickly dissipated since the 1980s because of changes in the ideological and political scenes in the U.S., beginning with the Reagan administration. The empirical evidence provided by the author shows that despite historical long-term volatility of growth rate and income, the rate of return on capital has remained steadily high; however, this should eventually change. According to his calculations, the ratio of capital to income will continue to grow over the 21st century to an average of seven, or 700% of national income (g = 1.5%, s (saving) = 10%, B = 10/1.5 = 7), and that is alarming and a cause for remedial action.

Dr. Piketty's recommendation is a progressive global tax on capital, a tax heavy enough to push the return on capital at par with or below the growth rate of income and output. He admits that this idea may not be popular and even hard to implement. It is, however, a good starting point and deserves thoughtful attention. The tax on capital alone, he admits, cannot solve the inequality problem; such a policy should be supplemented by a sound regulatory system, investment in education and training, and reform in the minimum wage rate.

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Reza Varjavand (Ph.D., University of Oklahoma) is associate professor of economics and finance at the Graham School of management, Saint Xavier University, of Chicago. He has been an avid participant in many professional organizations and active in (more...)

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