Thomas Piketty’s Capital in the 21st Century was finally released in English last Monday. It’s been hailed by many as one of those once-in-a-decade game changing books. Needless to say, I am very excited to read it. I’ve only read through the first fifty pages but the basic arguments are clear and already fascinating.
A narrative of economic development prominent today is that inequality is efficient (to an extent) and decreasing. Simon Kuznets observed in the middle of the twentieth century that in developed countries income inequality was decreasing and incomes were converging. He made it clear that this was only a correlation and he gave no declaration that this was inevitable or sustainable. Nonetheless, incomes were converging and many took this to be the beauty of capitalism: inequality may exist for a while but in the end we’re all better off.
In fact, convergence happened a century before. As the Industrial Revolution steadily expanded in the early 19th century, the vast majority of workers saw stagnant or falling wages next to exploding incomes of capital-owning individuals. David Ricardo and Karl Marx separately predicted different doomsday scenarios of a massive scarcity of land causing an unhealthy concentration of wealth and spiraling returns to capital causing a global revolution, respectively. Of course, neither apocalypse happened. In the last third of the 19th century, low-income individuals saw their wages rise, even if it occurred with massively increasing inequality.
Inequality increased in the roaring 20s until the Great Depression and World War II. From the time of these events until the early 1970s, income inequality decreased in most developed countries. The prevailing wisdom was that high inequality was followed by converging incomes in the natural progression of economic development.
What Piketty aims to drive home is that this convergence was the exception, not the rule. The Great Depression and Second World War caused the fortunes of the capitalists to implode. In fact, the financial crisis of late initially decreased inequality mostly because the rich had more to lose. After World War II, he argues, American policy was set up to reward broadly distributed growth instead of growth aimed at rewarding capitalists. Then, Reagan and Thatcher won and it was reversed. I should note here that Piketty is French, has been a member of the Socialist Party, and by virtue of being an inequality economist comes with certain biases. His points are largely data-driven but do need to be placed in the context of his background.
The fundamental identity he proposes in the book is that when r > g capitalism will breed unsustainable inequality. r is the rate of return on capital and g is economic growth. When the return to capital is bigger than the rate of economic growth, wealth accumulates in a concentrated set of hands. When an economy is slow-growing, past accumulated wealth has growing importance. Inequality is thus bound to increase and continue to do so. Developed economies have slowed since 1973 and r is becoming greater than g, in the eyes of Piketty. Further, g includes population growth and this has been close to zero in many countries. As he promises to show in later chapters, this identity need not be necessary. Policy can help change this to prevent a revolution or massive conflicts Ricardo and Marx once predicted.
I find the premises presented so far to be interesting for a number of reasons. One is that Piketty admits this divergence is not the result of any market failures. Rather, he finds the more perfect the capital market the more inequality a country will have. Second, I have always assumed a convergence of incomes in economic progress or, at the very least, figured that increasing inequality can be forgiven as long as everyone is better off in absolute terms. If this is not the natural path of capitalism, we are all in for a surprise of hurt. And third, a few writers have posited that we are in a Second Machine Age much like the first industrial revolution, where wages may stagnate now but eventually they will rise. Whereas the first industrial revolution replaced brawn with machines, now we are replacing brains. The gains from this may be realized by the masses eventually, but there could be a very rough transition period. I hope to see how Piketty addresses this and how fatalistic he sees a spiraling inequality.