Paul Krugman
Source: NYREV
Thomas Piketty, professor at the Paris School of Economics, isn’t a
household name, although that may change with the English-language
publication of his magnificent, sweeping meditation on inequality,
Capital in the Twenty-First Century.
Yet his influence runs deep. It has become a commonplace to say that we
are living in a second Gilded Age—or, as Piketty likes to put it, a
second Belle Époque—defined by the incredible rise of the “one percent.”
But it has only become a commonplace thanks to Piketty’s work. In
particular, he and a few colleagues (notably Anthony Atkinson at Oxford
and Emmanuel Saez at Berkeley) have pioneered statistical techniques
that make it possible to track the concentration of income and wealth
deep into the past—back to the early twentieth century for America and
Britain, and all the way to the late eighteenth century for France.
The
result has been a revolution in our understanding of long-term trends
in inequality.
Before this revolution, most discussions of economic
disparity more or less ignored the very rich. Some economists (not to
mention politicians) tried to shout down any mention of inequality at
all: “Of the tendencies that are harmful to sound economics, the most
seductive, and in my opinion the most poisonous, is to focus on
questions of distribution,” declared Robert Lucas Jr. of the University
of Chicago, the most influential macroeconomist of his generation, in
2004. But even those willing to discuss inequality generally focused on
the gap between the poor or the working class and the merely well-off,
not the truly rich—on college graduates whose wage gains outpaced those
of less-educated workers, or on the comparative good fortune of the top
fifth of the population compared with the bottom four fifths, not on the
rapidly rising incomes of executives and bankers.
It therefore
came as a revelation when Piketty and his colleagues showed that incomes
of the now famous “one percent,” and of even narrower groups, are
actually the big story in rising inequality. And this discovery came
with a second revelation: talk of a second Gilded Age, which might have
seemed like hyperbole, was nothing of the kind. In America in particular
the share of national income going to the top one percent has followed a
great U-shaped arc. Before World War I the one percent received around a
fifth of total income in both Britain and the United States. By 1950
that share had been cut by more than half. But since 1980 the one
percent has seen its income share surge again—and in the United States
it’s back to what it was a century ago.
Still, today’s economic elite is very different from that of the
nineteenth century, isn’t it? Back then, great wealth tended to be
inherited; aren’t today’s economic elite people who earned their
position? Well, Piketty tells us that this isn’t as true as you think,
and that in any case this state of affairs may prove no more durable
than the middle-class society that flourished for a generation after
World War II. The big idea of
Capital in the Twenty-First Century
is that we haven’t just gone back to nineteenth-century levels of
income inequality, we’re also on a path back to “patrimonial
capitalism,” in which the commanding heights of the economy are
controlled not by talented individuals but by family dynasties.
It’s
a remarkable claim—and precisely because it’s so remarkable, it needs
to be examined carefully and critically. Before I get into that,
however, let me say right away that Piketty has written a truly superb
book. It’s a work that melds grand historical sweep—when was the last
time you heard an economist invoke Jane Austen and Balzac?—with
painstaking data analysis. And even though Piketty mocks the economics
profession for its “childish passion for mathematics,” underlying his
discussion is a tour de force of economic modeling, an approach that
integrates the analysis of economic growth with that of the distribution
of income and wealth. This is a book that will change both the way we
think about society and the way we do economics.
1.
What
do we know about economic inequality, and about when do we know it?
Until the Piketty revolution swept through the field, most of what we
knew about income and wealth inequality came from surveys, in which
randomly chosen households are asked to fill in a questionnaire, and
their answers are tallied up to produce a statistical portrait of the
whole. The international gold standard for such surveys is the annual
survey conducted once a year by the Census Bureau. The Federal Reserve
also conducts a triennial survey of the distribution of wealth.
These
two surveys are an essential guide to the changing shape of American
society. Among other things, they have long pointed to a dramatic shift
in the process of US economic growth, one that started around 1980.
Before then, families at all levels saw their incomes grow more or less
in tandem with the growth of the economy as a whole. After 1980,
however, the lion’s share of gains went to the top end of the income
distribution, with families in the bottom half lagging far behind.
Historically,
other countries haven’t been equally good at keeping track of who gets
what; but this situation has improved over time, in large part thanks to
the efforts of the Luxembourg Income Study (with which I will soon be
affiliated). And the growing availability of survey data that can be
compared across nations has led to further important insights. In
particular, we now know both that the United States has a much more
unequal distribution of income than other advanced countries and that
much of this difference in outcomes can be attributed directly to
government action. European nations in general have highly unequal
incomes from market activity, just like the United States, although
possibly not to the same extent. But they do far more redistribution
through taxes and transfers than America does, leading to much less
inequality in disposable incomes.
Yet for all their usefulness,
survey data have important limitations. They tend to undercount or miss
entirely the income that accrues to the handful of individuals at the
very top of the income scale. They also have limited historical depth.
Even US survey data only take us to 1947.
Enter Piketty and his
colleagues, who have turned to an entirely different source of
information: tax records. This isn’t a new idea. Indeed, early analyses
of income distribution relied on tax data because they had little else
to go on. Piketty et al. have, however, found ways to merge tax data
with other sources to produce information that crucially complements
survey evidence. In particular, tax data tell us a great deal about the
elite. And tax-based estimates can reach much further into the past: the
United States has had an income tax since 1913, Britain since 1909.
France, thanks to elaborate estate tax collection and record-keeping,
has wealth data reaching back to the late eighteenth century.
Exploiting
these data isn’t simple. But by using all the tricks of the trade, plus
some educated guesswork, Piketty is able to produce a summary of the
fall and rise of extreme inequality over the course of the past century.
It looks like Table 1 on this page.
As I said, describing our
current era as a new Gilded Age or Belle Époque isn’t hyperbole; it’s
the simple truth. But how did this happen?
2.
Piketty throws down the intellectual gauntlet right away, with his book’s very title:
Capital in the Twenty-First Century. Are economists still allowed to talk like that?
It’s
not just the obvious allusion to Marx that makes this title so
startling. By invoking capital right from the beginning, Piketty breaks
ranks with most modern discussions of inequality, and hearkens back to
an older tradition.
The general presumption of most inequality
researchers has been that earned income, usually salaries, is where all
the action is, and that income from capital is neither important nor
interesting. Piketty shows, however, that even today income from
capital, not earnings, predominates at the top of the income
distribution. He also shows that in the past—during Europe’s Belle
Époque and, to a lesser extent, America’s Gilded Age—unequal ownership
of assets, not unequal pay, was the prime driver of income disparities.
And he argues that we’re on our way back to that kind of society. Nor is
this casual speculation on his part. For all that
Capital in the Twenty-First Century
is a work of principled empiricism, it is very much driven by a
theoretical frame that attempts to unify discussion of economic growth
and the distribution of both income and wealth. Basically, Piketty sees
economic history as the story of a race between capital accumulation and
other factors driving growth, mainly population growth and
technological progress.
To be sure, this is a race that can have
no permanent victor: over the very long run, the stock of capital and
total income must grow at roughly the same rate. But one side or the
other can pull ahead for decades at a time. On the eve of World War I,
Europe had accumulated capital worth six or seven times national income.
Over the next four decades, however, a combination of physical
destruction and the diversion of savings into war efforts cut that ratio
in half. Capital accumulation resumed after World War II, but this was a
period of spectacular economic growth—the
Trente Glorieuses, or
“Glorious Thirty” years; so the ratio of capital to income remained low.
Since the 1970s, however, slowing growth has meant a rising capital
ratio, so capital and wealth have been trending steadily back toward
Belle Époque levels. And this accumulation of capital, says Piketty,
will eventually recreate Belle Époque–style inequality unless opposed by
progressive taxation.
Why? It’s all about
r versus
g—the rate of return on capital versus the rate of economic growth.
Just about all economic models tell us that if
g
falls—which it has since 1970, a decline that is likely to continue due
to slower growth in the working-age population and slower technological
progress—
r will fall too. But Piketty asserts that
r will fall less than
g.
This doesn’t have to be true. However, if it’s sufficiently easy to
replace workers with machines—if, to use the technical jargon, the
elasticity of substitution between capital and labor is greater than
one—slow growth, and the resulting rise in the ratio of capital to
income, will indeed widen the gap between
r and
g. And Piketty argues that this is what the historical record shows will happen.
If
he’s right, one immediate consequence will be a redistribution of
income away from labor and toward holders of capital. The conventional
wisdom has long been that we needn’t worry about that happening, that
the shares of capital and labor respectively in total income are highly
stable over time. Over the very long run, however, this hasn’t been
true. In Britain, for example, capital’s share of income—whether in the
form of corporate profits, dividends, rents, or sales of property, for
example—fell from around 40 percent before World War I to barely 20
percent circa 1970, and has since bounced roughly halfway back. The
historical arc is less clear-cut in the United States, but here, too,
there is a redistribution in favor of capital underway. Notably,
corporate profits have soared since the financial crisis began, while
wages—including the wages of the highly educated—have stagnated.
A
rising share of capital, in turn, directly increases inequality,
because ownership of capital is always much more unequally distributed
than labor income. But the effects don’t stop there, because when the
rate of return on capital greatly exceeds the rate of economic growth,
“the past tends to devour the future”: society inexorably tends toward
dominance by inherited wealth.
Consider how this
worked in Belle Époque Europe. At the time, owners of capital could
expect to earn 4–5 percent on their investments, with minimal taxation;
meanwhile economic growth was only around one percent. So wealthy
individuals could easily reinvest enough of their income to ensure that
their wealth and hence their incomes were growing faster than the
economy, reinforcing their economic dominance, even while skimming
enough off to live lives of great luxury.
And what happened when
these wealthy individuals died? They passed their wealth on—again, with
minimal taxation—to their heirs. Money passed on to the next generation
accounted for 20 to 25 percent of annual income; the great bulk of
wealth, around 90 percent, was inherited rather than saved out of earned
income. And this inherited wealth was concentrated in the hands of a
very small minority: in 1910 the richest one percent controlled 60
percent of the wealth in France; in Britain, 70 percent.
No
wonder, then, that nineteenth-century novelists were obsessed with
inheritance. Piketty discusses at length the lecture that the scoundrel
Vautrin gives to Rastignac in Balzac’s
Père Goriot, whose gist is
that a most successful career could not possibly deliver more than a
fraction of the wealth Rastignac could acquire at a stroke by marrying a
rich man’s daughter. And it turns out that Vautrin was right: being in
the top one percent of nineteenth-century heirs and simply living off
your inherited wealth gave you around two and a half times the standard
of living you could achieve by clawing your way into the top one percent
of paid workers.
You might be tempted to say that modern society
is nothing like that. In fact, however, both capital income and
inherited wealth, though less important than they were in the Belle
Époque, are still powerful drivers of inequality—and their importance is
growing. In France, Piketty shows, the inherited share of total wealth
dropped sharply during the era of wars and postwar fast growth; circa
1970 it was less than 50 percent. But it’s now back up to 70 percent,
and rising. Correspondingly, there has been a fall and then a rise in
the importance of inheritance in conferring elite status: the living
standard of the top one percent of heirs fell below that of the top one
percent of earners between 1910 and 1950, but began rising again after
1970. It’s not all the way back to Rasti-gnac levels, but once again
it’s generally more valuable to have the right parents (or to marry into
having the right in-laws) than to have the right job.
And this may only be the beginning. Figure 1 on this page shows Piketty’s estimates of global
r and
g
over the long haul, suggesting that the era of equalization now lies
behind us, and that the conditions are now ripe for the reestablishment
of patrimonial capitalism.
Given this picture, why does inherited wealth play as small a
part in today’s public discourse as it does? Piketty suggests that the
very size of inherited fortunes in a way makes them invisible: “Wealth
is so concentrated that a large segment of society is virtually unaware
of its existence, so that some people imagine that it belongs to surreal
or mysterious entities.” This is a very good point. But it’s surely not
the whole explanation. For the fact is that the most conspicuous
example of soaring inequality in today’s world—the rise of the very rich
one percent in the Anglo-Saxon world, especially the United
States—doesn’t have all that much to do with capital accumulation, at
least so far. It has more to do with remarkably high compensation and
incomes.
3.
Capital in the Twenty-First Century is,
as I hope I’ve made clear, an awesome work. At a time when the
concentration of wealth and income in the hands of a few has resurfaced
as a central political issue, Piketty doesn’t just offer invaluable
documentation of what is happening, with unmatched historical depth. He
also offers what amounts to a unified field theory of inequality, one
that integrates economic growth, the distribution of income between
capital and labor, and the distribution of wealth and income among
individuals into a single frame.
And yet there is one thing that
slightly detracts from the achievement—a sort of intellectual sleight of
hand, albeit one that doesn’t actually involve any deception or
malfeasance on Piketty’s part. Still, here it is: the main reason there
has been a hankering for a book like this is the rise, not just of the
one percent, but specifically of the American one percent. Yet that
rise, it turns out, has happened for reasons that lie beyond the scope
of Piketty’s grand thesis.
Piketty is, of course, too good and too
honest an economist to try to gloss over inconvenient facts. “US
inequality in 2010,” he declares, “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.” Indeed, what
we have seen in America and are starting to see elsewhere is something
“radically new”—the rise of “supersalaries.”
Capital still
matters; at the very highest reaches of society, income from capital
still exceeds income from wages, salaries, and bonuses. Piketty
estimates that the increased inequality of capital income accounts for
about a third of the overall rise in US inequality. But wage income at
the top has also surged. Real wages for most US workers have increased
little if at all since the early 1970s, but wages for the top one
percent of earners have risen 165 percent, and wages for the top 0.1
percent have risen 362 percent. If Rastignac were alive today, Vautrin
might concede that he could in fact do as well by becoming a hedge fund
manager as he could by marrying wealth.
What explains this
dramatic rise in earnings inequality, with the lion’s share of the gains
going to people at the very top? Some US economists suggest that it’s
driven by changes in technology. In a famous 1981 paper titled “The
Economics of Superstars,” the Chicago economist Sherwin Rosen argued
that modern communications technology, by extending the reach of
talented individuals, was creating winner-take-all markets in which a
handful of exceptional individuals reap huge rewards, even if they’re
only modestly better at what they do than far less well paid rivals.
Piketty
is unconvinced. As he notes, conservative economists love to talk about
the high pay of performers of one kind or another, such as movie and
sports stars, as a way of suggesting that high incomes really are
deserved. But such people actually make up only a tiny fraction of the
earnings elite. What one finds instead is mainly executives of one sort
or another—people whose performance is, in fact, quite hard to assess or
give a monetary value to.
Who determines what a corporate
CEO is worth? Well, there’s normally a compensation committee, appointed by the
CEO
himself. In effect, Piketty argues, high-level executives set their own
pay, constrained by social norms rather than any sort of market
discipline. And he attributes skyrocketing pay at the top to an erosion
of these norms. In effect, he attributes soaring wage incomes at the top
to social and political rather than strictly economic forces.
Now,
to be fair, he then advances a possible economic analysis of changing
norms, arguing that falling tax rates for the rich have in effect
emboldened the earnings elite. When a top manager could expect to keep
only a small fraction of the income he might get by flouting social
norms and extracting a very large salary, he might have decided that the
opprobrium wasn’t worth it. Cut his marginal tax rate drastically, and
he may behave differently. And as more and more of the supersalaried
flout the norms, the norms themselves will change.
There’s a lot
to be said for this diagnosis, but it clearly lacks the rigor and
universality of Piketty’s analysis of the distribution of and returns to
wealth. Also, I don’t think
Capital in the Twenty-First Century
adequately answers the most telling criticism of the executive power
hypothesis: the concentration of very high incomes in finance, where
performance actually can, after a fashion, be evaluated. I didn’t
mention hedge fund managers idly:
such people are paid based on their
ability to attract clients and achieve investment returns. You can
question the social value of modern finance, but the Gordon Gekkos out
there are clearly good at something, and their rise can’t be attributed
solely to power relations, although I guess you could argue that
willingness to engage in morally dubious wheeling and dealing, like
willingness to flout pay norms, is encouraged by low marginal tax rates.
Overall,
I’m more or less persuaded by Piketty’s explanation of the surge in
wage inequality, though his failure to include deregulation is a
significant disappointment. But as I said, his analysis here lacks the
rigor of his capital analysis, not to mention its sheer, exhilarating
intellectual elegance.
Yet we shouldn’t overreact to this. Even if
the surge in US inequality to date has been driven mainly by wage
income, capital has nonetheless been significant too. And in any case,
the story looking forward is likely to be quite different. The current
generation of the very rich in America may consist largely of executives
rather than rentiers, people who live off accumulated capital, but
these executives have heirs. And America two decades from now could be a
rentier-dominated society even more unequal than Belle Époque Europe.
But this doesn’t have to happen.
4.
At
times, Piketty almost seems to offer a deterministic view of history,
in which everything flows from the rates of population growth and
technological progress. In reality, however,
Capital in the Twenty-First Century
makes it clear that public policy can make an enormous difference, that
even if the underlying economic conditions point toward extreme
inequality, what Piketty calls “a drift toward oligarchy” can be halted
and even reversed if the body politic so chooses.
The key point is
that when we make the crucial comparison between the rate of return on
wealth and the rate of economic growth, what matters is the
after-tax
return on wealth. So progressive taxation—in particular taxation of
wealth and inheritance—can be a powerful force limiting inequality.
Indeed, Piketty concludes his masterwork with a plea for just such a
form of taxation. Unfortunately, the history covered in his own book
does not encourage optimism.
It’s true that during much of the
twentieth century strongly progressive taxation did indeed help reduce
the concentration of income and wealth, and you might imagine that high
taxation at the top is the natural political outcome when democracy
confronts high inequality. Piketty, however, rejects this conclusion;
the triumph of progressive taxation during the twentieth century, he
contends, was “an ephemeral product of chaos.” Absent the wars and
upheavals of Europe’s modern Thirty Years’ War, he suggests, nothing of
the kind would have happened.
As evidence, he offers the example
of France’s Third Republic. The Republic’s official ideology was highly
egalitarian. Yet wealth and income were nearly as concentrated, economic
privilege almost as dominated by inheritance, as they were in the
aristocratic constitutional monarchy across the English Channel. And
public policy did almost nothing to oppose the economic domination by
rentiers: estate taxes, in particular, were almost laughably low.
Why
didn’t the universally enfranchised citizens of France vote in
politicians who would take on the rentier class? Well, then as now great
wealth purchased great influence—not just over policies, but over
public discourse. Upton Sinclair famously declared that “it is difficult
to get a man to understand something when his salary depends on his not
understanding it.” Piketty, looking at his own nation’s history,
arrives at a similar observation: “The experience of France in the Belle
Époque proves, if proof were needed, that no hypocrisy is too great
when economic and financial elites are obliged to defend their
interest.”
The same phenomenon is visible today. In fact, a
curious aspect of the American scene is that the politics of inequality
seem if anything to be running ahead of the reality. As we’ve seen, at
this point the US economic elite owes its status mainly to wages rather
than capital income. Nonetheless, conservative economic rhetoric already
emphasizes and celebrates capital rather than labor—“job creators,” not
workers.
In 2012 Eric Cantor, the House majority leader, chose to mark Labor Day—Labor Day!—with a tweet honoring business owners:
Today, we celebrate those who have taken a risk, worked hard, built a business and earned their own success.
Perhaps chastened by the reaction, he reportedly felt the need to remind his colleagues at a subsequent
GOP
retreat that most people don’t own their own businesses—but this in
itself shows how thoroughly the party identifies itself with capital to
the virtual exclusion of labor.
Nor is this orientation toward
capital just rhetorical. Tax burdens on high-income Americans have
fallen across the board since the 1970s, but the biggest reductions have
come on capital income—including a sharp fall in corporate taxes, which
indirectly benefits stockholders—and inheritance. Sometimes it seems as
if a substantial part of our political class is actively working to
restore Piketty’s patrimonial capitalism. And if you look at the sources
of political donations, many of which come from wealthy families, this
possibility is a lot less outlandish than it might seem.
Piketty ends
Capital in the Twenty-First Century
with a call to arms—a call, in particular, for wealth taxes, global if
possible, to restrain the growing power of inherited wealth. It’s easy
to be cynical about the prospects for anything of the kind. But surely
Piketty’s masterly diagnosis of where we are and where we’re heading
makes such a thing considerably more likely. So
Capital in the Twenty-First Century
is an extremely important book on all fronts. Piketty has transformed
our economic discourse; we’ll never talk about wealth and inequality the
same way we used to.
