Capital in the Twenty First Century

Thomas Piketty, translated from French by Arthur Goldhammer, Capital in the Twenty-First Century, (Cambridge, MA: Belknap Press of Harvard University Press, 2014) 577 pages, $39.95.

Capital in the Twenty-First Century by French economist Thomas Piketty studies and examines the only controversial question in economics: the distribution of income and wealth. It studies distribution between capital and labor, among wage earners, among capital owners, between countries and over several hundred years.

Few authors of economics books more than 500 pages with analytical foundations and a reflective data driven discussion attract attention in the popular media as Piketty has done. Paul Krugman comes to mind, but his notoriety comes in small doses from his New York Times editorials more than his books. None of Krugman’s books resemble Piketty’s except they both challenge the status quo and say things America’s wealthy like suppressed.

The book has four parts divided into sixteen chapters and subchapters that builds an economic framework and applies it to data from national income accounts. Data and discussion applies to France, Great Britain, Germany and the United States and a few more countries where data is available. Piketty develops his arguments after an expansive and rambling thirty-eight page introduction that has nearly as much to say about Piketty and the economics fraternity as it does about capital in the twenty first century.

The two part I chapters define terms from National Income Accounts: national income, capital, wealth, the capital to income ratio and growth of output, population, and per capita output. Piketty applies these terms in his first fundamental law of capitalism, which is the accounting identity α = r x β, where alpha(α) equals capital’s share of national income or the capital-labor split, r is the percentage rate of return on capital and Beta(β) is a ratio equal to the value of capital necessary to generate a years worth of national income.

The part II chapters develop an expanded discussion of Beta(β), the capital-income ratio already introduced. Here he applies his second fundamental law of capitalism: Beta(β) = s/g, where s is the percentage of net private saving and g is a percentage growth in national income. Economist readers will recognize this second fundamental law as a clever adaptation of market growth theory. Long ago economists theorized growth of national income depended on the saving rate multiplied by the ratio of income to capital, or g = s x (1/ β). Using the rules of algebra Piketty converted the equation to make the capital to income ratio depend on the ratio s/g. The conversion gives him a second way to study inequality.

Piketty builds his inequality discussion around these two fundamental laws. Several chapter five tables give example growth rates and saving rates in eight rich countries including the United States for the years 1970 to 2010. Both fundamental laws generate ratios to allow inter-country and inter-temporal comparisons of inequality. The data suggest the richer countries can expect s greater than g and r greater than g over long periods that can generate an ever higher capital to income ratio. If r = 5% and g = 1% then the wealthy have to consume at least 80 percent of their high incomes or capital will grow faster than national income and inequality will get worse.

Part II chapters report, chart and discuss the results for national economies where Piketty concludes that inequality does not necessarily diminish from market forces and can get much worse over time. This main or primary conclusion is also summarized in the introduction and again in the brief conclusion. Readers can get the main point with just the introduction and conclusion as I have heard people say they did, but only by missing extensive historical discussion and the much more detailed breakdown of inequality that comes in the part III material.

Keep in mind that Piketty has spent countless hours mastering the intricacies of national income accounting in a way that few American economists do. Our Federal government produces fine data for the U.S. economy but American economists still prefer theorizing while Piketty has built and maintains massive multi-country data files to test if its all true, or needs a few adjustments.

Part III makes extensive use of these data files in discussions that use forty percent of the book to cover inequality for combined capital and labor income, for labor income, for capital income, for inheritance and for wealth. The first of the six chapters in the structure of inequality section gives an introductory warm up to the others.

Piketty begins his warm up chapter with a plot summary from the Honore de Balzac novel, Pere Goriot. Occasional allusions to literature and history give a nice break to otherwise continuous technical material. The plot and characters in Pere Goriot contrast the inequality of class and culture from France around 1835, but you too may feel the parallel to the fading meritocracy of 2014. Then he summarizes and defines terms for the low, medium and high inequality he describes in more detail in the chapters that follow.

These remaining part III chapters build discussion from numerous charts that measure inequality of income and wealth for different countries over time, mostly 1910 to 2010 for income inequality and 1810-2010 for wealth inequality. Most charts plot the share of the top 10 percent of income, the decile, or 1 percent of income, the centile, against time, and similarly for wealth.

In the United States of the late 1920’s the top 10 percent had almost 50 percent of national income. That share declined in the depression and stayed 32 to 35 percent until 1980, but climbed back to 50 percent by 2010.

Wealth distributions generate greater inequality than income because the bottom half of a country’s population typically has no wealth at all. The U.S. share of the top 10 percent of wealth reached a high of 80 per cent in 1910. It dropped to 65 percent by 1950, before beginning a slow by steady climb to 70 percent in 2010.

One of many Piketty interpretations included “. . . 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 . . .”

Part IV has four chapters in a hundred page discussion of policy that repeatedly returns to the need for progressive taxation to correct for inequality. At page 497 he writes “The progressive tax is indispensable for making sure that everyone benefits from globalization, and the increasingly glaring absence of progressive taxation may ultimately undermine support for a globalized economy.”

He argues in favor of a progressive capital tax, but he offers support for, and historical discussion of, progressive income and inheritance taxes. He warns the rich progressive taxes offer a way to correct for inequality without undermining private property and the forces of competition.

The book is unnecessarily long in part because Piketty, or his editor, adopted conventions common to college textbooks. These are repeated plan of the book sections that give a roadmap of material yet to come and excessive introduction and summary. “I want to tell you about something important, but I can’t do that until I tell you about this, and then this, and then I will get back to that.” Textbook editors love this stuff but it is hard to follow or understand what you will read about later. I think of it as surplus.

More pages are added with material intended only for economists. Non-economists should notice in the introduction where he tells readers he was hired to teach at a university near Boston after finishing graduate school. He left off the name, MIT. After three years he went back to France. Then he writes “the discipline of economics has yet to get over its childish passion for mathematics and for purely theoretical and often highly ideological speculation, at the expense of historical research and collaboration with the other social sciences.”

Piketty learned at MIT that economics education at American colleges walks a fine line between education and indoctrination. American economists are expected to conform and confirm that capitalism and free enterprise bring ideal results. They theorize in ever more complex ways because they have nothing else to do. They avoid data that contradicts theory or career opportunities decline, or disappear.

His experience at MIT clearly left him with the urge to take a few pokes at American economists. After page 200 he brings in the Cobb-Douglas Production function, the elasticity of substitution, the Roy Harrod, Evsey Domar and Robert Solow growth theories, marginal productivity theory, Franco Modigliani’s Life Cycle theory and a few more; all standard fare in economics graduate programs at American Colleges. He can’t resist reporting his data contradict these long established market theories, but non-economists can skip this insider stuff.

Still there are many things to admire about this book that I can recommend it to non-economists. Non-economists can follow the principal arguments if they read carefully, study the charts, and doggedly keep in mind the difference between stocks and flows after he defines them in Part I and gives examples.

Piketty has attracted attention in the United States similar to British economist John Maynard Keynes after he published his General Theory of Employment, Interest and Money way back in 1936. The General Theory is not a general theory at all, but an abstract discussion of special cases in which Keynes describes conditions where markets and the economy break down and need an active policy of correction, even, god forbid, a policy of government spending.

Politicians and the Chamber of Commerce still attack and condemn Keynes after 78 years, but only a few of them care enough to read or study what he wrote; they just dislike his conclusions. It is early in the Piketty discussion but there are plenty of wealthy and well to do ready to condemn his conclusions without reading what he wrote. Keynes wrote only for economists while Piketty tries, somewhat erratically, for a broader audience. With some extra effort you can decide for yourself. It will be slow going, but forge ahead and the like.