The Dummies Guide to Piketty’s “Capital”


Dummies

From The Economist:

Thomas Piketty’s “Capital”, summarized in four paragraphs

IT IS the economics book taking the world by storm. “Capital in the Twenty-First Century”, written by the French economist Thomas Piketty, was published in French last year and in English in March of this year. The English version quickly became an unlikely bestseller, and it has prompted a broad and energetic debate on the book’s subject: the outlook for global inequality. Some reckon it heralds or may itself cause a pronounced shift in the focus of economic policy, toward distributional questions. This newspaper has hailed Mr Piketty as “the modern Marx” (Karl, that is). But what’s it all about?

“Capital” is built on more than a decade of research by Mr Piketty and a handful of other economists, detailing historical changes in the concentration of income and wealth. This pile of data allows Mr Piketty to sketch out the evolution of inequality since the beginning of the industrial revolution. In the 18th and 19th centuries western European society was highly unequal. Private wealth dwarfed national income and was concentrated in the hands of the rich families who sat atop a relatively rigid class structure. This system persisted even as industrialization slowly contributed to rising wages for workers. Only the chaos of the first and second world wars and the Depression disrupted this pattern. High taxes, inflation, bankruptcies, and the growth of sprawling welfare states caused wealth to shrink dramatically, and ushered in a period in which both income and wealth were distributed in relatively egalitarian fashion. But the shocks of the early 20th century have faded and wealth is now reasserting itself. On many measures, Mr Piketty reckons, the importance of wealth in modern economies is approaching levels last seen before the first world war.

From this history, Mr Piketty derives a grand theory of capital and inequality. As a general rule wealth grows faster than economic output, he explains, a concept he captures in the expression r > g (where r is the rate of return to wealth and g is the economic growth rate). Other things being equal, faster economic growth will diminish the importance of wealth in a society, whereas slower growth will increase it (and demographic change that slows global growth will make capital more dominant). But there are no natural forces pushing against the steady concentration of wealth [Blogger’s note: So, economic corrections and depressions are not natural market processes?]. Only a burst of rapid growth (from technological progress or rising population) or government intervention can be counted on to keep economies from returning to the “patrimonial capitalism” that worried Karl Marx. Mr Piketty closes the book by recommending that governments step in now, by adopting a global tax on wealth, to prevent soaring inequality contributing to economic or political instability down the road. [Ah, and who would get to disburse that global tax revenue?]

The book has unsurprisingly attracted plenty of criticism. Some wonder whether Mr Piketty is right to think the future will look like the past. Theory argues that it should become ever harder to earn a good return on wealth the more there is of it. And today’s super-rich mostly come by their wealth through work, rather than via inheritance. Others argue that Mr Piketty’s policy recommendations are more ideologically than economically driven and could do more harm than good. But many of the skeptics nonetheless have kind words for the book’s contributions, in terms of data and analysis. Whether or not Mr Piketty succeeds in changing policy, he will have influenced the way thousands of readers and plenty of economists think about these issues.

Dig deeper:
“Capital” is a great piece of scholarship, but a poor guide to policy (May 2014)
Why did the French version of “Capital” not make the same splash? (April 2014)
Revisiting an old argument about the impact of capitalism (January 2014)

I can’t actually recommend this summary of the argument as I think it fails to address some of the weaknesses of Piketty’s logic (for example, r is embodied in g but Piketty’s all-encompassing definition of capital inhibits our understanding of how r is composed and what are the disparate distributional effects of r and g.). His data do provide valuable insights, but how to interpret these is fraught with potential error and ideological bias. I’d have to say that Mr. Piketty possesses the same ability to predict the future as Mr. Marx. (And that’s not Groucho.)

Added comment by The Economist:
[Piketty] prescribes a progressive global tax on capital (an annual levy that could start at 0.1% and hits a maximum of perhaps 10% on the greatest fortunes). He also suggests a punitive 80% tax rate on incomes above $500,000 or so.

Here “Capital” drifts to the left and loses credibility. Mr Piketty asserts rather than explains why tempering wealth concentration should be the priority (as opposed to, say, boosting growth). He barely acknowledges any trade-offs or costs to his redistributionist agenda. Most economists, common sense and a lot of French businesspeople would argue that higher taxes on income and wealth put off entrepreneurs and risk taking; he blithely dismisses that. And his to-do list is oddly blinkered in its focus on taxing the rich. He ignores ways to broaden the ownership of capital, from “baby bonds” to government top-ups of private saving accounts. Some capital taxes could sit nicely in a sensible 21st-century policy toolkit (inheritance taxes, in particular), but they are not the only, or even the main, way to ensure broad-based prosperity.

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