Capital in the Twenty-First Century

Capital in the 21^st Century by Thomas Piketty officially takes the spot for the longest and most technically dense book I have read. (Dense as in packed with useful knowledge, not thickheaded knowledge.) It taught me the history and causes of wealth inequality, various economic principles, and that I should probably learn more about European history and politics. For this report, I think it’s best to have two sections, one for breaking down the concepts and one for defining technical terms and formulas.

Piketty gave me an appreciation for Jane Austin and other century-plus old novelists by explaining how wealth translated into their writings. I may find myself reading Père Goriot soon. Interestingly, Piketty seemed to think clean energy would dominate the economy when he was writing, not foreseeing the surge in AI which is completely understandable. Energy is more of a roadblock than an opportunity today which is unfortunate. I liked how pragmatic Piketty is at points when discussing estimates and pointing out when numbers should be taken with a grain of salt. This is maybe something he could have done a little more with his own solutions. Getting the government to take money away from the wealthy that fund the campaigns of those government representatives seems like an even greater challenge than international cooperation on progressive taxes.

I struggled with the last parts of the texts when it runs through the EU and some operations of central banks, but overall, the majority was understandable to me with enough focus and time to reflect. I’d be lying if I said I know enough about wealth inequality now to participate in a sophisticated debate but luckily for me most people aren’t sophisticated. I have more books in the fields of finance and economics I want to read and I’m expecting them to be easier to digest now that I have worked through this beast.

At one point, Piketty brings up the Aristocats and how it portrays wealth in 1910’s Paris and how, “the size of the old lady’s fortune… to get rid of Duchesse and her three kittens… must have been considerable.” I found that funny.

The Gist

Piketty takes a data driven look at wealth inequality in various countries since the 18^th century to predict how capital will progress in our current century and how we might influence that progression. Inequality is the result of both economic and political mechanisms with forces. Convergent forces are knowledge and skills which historically lessen inequality. Whenever lesser developed societies gain access to more advanced knowledge, which helps develop more advanced skills, inequality lessens. An example of a divergent force is r > g. This is the fact that the average rate of return on capital is greater than the growth of the economy.

Countries with the highest GDPs have an even more unequal distribution of global income as they can afford to invest in poor countries to generate more income. A rich country’s investment into a poorer one can increase output but does not guarantee significantly increase income. Knowledge, skill, and (likely required) government support do this.

When measuring purchasing power and how incomes have progressed, price indices are the norm, but Piketty argues that they are too generalized. Looking at increased average purchasing power from 1900-2010, which increased approximately sixfold, consumption of all products did not increase sixfold. Some items increased in price accordingly, or even got more expensive, while some became even easier to purchase. In the 1880s, the bicycle was 6 months wages, by 1970 they were a week’s worth while receiving many improvements over the 1880’s version. Purchasing power here increased by a factor of 40. Purchasing power varies between products so significantly it makes averages futile and reductive according to Piketty.

Industrial goods and foodstuffs have generally gotten easier to produce while the service sector has not seen this efficiency. This reflects shifts in the employment market.

Another bias in measuring that’s worth considering is how the privatization/publicization of sectors can affect GDP. For countries with free public services, taxpayer cost is added to GDP. Production costs like wages paid to hospitals, schools, and public universities. If a country privatized these industries (like America) GDP can be artificially higher and not necessarily indicative of an overall higher quality. Mentioning America, its history is shorter than other countries and is more recently established. America in the late 18^th century and the mid-late 19^th century are completely different animals, making it hard to extrapolate any lessons from economic data compared to countries like France and Britain which were less dynamic.

Annual economic growth is typically low, >1%, but this is still significant over time due to the law of cumulative growth. By 2050-2100, economist Robert Gordon predicts per capita output growth to sink below 0.5%. High annual growth of +1.5% typically only occurs when countries are catching up to more developed countries. Only 0.1-0.2% growth is needed to maintain the current societal structure.

In the history of capital/income ratio, 1913-1950 is significant. The two world wars made the levels of capital fall significantly for European countries (France, Britain, & Germany especially) past the level of physical destruction. The actual breakdown of physical assets during this time was small compared to the loss of foreign assets and low savings rate. Additionally, assets were generally priced lower postwar.

Shifting from a macro view of countries’ output and looking into disparities of individuals capital and income, inequality is apparent. Inequalities of capital are always more extreme than those of income. The top 10% of the labor distribution usually receive 25-30% of labor income but the top 10% of the capital income distribution own more than 50% of all capital. Contrast this with the bottom 50% who receive 25-33% of labor income and own <10% of capital. In some societies, like Europe in 1910, the top decile owned 90% of capital. Within the top decile, the top percentile will traditionally see an even greater concentration of wealth. Additionally, as you progress through the top decile of total income, there is a point where income from capital surpasses income from labor. These are the two worlds of the top decile.

High inequality societies are created through two ways. They first is through a society where inherited wealth attains extreme concentration. This is a hyper patrimonial society or a society of rentiers. The second is through a society of supermangers which is a relatively new means. This is a society where the highest incomes come from labor rather than inherited wealth. This is sometimes called a hyper meritocratic society where these incomes from labor are perceived as deserved. However, when looking at the high wages of C-Suite and senior leadership, it is not clear that their salaries are representative of marginal productivity like Adam Smith’s Invisible Hand theorizes.

After and during the 1980’s, high pay packages became tolerated and expected due to Regan’s tax policies and similar policies in other countries. Social norms took precedence over skills and technology, and equality was further distorted.

Figures are likely underestimated due to tax havens.

During the WWI-WWII era, the wealthy sold capital to maintain their lifestyle, giving less and less to descendants and thus redistributed wealth. The reason wealth inequality isn’t as severe as pre-WW1 levels is because of time. There are also more taxes than before which is slowing down the growth of inequality. Even so, r is great enough still for inequality to catch up further albeit not to the levels of 1910 Europe.

The prevalence of inherited wealth can be measured as a share of national income. Looking at the graph, the growth of inherited wealth as a fraction of national income is coming back from the drop caused by the two world wars.

What high levels of inherited wealth show is that Modigliani’s triangle, which hypothesized that people accrue wealth to support their retirement, is false. Wealth at death is higher than the average living wealth meaning that people also desire to pass down their wealth.

For a society to be dominated by inherited wealth there needs to be high capital stock and a large share of inherited wealth that is concentrated. Because returns on capital generally surpass average returns the more capital there is, this occurs naturally. With fortunes large enough, it is easy to live on a fraction of income generated from wealth and then reinvest the rest. This can be plainly observed with university endowments where the rate of returns increases the higher the endowment. The highest endowments allocate higher portions to alternative investments with higher returns. These more sophisticated practices can be afforded because of their price relative to the fortune.

From 1932-1980, the top federal income tax bracket averaged 81%. This dropped to 30-40% with Regan reform bringing in an all-time low of 28%. In countries that lowered the top tax rates, the share of national income owned by the top increased, showing the two were correlated. Salaries became larger and productivity showed no sign of increasing compared with countries that didn’t cut tax rates.

Piketty’s call to fix wealth inequality involves progressive taxes on income and inheritance, generally targeting those who make more than 1,000,000 euro, along with international coordination to ensure that the well off cannot evade these taxes. Theoretically, this could make a great impact, on wealth inequality especially, over just a couple of generations. My main critique, assuming international cooperation is possible and there is true transparency, is that the powers in charge are funded by the wealthy and they will spend heavily to keep things as they are.

Technical Terms

• Capital/Wealth- nonhuman assets that can be owned & exchanged on some market, i.e. land, real estate, financial instruments, industrial equipment, patents, etc.

• Income from Labor- wages, salaries, bonuses, earnings from non-wage labor, and other labor related renumeration

• Income from Capital/Wealth- rent, dividends, interests, profits, capital gains, royalties, and other income derived from the mere fact of owning capital

• Net Domestic Product/Domestic Output = GDP – Depreciation of capital/10% of GDP

• National Income- sum of all income available to the residents of a country in a given year

• National Income = Domestic output +/- abroad net income

In most countries, national income is within 1-2% of domestic output

• National Income = Capital Income + Labor Income

• National Wealth/Capital- total market value of everything owned by the residents and government of a country at a given time provided it can be traded on some market, i.e. sum of financial and non-financial assets minus liabilities

• National Wealth = private wealth (overwhelming majority) + public wealth (govt)

• National Wealth = domestic capital +/- net foreign capital

• Capital/Income Ratio = β. Ratio of total private wealth. Where capital is total wealth at a given time and income the quantity of goods produced in a given period. Typically, around 5-6.

β = s/g over the long term where s is the rate of savings and g is the growth of the economy

• Share of Income from Capital in National Income = α.

            α = r x β where r is the rate of return of capital

• Law of Cumulative Growth- a low annual growth rate over a very long period of time gives rise to considerable progress.

• Gini Coefficient- Measure of inequality in a society where 0 is egalitarian and 1 is absolute inequality.

• Tobin’s Q- the ratio of market value to book value of a company.

• Nominal Assets- Assets that are fixed to at an initial value like money in a savings/checking account.

• Real Assets- Assets that are directly related to a real economic activity that’s price evolves with that activity like housing or company shares.

• Annual Economic Flow of Inheritances & Gift as a Proportion of National Income= b_y= µ x m x β

µ= ratio of average wealth at time of death to average wealth of living individuals

m= mortality rate

As m decreases, µ ages and gets larger, meaning people are generally inheriting later than previously but also getting larger sums

• r > g- the return of capital outpaces the growth of the economy