Capital in the Twenty-First Century

“But by patiently searching for facts and patterns and calmly analysing the economic, social, and political mechanisms that might explain them, it can inform democratic debate and focus attention on the right questions.”

Piketty outlines the purpose of his work and the ideal aim of economics. It is not necessarily to provide all the answers to social and political problems. Rather, it is to provide some factual grounding to a possible democratic dialogue.

“The law of supply and demand then implies that the price of land will rise continuously, as will the rents paid to land-lords.”

This is the idea of 18th century economist David Ricardo. If the amount of land is fixed but the population grows, land prices, rent, and the landlords’ wealth will grow astronomically, endangering the social equilibrium. This prediction turned out to be false, but it reflects a worry, still present today, about wealth’s capacity to grow exponentially and the threat this presents to social order.

“I have no interest in denouncing inequality or capitalism per se- especially since social inequalities are not in themselves a problem as long as they are justified, that is, founded only upon common utility.”

Piketty emphasises that inequality is not necessarily itself a problem. What matters is whether these inequalities benefit society overall. Addressing this issue is one of the main tasks of his work.

“In this book, capital is defined as the sum total of nonhuman assets that can be owned and exchanged on some market.”

Piketty rejects the notion, popular amongst some economists, that there can be human capital. For Piketty something can only class as capital if it can be the potentially permanent property of a person. Since labour, in non-slave societies, cannot be owned in this way it does not count as capital.

“Instead of living in societies where the life expectancy was barely forty years and nearly everyone was illiterate, we now live in societies where it is common to reach the age of eighty and everyone has at least minimal access to culture.”

Here, Piketty outlines the long run benefits of growth. These include massive improvements in education, literacy, and health, the latter evidenced by a doubling of human life expectancy. However, Piketty cautions that growth, especially when low, will not obviate the destabilising effects of high and growing inequality.

“[…] an amount greater, for example, than the total expenditure on education throughout this period.”

Piketty refers to the amount paid by the British government between 1815 and 1914 to service the interest on its public debt. This debt was sufficiently big, one year of national income, that this payment was larger than the entire budget for education. This fact highlights the absurdity and inequity of large public debts.

“To be sure, there was substantial physical destruction of capital, especially in France during World War I.”

Piketty gives an explanation for the dramatic fall in the capital/income ratio between 1910 and 1950. The destruction caused by both world wars played a part in this. However, it was a less significant factor than the collapse of foreign portfolios caused by revolution and decolonisation, and by the post-war nationalization of industry.

“[…] the gradual privatization and transfer of public wealth into private hands in the 1970s and 1980s.”

Piketty alludes to the reasons for a recovery in the relative size of private capital since the 1970s. One of these was the reversal of the post-war nationalizations and the privatization of public assets. Another factor was the rise in real estate and stock market prices.

“In other words, by 2100, the entire planet could look like Europe at the turn of the 20th century, at least in terms of capital intensity.”

Piketty suggests that given the apparent long term trends the size of capital relative to income could equal, and even surpass, the historic highs attained in Europe between 1890 and 1910. This is because the rate of return on capital is greater than the rate of growth. Further there is no automatic mechanism to check capital’s growth, in the absence of external shocks.

“In more complex models, which are also more realistic, the rate of return on capital also depends on the relative bargaining power of the various parties involved.”

The causes of the rate of return on capital are discussed. In more basic economic models this rate is determined by the marginal productivity of capital, that is the extra value an additional unit of capital brings to a company. In more sophisticated models the social and political power of capital is also taken into account.

“In substance, Vautrin explains to Rastignac that it is illusory to think that social success can be achieved through study, talent and effort.”

Piketty alludes to the scene from Balzac’s Pere Goriot, when a scoundrel, Vautrin, lectures a young law student, Rastignac, on the respective incomes to be gained from a large inheritance and a career as a lawyer. The lesson is clear: Even with the greatest effort and luck, the most successful law career will bring in merely a fraction of the income that can be gained from marrying into wealth. This is a comment on the deeply unmeritocratic character of 19th century society.

“In historical terms, it was a major transformation, which deeply altered the social landscape and the political structure of society.”

This refers to the rise of a middle class in the 20th century, which was a radical change from what had gone before. This class, the middle forty percent of society, came to own between a quarter and a third of all wealth. This altered and complicated the traditional political divide between rich and poor, and between workers and capital owners.

“To a large extent, we have gone from a society of rentiers to a society of managers.”

Piketty reflects on the difference between the early 20th century and the present day. The number of people who can make a living solely from the rent on capital (rentiers) has diminished. However, they have been replaced by a new class of high-earning managers.

“More precisely, too many people failed to receive the necessary training, in part because families could not afford the high cost of tuition.”

Piketty gives an explanation for higher wage inequalities in the US, relative to Europe. Part of the reason is that a substantial number of people cannot afford to send their children to university. In contrast, in Sweden, where universities are more accessible to those on low incomes, overall wage inequality is lower.

“A precise, objective answer to this question is clearly impossible.”

Classical economic theory, and many contemporary economists, argue that high, and growing, managerial pay merely reflects a higher marginal productivity. That is, managers are bringing more additional value to the companies they work for. One of the problems with this idea is that in large, complex companies it is impossible to precisely calculate what this marginal productivity is.

“The inequality r>g in one sense implies that the past tends to devour the future.”

This is the law that explains the growing predominance of wealth in a society. When the rate of return on capital is higher than the rate of growth, wealth starts to accumulate faster than income. In such a society inherited wealth comes to assume a disproportionate influence over people’s status and living standards.

“Or one may save to amass or perpetuate a family fortune.”

People may save for many reasons, for example, to provide for their old age, or as an insurance against loss of employment. However, they also often save to pass on wealth to their children. This creates the problem of inheritance and intergenerational wealth inequality.

“The world to come may well combine the worst of two past worlds: both very large inequality of inherited wealth and very high wage inequality justified in terms of merit and productivity.”

Piketty gives a grim assessment of what the future holds for capitalist societies in the 21st century. On the one hand, they will still have large inequalities of wealth, as in the 19th century. This will be combined with extreme inequalities of income caused by the rise of a class of high-earning managers.

“Both the antimarket and antistate camps are partly correct: new instruments are needed to regain control over a financial capitalism that has run amok.”

Following the financial crisis of 2007-2008, much debate was had about the role and limitations of the state. Some have argued that the state needs to take more of a role in the economy, whereas others have claimed that this is not the answer. Either way, there is a broad recognition that something must be done to address the excesses which led to the crisis.

 “[…] political democracies that do not democratize their economic systems are inherently unstable.”

Piketty quotes British philosopher Bertrand Russell, writing about the rise of fascism. His point is that the political structures of democracy will be fragile so long as the economic structures of society are undemocratic. By this he means both that people have no or little say in the running of the economy and that wealth and good living standards are the preserve of a minority.

“Has the US political process has been captured by the one percent?”

The political viability of an increase in progressive income tax is considered. If, as some claim, US politics is dominated by the interests of the wealthy then its prospects do not look good. Naturally, the rich would oppose such a tax and use their control over the media and political parties and candidates to block it.

“Unless something like this happens, a defensive reaction of a nationalist stripe would very likely occur.”

Piketty discusses the alternatives to his proposed international tax on capital, in terms of controlling globalised capitalism. One of these would be a nationalistic return to protectionism. This could be politically destabilising, provoking conflicts with other nations, but would also make all nations worse off in the long run.

“The worst solution in terms of both justice and efficiency is a prolonged dose of austerity.”

Of the three main solutions to high public debt (taxation, inflation, and austerity, or cuts to government spending) the latter is the least fair and efficient. It hits the poorest, who rely on government services the most. It also takes the longest to succeed because of the negative effects of austerity on growth and thus government revenues.