The historical story is fascinating and well told, with particular reference to the share of the top incomes. The picture is familiar – a widening gap between high and low earners over the past quarter of a century. Technological change and global competition have raised the demand for special talent and lowered it for unskilled labour. The rewards for success have risen and wages towards the bottom of the income distribution have been squeezed.
In a few weeks, Wimbledon will return to our television screens. The top tennis players in the world will compete for prize money that, boosted by broadcast income from more than 200 countries, will this year total £25 million.
Forty years ago, the total prize money was £91,000. Taking into account the rise in the cost of living, the players will receive 33 times as much this year compared with in 1974. Over the same period, average real hourly earnings in manufacturing have merely doubled.
The fall in travel costs and the advent of global television coverage have extended the status of stardom from film stars to a much broader group. Returns go to the winners of the tournament, whether in tennis, finance, law, computing, advertising or other occupations. The “winner takes all” mentality has invaded many walks of life, although the identity of the winner changes over time – there are few Warren Buffetts and Alex Fergusons who stay at the top for long periods.
Is this growing inequality of income showing up in a correspondingly more unequal distribution of wealth? It is far too soon to tell. Nevertheless, we should be concerned that greater income inequality might be transmitted to succeeding generations if money is a key element in providing opportunities to the young (as in Britain’s education system). Equality of opportunity is an objective that successive governments have struggled to realise.
Piketty’s critique of capitalism, however, is based more on his views about the factors determining the distribution of wealth than on his concerns about income inequality. To understand the origins and perpetuation of wealth inequality we need to consider all the relevant differences between people: their talent and drive, education, savings behaviour, inheritances and bequests, and that most important factor – luck.
Whether the distribution of wealth diverges, shrinks or tends to a stable position depends on all the factors that determine social and economic mobility (inheritance pulls in one direction, educational opportunities in the other).
Somewhat bizarrely, Piketty chooses instead to focus on what he calls “the central contradiction of capitalism”, namely the fact that the average rate of return on capital, r, normally exceeds the rate of output growth, g. He interprets this to mean that “the entrepreneur inevitably tends to become a rentier, more and more dominant over those who own nothing but their labour. Once constituted, capital reproduces itself faster than output increases.”
But the fact that r exceeds g is simply a necessary condition for an efficient allocation of an economy’s investment over time, whether in a capitalist or a centrally planned economy (the former Soviet Union and, arguably, China are examples of countries that over-invested, so damaging their own consumption opportunities), and is consistent with any pattern of inequality, high or low, rising or falling.
Only a detailed, and empirically based, description of differences between people will yield a theory of inequality, not a reliance on an aggregate relationship of dubious relevance.
There is much more to be said about how wealth is distributed than the idea that the owners of capital reinvest all their profits and the spendthrift workers consume all their wages. Where are the families who have pensions and own houses? Where are the sovereign wealth funds that have become such important forms of collective ownership in some countries? Where is the tax treatment of income and bequests, and the role of primogeniture and other legal forms of inheritance?
Also absent from the heart of the analysis is any recognition that the main reason for the average rate of return exceeding the growth rate by a good margin is that savers require a risk premium to compensate for the uncertain nature of the returns on investment. Adjusting for risk, average rates of return have historically been much closer to growth rates.
And the present concern in capital markets is not that the rate of return is above the growth rate, but that the (risk-adjusted) rate of interest is below the growth rate.
Five-year real interest rates in the US and UK, adjusted for risk, are at present slightly negative whereas current growth rates of the economy, and even more so expected rates over the next five years, are significantly positive. It is proving very difficult to escape from that trap, and the risk to asset values is not that they grow more rapidly than national income but that they fall back at some point.
In essence, the principal weakness of the book is that the carefully assembled data do not live up to Piketty’s rhetoric about the nature of capitalism. Take, for example, his fascinating statistics on the changing shares of total wealth owned by the top one per cent of the population over the past 200 years in four countries: Britain, France, Sweden and the United States. Consider the history in France. At the beginning of the 19th century, the top one per cent owned about 50 per cent of total wealth – certainly extreme concentration. That proportion remained roughly constant until 1890. The share then rose to 60 per cent by 1910, but by 1920 this had been completely reversed by the destruction of the First World War. The share of the top one per cent then declined precipitously to around 20 per cent by 1970, from which point it has risen slightly. The result is that the share of the top one per cent is markedly lower today than 200 years ago.
A similar story can be told for Britain and Sweden. In Europe, the concentration of wealth among the elite remains far below what it was in the 19th century. In the US, the shares of the top groups have been much more stable (although the data are probably less reliable), but it is hard to see evidence of rising inequality over 200 years.
The problem is that Piketty is determined to regard the period between 1910 and 1970 as exceptional; it tells us little, he argues, about wealth evolution in a normal capitalist society. But the risk premium, which constitutes a large part of the rate of return on capital, reflects the huge uncertainty about a recurrence of major shocks that have occurred in the past, and could do so again.
Surely, the financial crisis showed that periods of apparent stability can be followed by destructive shocks. And if we were to believe that the world would remain tranquil then the risk premium, and Piketty’s key driver of rising inequality, would fall back. Perhaps it is not the first half of the 20th century that was exceptional but the second.
No sooner had the ink dried on volume one of Das Kapital than Marx’s prediction that under capitalism real wages would fall or remain stagnant was dramatically disproved. Will Piketty’s predictions suffer the same fate? We simply don’t know. Economics is not governed by immutable laws of nature. Sweeping generalisations about the laws of capitalism are less useful than careful empirical studies of behaviour over time and across countries.
This book, which contains much of value, is a strange mixture of both. That is why it has divided American economists down wholly predictable political lines.
Inequality does matter, and measures to reduce it have a proper place in economic policy. But by promoting efficiency and raising living standards, a market economy has proved its worth. To argue that inequality is the fundamental weakness of modern capitalism, while ignoring capitalism’s achievements, may excite the well-heeled intellectual salons of Paris and New York, but most of us recognise that a market economy has served us well by creating growth and reducing poverty.
