In Balzac’s novel Le père Goriot (1834-35), the impoverished young nobleman Rastignac is confronted with a dilemma by the cynical convict Vautrin: should he work and study hard to become a lawyer, only to earn a mediocre income, or should he seduce an eligible heiress and lay his hands on an inheritance sufficient to pay him an income worth ten times as much? Rastignac mulls the path of seduction until he is asked to bump off a brother who stands inconveniently between the heiress and her fortune. Murder is a step too far, even for a social climber.
Rastignac’s dilemma is one of the literary vignettes that enliven the most remarkable work of economics in recent years, if not decades: the French economist Thomas Piketty’s Capital in the 21st Century. It was first published last year in France, and its appearance in English this spring (Belknap/Harvard, £29.95) has caused an intellectual sensation on both sides of the Atlantic. It has been called “one of the watershed books in economic thinking”, a “magisterial treatise on capitalism’s inherent dynamics” and a “bold attempt to pick up where Marx left off and correct what he got wrong”. The American Nobel economics laureate Paul Krugman has described it as “epic”, with a “sweeping vision”, while Jacob Hacker – the Yale political scientist credited with coining the term “predistribution” – has compared Piketty to de Tocqueville.
Piketty, who was born in 1971, has made his name studying the historical evolution of income and wealth distributions in advanced economies. A son of parents from the radical soixante-huit generation, Piketty was an intellectual star in the making from an early age, completing his doctorate on wealth redistribution at 22 before becoming an assistant professor at Massachusetts Institute of Technology. A few years later, dissatisfied with the mathematical abstractions of US economics, he returned to France and began researching the work that would establish his academic reputation, Top Incomes in France in the 20th Century. From there, Piketty collaborated with other academic luminaries such as Emmanuel Saez, Tony Atkinson and Facundo Alvaredo to produce groundbreaking empirical studies of the highest incomes in leading capitalist economies, now synthesised into the World Top Incomes Database. These have galvanised new interest in the causes and consequences of widening inequality, while helping inspire the slogan of the Occupy movement: “We are the 99 per cent.”
The central thesis of Piketty’s latest book is that in societies where the rate of return on capital outstrips economic growth, wealth inequality ineluctably rises. Once constituted, capital reproduces itself faster than economic output increases. The entrepreneur becomes a rentier and inequalities harden. We are returning to the 19th-century world of the novels of Balzac and Jane Austen, whose characters are caught up in the trials and tribulations of inheriting, living off or losing wealth.
Piketty’s thesis is arresting because he buttresses it with ample historical data to show that the reduction of inequality in the middle of the 20th century was an exception, not the norm in a market economy. Ordinarily, he argues, if capital is reinvested it yields between 4 and 5 per cent a year, outstripping economic growth. Wealth inequalities therefore increase. This has been true of almost all human history. The 20th century was exceptional because of the capital shocks of two world wars, decolonisation and the growth of the welfare state. The huge inequalities of the belle époque gave way to a more egalitarian distribution as capital was destroyed, taxed or nationalised to pay for the war effort and the building of public services and social security. Growth, on the other hand, was relatively high because of technological catch-up and convergence, particularly in Europe and Japan following the Second World War.
In the late 1970s and 1980s, these processes started to go into reverse, as growth rates slowed, capital was rebuilt, taxes on wealth and top incomes were cut, and the institutions of postwar social democracy were dismantled. Today, wealth holdings in the advanced economies are six times as large as annual national income – the same sort of level as existed before the First World War.
There are important differences in the structure of wealth inequality between these two epochs, however. In the Edwardian era, the richest 10 per cent owned virtually all the nation’s wealth in countries such as France and Britain; the wealthiest 1 per cent owned roughly half, and the middle 40 per cent only 5 per cent. Today, the top 10 per cent own 60 per cent of Europe’s wealth and 70 per cent in the US, while the middle class owns between a third and a quarter, respectively. In historical terms, this growth of a “patrimonial middle class” has been an important transformation, underpinning its political importance in distributional conflicts and its swing position in the electoral landscapes of advanced economies. In contrast, nothing has changed for the assets of the poorer half of the population: it still owns less than 5 per cent of the wealth, as it did before the First World War.
Piketty also shows that increased income inequality in the past 30 years has changed patterns at the top. The top 1 per cent of the income distribution now lives off higher labour incomes, and not just rents from wealth. As property has penetrated into the middle classes, so the “coupon-clippers” cohabit with the “working rich” at the very top. These are the “supermanagers” or top executives of large firms who have vastly increased their compensation packages since the 1980s.
In 1929, the year of the Wall Street crash, income from capital was the primary resource of the top 1 per cent of the income hierarchy in the US; in 2007, you have to climb into the top 0.1 per cent before that is true. Of this super-elite group at the pinnacle of the income distribution, between 60 and 70 per cent consists of top executives. Contrary to popular myths, less than one in 20 is a celebrity or sports star, and only one in five is a banker. There has been a “skyrocketing” of the pay packages of leading executives in large firms in the non-financial as well as financial sectors.
What accounts for this? Piketty argues that it has nothing whatever to do with managerial talent. It is the product of collusion between executives and their boards, pure and simple. When marginal tax rates onthe super-rich ran at 90 per cent, as they did in the 1960s and 1970s in the US and elsewhere, there was little point awarding oneself a huge pay rise. But when those rates fell to 25 per cent, there was every incentive to do so.
This income inequality produces its own peculiar ideology, which Piketty terms “meritocratic extremism”. Without very high pay, the argument goes, only those who inherit wealth can amass riches, which would be unfair. Very high pay rewards talent and enterprise and therefore contributes to social justice. Piketty is scathing in his contempt for this ideology.
“This kind of argument,” he writes, “could well the lay the groundwork for greater and more violent inequality in the future. The world may come to combine the worst of two past worlds: both very large inequality of inherited wealth and very high wage inequalities justified in terms of merit and productivity . . . Meritocratic extremism can thus lead to a race between supermanagers and rentiers, to the detriment of those who are neither.”
Given these findings, it is not surprising that Piketty’s prognosis is bleak. Without countervailing political action, we can expect worsening trends. Population will be stable or falling in the advanced economies, while the rate of technological progress cannot be expected to exceed 1-1.5 per cent. Hence, if the rate of return on capital remains between 4 and 5 per cent, it will easily outstrip growth. In the 21st century, current wealth inequalities will therefore be amplified, the consequences of which, Piketty argues, “are potentially terrifying”. We will all live under the dead hand of the accumulated inequalities of past generations. “The earth belongs to the living,” Thomas Jefferson once wrote. But if Piketty is right, in the coming century, the dead will rule the world as “the past devours the future”.
A more competitive market – doubling down on the free-market experiment – will not spring this trap. As Piketty noted in a recent interview, “. . . the fact that returns on capital are higher than the growth rate has nothing to do with monopolies, and cannot be resolved by more competition. On the contrary, the purer and more competitive the capital market, the greater the gap between return on capital and the growth rate.”
Instead, we need to rebuild the democratic institutions that can redistribute income and wealth. His signature policy is a global tax on wealth, levied progressively at different wealth bands. He is politically realistic enough to know that formidable practical and political obstacles lie in the path towards that objective. So he sets out various steps towards it, such as greater transparency about asset ownership, and automatic transmission of bank data to tax authorities, while urging the adoption of a wealth tax at the European level. A tax at 0 per cent on fortunes below €1m, 1 per cent between €1m and €5m, and 2 per cent above €5m would affect about 2.5 per cent of the population of the European Union and raise about 2 per cent of Europe’s GDP.
This would of course require greater political and fiscal integration in Europe, which is why Piketty was a co-signatory, with Pierre Rosanvallon and other French intellectuals, to a recent open letter calling for tax-raising powers and a budget for the eurozone, held accountable to a new European chamber of national parliamentarians. Is this utopian? No more so than the “stateless currency” the eurozone already possesses, he says.
Is Piketty’s analysis too pessimistic? Thoughtful politicians will embrace much of his analysis. Stewart Wood, Ed Miliband’s intellectual consigliere, has read the book and called for its arguments to be debated widely. Piketty’s work gives substantive grounding to the core argument of Miliband’s leadership that Britain’s post-Thatcherite economic model generates socially destructive, unjustified and ultimately unstable inequalities. But parties aspiring to elected office will also be deeply wary of the politics of levying supertaxes on the wealthy, and with good reason: François Hollande is currently the most unpopular president in French history.
When the social-democratic and liberal politicians of the mid-20th century built the good society, they did so with an organised working class at their backs, pushing them forward. No such historical force exists today in advanced capitalist democracies. Nor do we really know from Piketty’s analysis what political action can achieve, because his analysis of the reduction of wealth and income inequality in the 20th century doesn’t quantify how much came from wars, and how much from public action, such as taxation.
Piketty also rests his central claim that the rate of return on capital exceeds growth largely on historical data, which leaves him open to the criticism that Dean Baker and other economists have made, namely that he underplays the potential to reduce inequality offered by progressive policies other than taxation, such as reforms to corporate governance and intellectual property rights, or egalitarian education and skills, wage enhancement and public investment strategies. He leaves largely unexplored the potential for spreading capital ownership itself more equitably in society, so that more can share in its returns. Indeed, his work could be used to justify wealth predistribution policies, such as employee share ownership, profit-sharing, the creation of new sovereign wealth funds and universal asset stakes for citizens, instead of redistributive wealth taxes.
The magisterial sweep of Piketty’s Capital is such that he cannot answer everything. His range is immense. And his open, fluent style will guarantee him a wide readership. In contrast to much of what passes for orthodox economics, he is engaged with the problems of the real world (indeed, he took time out from his academic career to advise the Socialist candidate Ségolène Royal in her bid for the French presidency in 2007). The discipline of economics, Piketty argues, remains trapped in a juvenile passion for mathematics, divorced from history and its sister social sciences. His work aims to change that.
Perhaps his greatest achievement is to rescue the study of inequality for “political economy” – a term that went out of fashion in the 20th century but which is now experiencing a revival. Despite the enormity of the challenges Thomas Piketty’s book poses, it ends on a note of urgent activism, not acquiescence: “If democracy is some day to regain control of capitalism, it must start by recognising that the concrete institutions in which democracy and capitalism are embodied need to be reinvented again and again.”
Nick Pearce is the director of the Institute for Public Policy Research, where Thomas Piketty will be speaking on 30 April. For details visit: ippr.org/events