By Chet Yarbrough
What follows Thomas Piketty’s erudite introduction to Capital in the Twenty-First Century is a detailed history of capital formation and income inequality that nearly puts one in a coma. In truth, Piketty’s peregrination is essential for credibility but only for the sake of economists that wish to challenge Piketty’s conclusions.
To a non-economist, less traveling between economic histories would have offered more clarity and less boredom. I suspect, even this brief synopsis will make many eyes glaze over. That is unfortunate, because Pikertty’s book is important.
Thomas Piketty’s hypothesis in Capital in the Twenty-First Century is that the wealth and income gap between economic classes is widening in modern, post-industrial nations. He reaches back in history to note that at one time ninety percent of the wealth of nations was held by less than 1% of the population. This high water mark lessened with industrialization and the growth of a middle class. A major break in wealth and income disequilibrium came with the Great Depression, and World War I and II’s conflagrations. However, Piketty argues that the income gap widens once again, after World War II. He estimates 60% of 2010’s wealth is held by less than 1% of the population; with a lean toward the historical 90% threshold.
Piketty’s book could not have been written until the modern age. Analysis of economic data requires mathematical modeling on a scale only achievable with computers. He offers an interesting introduction to Capital in the Twenty-First Century. However, Piketty’s dense and lengthy forward requires listener’ concentration; and for some of us, a re-winding and re-hearing.
The dramatic collapse of the stock market, war’s destruction, and world debt obligations hit high income earners harder than the middle class. Piketty explains–the superrich lose wealth accumulation from capital investment when the Depression and two World Wars disrupt the economy.
The working middle and lower classes use income to live; not to invest. If they had jobs, they continue to receive income equal to or better than what they had before. The consequence of Depression and World Wars reduces income disparity between the super-rich and the middle class because capital investment income is lost by the wealthy; not the middle class and poor.
As the economy recovers from Depression and War, capital investment’ income increases and wealth, once again, begets wealth. Until the 1980s, increases in income from capital investment fluctuated but productivity and higher wages helped workers incomes keep pace with the wealthy. It was still possible for the upper middle class to cross class barriers and become capital investors as well as workers. Pre-1980 (post WWII) economic growth mitigated a widening gap between socioeconomic’ classes.
However, after 1983, Piketty argues that capital investment income begins to widely outstrip labor income. Thus begins a return of the widening gap between the superrich and everyone else.
Piketty infers that political influences and economic power begin to coalesce after the 1980s; creating steadily disproportionate increases in income for capital versus labor. Tax shelters and inherited wealth, based on coalescing politics and economics, disproportionately raises income for the wealthy versus the middle class and everyone else. The rich get richer, a middle class becomes smaller, and low-income populations become bigger. Piketty explains that income from labor does not rise as fast as income from capital investment. The wealthy have income from both labor and capital (passive investment); while the middle class and poor have income solely from labor. Income for the middle class and poor does not increase fast enough to allow capital investment; compounding the income gap between the rich and everyone else.
Piketty reports that the wealthy make more money from capital investment than they do from their labor. (SEE GRAPH ABOVE) At the same time, the middle class and poor have little or no capital investment income. Investment income widens the gap between economic classes because labor wages do not provide enough discretionary income for capital investment. The wealthy have enough discretionary income to increase capital investment while the middle class has less discretionary income because of the cost of living.
Piketty reaches into history to remind listeners of Ricardo, Marx, Kuznets and other famous economists. He notes that an economic theory offered after WWII suggests that “a rising tide lifts all boats”. (The Kennedy administration made the “…rising tide…” quote famous.)
In the 1940s, Kuznets argues that the income gap between rich and poor would eventually reach a level of stasis. His basis for that argument is statistical evidence showing a reduced gap between the rich and the general population after the Second World War. However, Piketty argues that stasis for an income gap is dependent on economic growth. Piketty explains that the economic shocks of Depression and World Wars are an anomaly that distorts Kuznets’ theory of stasis in income inequality.
Labor income growth has not historically kept up with capital investment growth. Piketty argues that parity is not necessary but general economic growth averages under 1% while capital investment growth averages over 5%. This gap will inure to the benefit of the wealthy; not to the middle class or poor. Over time, the gap guarantees increasing income to the wealthy and dwindling income to the middle class; a middle class slipping into poverty. A concentrated wealth bias and an increasing gap between the rich and everyone else is reinforced by inheritance.
Piketty infers that labor-income’ increases have not been big enough for middle class’ capital investment since the 1980s. Piketty argues that the depression and two world wars were the primary reasons for relative stasis of the income gap between 1939 and early 1980s. From 1980s onward, the income gap only widens.
Piketty explains, because the rate of economic growth in post industrial nations has not been big enough; and because income tax structure disproportionately benefits capital investment, the gap between the wealthy and the middle class is widening. Piketty re-states the cause as increasing capital income for the wealthy and decreasing labor income for the middle class and poor. In the U.S., the income gap is magnified by the rise of CEO’ super salaries that exceed 400:1 in relation to average worker’s pay; this is also true in Europe with a 25:1 ratio.
The climax of Piketty’s argument is that without economic growth nearer the rate of capital investment, national’ economies will return to historic highs where 90% of the world’s wealth is held by less than 1% of the population.
In the fourth and final section of Piketty’s book, he offers a theoretical cure for today’s trend toward income inequality. One, create a progressive tax on capital investment income. Two, provide public financing for and to level the playing field for all. Three, protect pension rights of the working class. Four, increase the retirement age based on changes in life expectancy.
Five, revise the income tax code to make it genuinely progressive.
Piketty’s fundamental point is that the gap between the rich and everyone else must be understood in the context of real economic growth. As long as capital income disproportionately exceeds growth of labor income, the income gap between classes will continue to increase. That income gap militates against real economic growth because it reinforces expansion of either a welfare state or chaos. Human nature is an unruly beast; i.e. it desires freedom, but not with dependence on a welfare state or social isolation from chaos. Piketty does not have incontestable answers but he has credibly framed the problem of income inequality.