Book: Capital in the Twenty-First Century
Author: Thomas Piketty
Publisher: Harvard Business Publishing
Pages: 696 pages
Price: Rs 1495
Rising income inequality has been a cause of much concern globally. RBI governor Raghuram Rajan points it out as one of the key “fault lines” in the global economy that caused the global financial crisis of 2008, and which is still unresolved. So, not surprisingly, Thomas Piketty’s acclaimed and controversial book has made waves among academics as well as financial commentators. Piketty freely acknowledges that inequality and the ways to address it are deeply political issues. His take on French President François Hollande’s 75 per cent peak income tax rate is also clear: “Wealth is so concentrated that a large segment of society is virtually unaware of its existence.” He frets about the political power of the ultra-rich.
But it would be grossly unfair and indeed myopic to view the tome through this prism. Some of Piketty’s conclusions are debatable. A good academician, he accepts this: “All my conclusions are by nature tenuous and deserve to be questioned and debated.” In the eyes of this reviewer, the book and Piketty’s research serve as the starting point of a debate, not the end of one. The book’s key contributions to the debate are two-fold: the data and the framework.
Piketty starts with a denunciation of economic theory and its inclination to theorise without any data. He has led a 15-year-long global collaboration to tabulate and estimate wealth and income data going back to 1700. He gathered data on tax returns for the previous century, mined past research and even the novels of Jane Austen and Honoré de Balzac for the period before that. In his framework, income is divided into income from labour and income from capital. These two streams vary in importance: for the ultra-rich (the top 1 per cent), most of income comes from capital (dividends, interest on bonds, rents, etc.) whereas for most of the rest, income from labour (wages) dominates. It follows that income inequality can be due to a dominance of capital over labour, and/or extreme wage inequality.
This framework drives some brilliant insights, like splitting the top 10 per cent earners into “the first 9 per cent” and the “top 1 per cent”: the former are wage-dependent and the latter capital dependent. This explains why during the Great Depression, the income share of the top 10 per cent went up even when that of the top 1 per cent fell. Senior-level jobs, particularly in government, were not hurt as much as low-level jobs, while there was significant capital destruction.
It also helps dismiss the popular “trickle-down” theory, which says that inequality rises in the early stages of economic growth but normalises naturally later. Piketty notes that the sharp reduction in inequality in the period between the two World Wars, often quoted by “trickle-down” theorists, was mostly driven by large-scale destruction of capital.
Piketty accepts that inequality of income from labour is less permanent (harder to inherit), even if no less pernicious. He ascribes the scarily high income inequality in the US, comparable to that in Old Europe before the First World War, to this relatively new trend. Starting in the 1990s, wages in some positions and professions have risen abnormally. That said, one wonders if high income, even if for a select few, is not a solution, however imperfect, to counter the inexorable cycle of inter-generational wealth transfer, which his quote from Balzac’s Le Père Goriot (Vautrin’s lesson) elegantly describes. Piketty’s most dire predictions are, however, linked to inequality in income from capital, which drives the title of the book. Unfortunately, this is where his arguments are the weakest.
His primary concern is that as the economy slows, as it must (he explains why, in detail), the relative importance of capital increases sharply.
This is ominous, as the distribution of capital is far more skewed than the distribution of wages: the top 10 per cent wealthy people control 62 per cent of wealth, but the top 10 per cent of earners get 35 per cent of wages. Therefore, the rising importance of capital benefits only a small fraction of the population and inequality can potentially keep rising forever unless it is stopped by social revolution or direct government action.
Several of the assertions behind this seem flawed, like Piketty’s claim that real returns on capital average 4-5 per cent over the long term. Returns on capital cannot be independent of economic growth and the quantum of available capital, unless the market gets distorted by the government.
That Jane Austen’s characters enjoyed stable returns on government bonds for decades is perhaps factually correct, but hard to replicate now. The British government choosing to pay down their high debt by raising taxes (not on income!) was likely the reason: one can view this as a mandated wealth transfer from taxpayer to bondholder. Further, high inflation today would eat into returns: Piketty highlights the capital destruction in France caused by high inflation after 1910, but he doesn’t link the stable returns in 19th century Britain to near-zero inflation.
Moreover, while comparing the bargaining power of capital and labour, greater analysis of the labour market is required, particularly the dynamics of urbanisation in 19th century Europe. With the global population ageing rapidly, labour could regain its pricing power in the coming decades.
While India is unlikely to reach 1-2 per cent steady growth anytime soon, several of Piketty’s insights matter. For example, the form of wealth changes with rising levels: real estate accounts for less than 10 per cent of the wealth of the ultra-rich, whereas for the middle classes, it could be more than 90 per cent. People first buy a house, and then raise financial savings. Could this explain the Indian love affair with real estate while regulators and policymakers fret about low investment in financial assets?In its scope and depth, if not in its ambition, the book inspires awe, though the reader would be well advised to focus on the data and the framework rather than the conclusions. Lastly, one cannot ignore the unstated assertion that wealth transfers seamlessly across generations: who hasn’t heard the prophetic phrase, “One generation earns, the second enjoys, and the third destroys”?
The writer is the India Equity Strategist for Credit Suisse