Thomas Piketty’s Capital in the Twenty-First Century has been easily the top-selling new economics book in years, rocketing to the top of the New York Times bestseller list and remaining there for week after week. It’s obvious, as reviewers like Dani Rodrik have pointed out, that a lengthy book on the distribution of income and wealth would not have sold in these quantities a decade or two ago. This is a book that suits the mood of the times.
Can the zeitgeist of an era be summed up by the books people choose to read (or at least to talk about as if they have read)? The contrast with the 1990s – when the big economics books were Francis Fukuyama’s The End of History and the Last Man and Thomas Friedman’s The Lexus and the Olive Tree – suggests that in some ways it can.
Particularly in the United States, the 1990s were experienced as a period of prosperity and of economic and cultural triumph. In reality, the economic gains were not especially spectacular, but the decade benefited from the comparison with the economic chaos of the 1970s, the deep recession of the early 1980s and the fears generated by the stockmarket crash of 1987. A spectacular rise in share prices, ceaselessly publicised by TV networks like CNBC and widely shared via defined-contribution pension accounts, created large amounts of wealth, at least on paper, and seemed to promise far more in the future.
For those who had lived through the long boom of the 1950s and 1960s, though, the 1990s represented, at most, an apparent return to conditions once considered normal. What really made the 1990s special was the seeming disappearance of any alternative to American-style capitalist democracy.
The collapse of the Soviet Empire in Europe between 1989 and 1991 had brought a sudden, and surprisingly conclusive, end to decades of ideological and economic rivalry. Nominally communist parties remained in power in numerous countries, most notably China, but the threat of a revolutionary alternative to capitalism was gone, seemingly forever, and so too was any significant pressure to make concessions to working-class discontent.
Increasingly, governments felt the need to answer to the bond markets rather than to domestic electorates. Despite their global nature, the banks and traders who operated these markets were overwhelmingly located in London and New York, and saw the American model (emulated in Britain by Margaret Thatcher) as the natural way of organising an economy.
Also important in the rise of American triumphalism was the collapse of the “Japanese miracle,” sparked by the stockmarket crash of 1990 and continuing through decades of economic stagnation. Americans had been warned during the 1980s that Japan was about to overtake the United States economically and become a major geopolitical rival. The culmination of a steady stream of books and articles pushing this theme was Shintaro Isihara’s book The Japan That Can Say No, which proclaimed Japan as “first among equals.”
Only a few years after its publication, with the Nikkei at a third of its 1980s value and Japan facing its own challenges from the tiger economies of Southeast Asia, Isihara’s bombast looked laughable rather than threatening. Indeed, far from merely reaffirming that the United States was the natural leader among the group of democratic countries, American political discussion rejected as unpatriotic any theory of world politics that stopped short of claiming complete political hegemony – a claim embodied in the Project for the New American Century, a neoconservative think tank established in 1997.
It was in this atmosphere that Fukuyama’s End of History received such a rapturous response. Although Fukuyama disclaimed any particular focus on the American model, such nuance was absent in the many vulgarisations of his work. The best known of these, Thomas Friedman’s The Lexus and the Olive Tree, eulogised Wall Street’s “Electronic Herd,” an allusion to the nickname “The Thundering Herd,” commonly applied to stockbroking firm Merrill Lynch.
The euphoria of the 1990s evaporated with the turn of the millennium. The bursting of the dotcom bubble in early 2000 and the fiasco of the Iraq war deflated American triumphalism, without producing any real alternative. Yet the belief in the benefits of financial markets and free-market capitalism remained, even as people realised that they themselves were not seeing many of these benefits.
With its content-free slogans, “Yes We Can” and “Change We Can Believe In,” Barack Obama’s 2008 election victory epitomised the national mood: the United States was on the wrong track but there was no agreed analysis of the problems, let alone a serious policy program to fix them. Obama proposed only marginal adjustments to the status quo, primarily focused on the expansion of health insurance (what became known as “Obamacare”). As is usual in politics, Obama talked a lot about the crucial role of education, but offered little to offset the massive, and growing, inequality of access to high-quality schools.
Even the shock of the global financial crisis didn’t produce a coherent alternative to the discredited consensus of the 1990s. In the immediate aftermath of the crisis, fiscal and monetary authorities underwent an emergency conversion to Keynesianism. But as soon as it was obvious that a full-scale meltdown had been avoided, the old tropes of austerity and faith in financial markets re-emerged.
Moreover, despite the obvious failure of the dominant approach to macroeconomics, no new Keynes emerged to point the way forward. Macroeconomic theorists tweaked their models to include financial markets and went on much as before. Economists concerned with macroeconomic policy, including those who work in bodies like the International Monetary Fund, eventually lost faith in austerity and returned to more Keynesian views of the world, but these debates ceased to dominate the front pages.
The real shift came with the “recovery.” Particularly in the United States, it became increasingly evident that the benefits of economic recovery were confined to a wealthy few and that the biggest benefits were flowing to operators in the same financial markets that had caused the crisis in the first place. It became politically acceptable to point out facts that had been in plain view for years, even decades. The shift was crystallised by the Occupy movement, and the identification of the top 1 per cent of income earners as the chief, arguably the only, beneficiaries of the free-market triumphs of the late twentieth century.
The focus on “the 1 per cent” reflected the outcomes of a program of research into the growth of inequality that had carried on, in relative obscurity, since the 1980s. For most of the twentieth century, the standard view had been that proposed by Simon Kuznets, who argued that, although inequality typically increased in the early stages of capitalist development, the longer-term trend was towards greater equality, as was observed in nearly all developed countries in the decades after 1945.
From the beginning of the Reagan era, however, it became evident that inequality was growing. Wage growth in unionised industries slowed to a crawl and was replaced by employer-imposed “givebacks,” typically involving the loss of conditions or non-wage compensation, but sometimes extending to actual reductions in hourly rates of pay. Meanwhile, the “tax revolt” among higher-earning Americans led to large cuts in taxes for the wealthy while the sales taxes and payroll taxes paid by lower-income earners continued to grow. Although the resulting growth in inequality was documented by economists and other social scientists, their work was read, if at all, only by other economists and social scientists.
One of the most striking contributions came from Thomas Piketty and Emmanuel Saez, whose work focused on incomes at the very top of the distribution scale, the group that became famous as the 1 per cent. This group had been neglected in work on income distribution, partly because of data limitations, but also because of a feeling, broadly justified under the conditions of the mid twentieth century, that they were not important enough or distinctive enough to justify being treated separately from the rest of the high-income group (usually the top 10 per cent or top 20 per cent). Indeed, many standard measures of inequality, such as the 90–10 ratio (the ratio of income at the ninetieth percentile of the income distribution to income at the tenth percentile), are designed specifically to exclude “outliers,” or those at the extremes of the distribution.
In a series of papers over the past decade, Piketty and Saez have shown that the share of income accruing to the top 1 per cent is large and growing. Having fallen as low as 10 per cent in the mid twentieth century, its share of income is now around 20 per cent in the United States, and on some measures as high as 25 per cent. Once the top 1 per cent was excluded, the rest of the well-off (those in the eightieth to ninety-ninth percentiles of the distribution), previously seen as beneficiaries of growing inequality, turned out to have merely maintained their share of national income. Everyone else – 80 per cent of the population – was falling behind in relative terms, and many were experiencing absolute declines in real incomes.
The initial response of defenders of market liberalism was to deny the evidence, an effort that has since been abandoned by all but the most determined. The upshot of their effort was to show that the stagnation or decline of real incomes for the majority of US wage-earning households between 1990 and 2000 was overstated because the calculations failed to take account of problems with consumer price indexes, changes in household size, and the contribution of non-wage benefits, including the earned income tax credit (similar to Australia’s family tax benefit). But none of these excuses is applicable to the period since 2000, which has seen a continuation and broadening of the trend. The median real income of American households has fallen in real terms since 2000, and is now back to the levels of 1990.
The second line of defence was to argue that, although inequality in the United States is high (by global and historical standards) and increasing, this is the price that must be paid for a society in which everyone has an opportunity to work and grow rich – the opportunity to participate in “the American dream” – unlike the unfortunate citizens trapped by Europe’s stale hierarchies. Unfortunately, a steady stream of research since the 1990s has shown that the life chances of young Americans, far more so than those of young Europeans, are largely determined by their parents’ economic status. In the technical terminology of the field, the United States has less intergenerational and social mobility than other developed countries, and almost certainly less than it had in the past.
Because of the long time periods needed to demonstrate the trend, it is hard to determine exactly when social mobility began to decline, or to prove in statistical terms that it is declining now. But what was once a matter of technical research is now part of everyday experience. Everyone knows that Ivy League schools and the opportunities they represent are only for the wealthy, and everyone knows that a lifetime of hard work will barely generate enough to live on in retirement, let alone to enjoy a middle-class lifestyle.
These are the circumstances that created a mass audience for Capital, which focuses mainly on examining how current trends will project into the future. Piketty sets out in detail the power of the forces pushing us towards a society of entrenched and inherited inequality, and identifies the weakness of many of the policies – such as expansion of educational opportunities – traditionally presented as remedies. He then describes what such a society would look like.
Paradoxically, at least for those accustomed to a twentieth-century notion of modernity, Piketty delineates the future by going back to the past. He begins with reference to how classic French and English literature of the nineteenth century described the way a “patrimonial” economy (one based on inherited wealth) operates. In such a society, the only reliable ways to become wealthy are through inheritance or marriage, and the standard plots of many nineteenth-century novels turn on these two possibilities.
Piketty’s literary treatment is reminiscent of David Lodge’s Nice Work, a parody on the nineteenth-century “industrial novel” in which the possible solutions to the problems on which the plot turns were listed as “death, marriage, emigration, a legacy.” Lodge’s twentieth-century heroine (an academic researcher on the novels in question) is given access to all of these options, except death. After turning down an overseas academic post and a marriage offer from her former boyfriend (a fellow student who has ditched the academy to become a City financier), she eventually relies on what one reviewer calls “the solution that appears least likely to modern minds,” namely an inheritance from a wealthy uncle.
In the past, and in the future described by Piketty, inheritance was the first and most reliable way of gaining wealth, with marriage coming a risky second. Compared to these options, even the labour of skilled professionals like lawyers and doctors yielded little more than a better class of poverty. In Pride and Prejudice, for example, Mr Darcy demonstrates his magnanimity by being polite to Elizabeth’s Uncle Gardiner, a mere lawyer.
Austen is a sharp observer of her society, but her comedies of manners are inevitably focused on what is now called the 1 per cent. As Piketty observes, even the genteel poverty to which Mrs Dashwood and her daughters are reduced in the opening scenes of Sense and Sensibility leaves them with four times the average English income of the day.
For a sharper view of the social realities, Piketty turns to Balzac’s novel Le Père Goriot, and the scene in which the villain, Vautrin, explains the realities of life to the naïve protagonist Rastignac, an impoverished aristocrat studying law. As Vautrin observes, the biggest and least attainable prizes in the legal profession – the position of royal prosecutor, for example – offer only a tiny fraction of the income and wealth to be obtained by marrying a wealthy heiress.
Piketty’s review of the dynamics of wealth in the nineteenth century suggests that the growing inequality of income and wealth observed over the past few decades is not an aberration, and that a reliance on inherited wealth is not a relic of the past. Rather it is the full employment and relative equality that prevailed in the mid twentieth century which is exceptional.
To explain this important period, Piketty points to the political and economic chaos of the world wars and the Great Depression. These events, he contends (without defending the argument in detail), led to a destruction of accumulated wealth that created the conditions for a golden age of equality from the late 1940s.
At this point, it’s important to observe that Piketty uses the term “capital” where economists would more commonly refer to “wealth.” Economists usually use “capital” to refer to physical goods used in production, such as factories, machinery and, because they “produce” housing services, houses. Wealth is the value of assets based on ownership claims over capital. Despite the destructive effects of the world wars and the decline in investment during the 1930s depression, the world’s stock of capital (including electricity networks, cars and highways, and modern factories) grew dramatically over the first half of the twentieth century. It was wealth, rather than physical capital, that was destroyed on a massive scale.
Piketty argues that this period, in which the wealthy became absolutely worse-off, laid the basis for the postwar decades in which wealth grew more slowly than income. His key idea is a very simple one. The dynamics of the distribution of wealth and income, he argues, turn on whether the rate of interest (or, more generally, the rate of return to capital) is greater than or equal to the rate of growth of the economy, or GDP.
To see how this works, suppose that you have borrowed money, that your income grows in line with the economy as a whole, and that you make no repayments of principal or interest but simply let the debt compound. If the rate of interest is less than the overall rate of economic growth then your debt, even compounding, will grow more slowly than your income. So your debt, considered as part of your total financial position, will become less significant over time. Conversely, the wealth of your creditor will grow more slowly than GDP.
Piketty argues, however, that the more normal situation is one in which the rate of return on capital is greater than the rate at which economies grow. If the owners of wealth save most of their income (more precisely, enough that the rate of interest, after covering consumption financed by interest income, is still greater than GDP growth) then the ratio of wealth to income will also rise.
The latter situation, Piketty argues, is the one which is normal under capitalism, and to which we are returning. In part this is because he expects the relatively low rates of growth observed in the West during the twenty-first century to continue. More importantly, Piketty suggests that the rate of return to capital will increase. Some critics have read him as making an argument that this increase reflects the marginal productivity of capital. But it seems more natural to see the increase as a return to wealth, and to see it as a reflection of, and contribution to, the increasing political power of the wealthy.
Since the rate of growth is largely outside the control of governments, the only way to prevent compounding inequality of wealth is to reduce earnings on wealth. This can be done either by taxing capital income or, using Piketty’s preferred approach, taxing wealth itself. In either case, the problem arises that, under the conditions of market liberalism, capital is mobile, and owners of capital can easily avoid or evade taxation. At a minimum, the use of tax havens, transfer pricing, artificial corporate structures and so on to evade national taxation needs to be curbed.
Given the limited record of success in past efforts to control global tax evasion and avoidance, Piketty is reasonably pessimistic about efforts in this direction. Yet the latest news from the OECD is remarkably positive. All members of the OECD (even evader-friendly jurisdictions like Austria, Luxembourg and Switzerland) have agreed to a system of automatic information exchange for tax purposes. Moreover, the too-big-to-jail status of major banks engaged in facilitating tax evasion and money laundering may finally be coming to an end. Even the use of shell companies, incorporated in business-friendly jurisdictions like Delaware in the United States, is coming under increasing pressure.
An optimistic interpretation is that the same intellectual atmosphere that has produced a mass audience for Capital is finally beginning to influence public policy and the policy elite, long saturated by the ideology of financial market liberalism. Alternatively, it may be that the share of income accruing to the 1 per cent has grown so large that governments have no alternative but to tax it. Either way, it seems certain that issues of inequality and entrenched privilege, long ruled out of court as “class warfare,” are back on the political agenda. The end of history will need to be postponed for a while yet. •