Understanding the Basics of Thomas Piketty’s Capital in the Twenty-First Century

We explain the general idea behind Thomas Piketty’s Capital in the Twenty-First Century and offer links to summaries and the full text.[1][2][3][4]

An Introduction to Piketty’s Capital and His Main Theses: R > G (Return on Capital Over Time is Greater Than Economic Growth), The Laws of Cumulative Growth and Cumulative Returns (Referring to the Last Point), the Wealth Gap (the Consequence), the 1% (the Class Who Benefits), and “Dynastical Oligarchy” (the Problem)

Thomas Piketty’s Capital in the Twenty-First Century can perhaps be best understood by the following fabricated quote pertaining to economic inequality and the wealth gap (in which I synthesize Piketty’s main thesis with a famous Marxian quote mentioned in the book):

“A specter is haunting the World—the specter of the wealth gap over time [as the rate of return on capital outpaces economic growth.]”

– Fabricated Marx-Piketty Quote

Or, to state the main point of Piketty’s theory:

The modern day wealth gap, which had been curved in the World Wars eras but started to widen again since the 1980’s and is projected to widen further, is a result of the consolidation of wealth over time (not just for a person, but from generation to generation) as the rate of return on capital (stocks, lands, bonds, etc) outpaces economic growth (a current trend; no one can predict the future).

Over time this could theoretically create a wealth gap so wide that no “new money” could cross it in a few generations (30 year periods). We can call this advent of the wealth gap dynastical oligarchy.

With that in mind, we also need to consider factors like taxes, regulation/deregulation, population growth, technology, and more for a full picture.

“…the history of the progressive tax over the course of the twentieth century [which is becoming flatter] suggests that the risk of a drift toward oligarchy is real and gives little reason for optimism about where the United States is headed.” – Piketty

TIP: The theory can be summed up as: the rate of return on wealth is higher than the economic growth rate; or for short r > g (where r is the rate of return to wealth and g is the economic growth rate).

FACT: In general, the rich save more than the poor, and the poor are extended on credit. This is one of many factors, like capital growing faster than economic growth or inflation in wages (especially for low wage workers), that contributes to a growing wealth gap.

Criticism of Piketty’s Capital in the 21st Century: Piketty caught some flack for leaving out some data on taxes and redistribution programs, for not including adjustments for inflation, and for using IRS data (which may not fully show non-taxable income distributions). It is perhaps with this in mind that Piketty (and friends) published a 2017 update-of-sorts to Capital. This update confirms that the wealth gap is growing, and that capital income is growing faster than labor income, but it also helps shed light on what FDR’s tax rate really meant in context and the ways in which wealth trickles down to lift all boats in its rising tide. For a quick overview of the new paper, see VOX’s “You’re not imagining it: the rich really are hoarding economic growth” and for the full version see “Distributional National Accounts: Methods and Estimates for the United States∗ Thomas Piketty (Paris School of Economics) Emmanuel Saez (UC Berkeley and NBER) Gabriel Zucman (UC Berkeley and NBER) July 6, 2017.”

A chart showing how the tax rates affect income and do or don’t contribute to the wealth gap. See Pages 38 of the new paper forward for descriptions of the above images. This paper pairs well with Capital to tell the full story of the growing wealth gap.

The Problem of the Wealth Gap

The problem with the wealth gap over time is that it affects global social, political, and economic inequality; especially in a world where money is power (in a world with aspects of Oligarchy).

In other words, the problem isn’t being green with envy over what the Jones’ have, it is the power gap between the average Joe and the 1% over time.

Here in the modern day we can already see the effects of this inequality in the way that money influences politics. Likewise, we can see this is in the consolidation of more and more businesses assets into the hands of fewer and fewer shareholders (consider, the Trumps, Waltons, Kochs are all second generation wealth). Of course with that said, certainly those two simple examples aren’t the only ones.

In simple terms, to restate this: Capital has been outpacing economic growth since the 1980’s (since Reaganomics roughly), leading to a wealth gap between capital and labor (where wage trends are down but profits from capital are up) and contributing to a global wealth gap (between the global .01% and 99.9%).

The problem here is that economic growth is dependent on population growth (which is slowing) while the return on capital is not dependent on economic growth (and is not slowing).

In other words, in the 21st century we are likely to see economic growth decline and growth from capital sustain and compound (funneling money into the hands of the top 1% of families as money is passed from generation to generation; note: given that Trump wants to abolish the estate tax, a tax on inherited wealth of over $5.49 million, and given that his plan flattens and lowers the income tax, this will likely only be more true; Piketty correctly predicted this trend in 2014).

As we can see in the chart below, since the Industrial Revolution economic growth has expanded with the population, however population growth is projected to to plateau (while the return rate on capital isn’t). This implies, if nothing else changes,  r > g would be projected to increase over time.

Wealth growth since the revolution from Piketty’s book. It shows economic growth correlates with population growth.

The above is what all 650 something pages of Picketty’s book are about (it is the data, insight, solutions, and specifics that take up the bulk of the book).

Pair this fact with the growing rate of debt and the almost stagnant growth in the minimum wage (which hasn’t even kept up with economic growth) and one can see the general issue. That issue is that wealth doesn’t trickle down as much as return on capital compounds at the top (even in an era where economic growth is steady, it is only worse if that growth declines!)

Many of us feel like we know many of the above truisms somewhat instinctively, and we’ve all seen the YouTube video on the wealth gap, but what we feel we know from our intuition and YouTube, Piketty attempts to prove with data it in his Capital in the Twenty-First Century.

The laws of cumulative growth and cumulative returns: Consider the following quote from Piketty’s Capital that sums up his central thesis, that even a small return on capital can lead to a large wealth gap over time via what Piketty calls “the law of cumulative growth and cumulative returns.” The law of cumulative growth says a low annual growth rate over a very long period of time gives rise to considerable progress (this applies to capital and to population growth and economic growth). The law of cumulative returns meanwhile is almost exactly the same, but speaks to the ability to grow capital over time. The law of cumulative returns says that an annual rate of return of a few percent, compounded over several decades, automatically results in a very large increase of the initial capital, provided that the return is constantly reinvested, or at a minimum that only a small portion of it is consumed by the owner of the capital (small in comparison with the growth rate of the society in question).

“The central thesis of this book is precisely that an apparently small gap between the return on capital and the rate of growth can in the long run have powerful and destabilizing effects on the structure and dynamics of social inequality. In a sense, everything follows from the laws of cumulative growth and cumulative returns, and that is why the reader will find it useful at this point to become familiar with these notions.”

A chart from Piketty’s work showing how capital growth leads to a wealth gap over time.

ReadCapital in the Twenty-First Century By Thomas Piketty free online. Get it while you can (the link is legit); and consider buying the book and supporting one of the greatest economic minds of our time.

TIP: It is Piketty as in “picket-tea.”

An Introduction to Thomas Piketty’s Capital in the 21st Century- A Macat Economics Analysis.

Wealth and Income Inequality: The terms wealth and income inequality generally describes the gap in wealth and income respectively (where income is a short term measure and wealth is a measure of capital assets over time) between labor and capital, between supervisory labor and non-supervisory labor, and sometimes even between countries. Generally the gap between labor and capital is the biggest gap, next supervisory labor and non-supervisory, and finally this is happening inside countries more than between them (although there is a wealth gap between countries as well). In other words, the main problem is the wealth gap between individuals on a global level where the richest are getting richer faster than the rate of economic growth due to capital investments. Meanwhile, the related problem is that economic inequality leads to social and political inequality. NOTE: There is also obviously a gap between capital and capital too, of a group who all manage their assets wisely, on average those with more capital grow their capital faster (the effect is exponential). Factor in the fact that nations take out debt and labor typically holds the debt, while capital holds the loans and their interest, and that those with capital tend to control policy (SEE: “money in politics”), and we see the mechanics of the wealth gap. SEEA Guide to Statistics on Historical Trends in Income Inequality for non-Piketty data.

The Gist of Capital in the Twenty-First Century

Thomas Piketty’s Capital in the Twenty-First Century is the economic masterwork of modern times, it explains the wealth gap, and its to social, political, and economic inequality.

The explanation is not based on Pure Reason, but is instead based on experience and empirical data, from the vantage-point of the shoulders of giants. This isn’t to say Piketty takes the lazy route, quoting past greats without a second thought, instead he dissects past theories, and makes them face modern data, thus applying proper skepticism.

Thomas Piketty’s ‘Capital’ in 3 minutes – Newsnight.

An Introduction to the Introduction of Thomas Piketty’s Capital in the Twenty-First Century

Capital in the Twenty-First Century doesn’t just look at the modern wealth gap, instead it also explains the historical effects of wealth and income inequality in 20 nations including “the West” and those in close relations with it like Japan and Russia (where a particular focus is on France and America).

The book’s main focus is then: 1. proving the wealth gap and its effects in history AND in modern times, 2. explaining the impact of the wealth gap on the past and future, and 3. pointing out the social and economic factors that impact the gap (and those which the gap impacts).

The book gives insight into what exactly the “1%” is, after-all, it is a term that Thomas’s work popularized, and it frames why it is a problem (not due to jealousy, but due to the consolidation of capital assets in fewer-and-fewer hands over time).

The book also gives insight into ideas of almost every important past economist from Smith (the father of modern economics), to Ricardo, to Marx. Thomas picks apart their theories, based on data, showing where their predictions were right, wrong, or simply insightful for their times (but not nuanced enough in hindsight with our current data and technology).

Overall the book is hopeful, and does some vital groundwork upon which technology can be built, but it is hardly a promise that the market will just work itself out.

In fact, it is a promise that, if nothing changes (either via direct action or as an advent of technology), that the wealth gap will continue to grow and this will result in “dynastical oligarchy” (that is, like it is with the Waltons, where the one who earned the wealth is long gone and the heirs enjoy the effects of compounding capital as they accumulate more assets).

Thus, this work is the modern version of Malthus, Ricardo, Marx, or Mises, as it is suggesting a sort of doomsday if nothing is done, but it is far more hopeful and well cited than those works.

To be clear, no one will in-fact mistake this work as a work of Mises (who offers a pure free-market answer to inequality), nor will the mistake it as a book of Malthus or Ricardo (liberals concerned about population growth and inequality, and in the case of Ricardo land being owned by fewer and fewer people who would control rent), but nor will they mistake it for work of “young Marx” (a doomsayer with an economic theory that capital in industrial society would be placed in fewer and fewer hands as a natural advent of capitalism, gleaned from his time).

This is a work more in the vein of Keynes (who influenced social liberal economics) or Kuznets (an American economist with an optimistic view on modern economy who is cited in the book), but unlike any predecessor this book is more fact than theory. This is a book based on piles of data, only available to the most modern economist, and [according to Piketty] fifteen years of research (1998–2013) devoted essentially to understanding the historical dynamics of wealth and income.

Thomas Piketty: New thoughts on capital in the twenty-first century.

… “there was contention for a long time between the upper classes and the populace. Not only was the constitution at this time oligarchical in every respect, but the poorer classes, men, women, and children, were the serfs of the rich. They were known as Pelatae and also as Hectemori, because they cultivated the lands of the rich at the rent thus indicated. The whole country was in the hands of a few persons, and if the tenants failed to pay their rent they were liable to be haled into slavery, and their children with them. All loans secured upon the debtor’s person, a custom which prevailed until the time of Solon, who was the first to appear as the champion of the people. But the hardest and bitterest part of the constitution in the eyes of the masses was their state of serfdom. Not but what they were also discontented with every other feature of their lot; for, to speak generally, they had no part nor share in anything.”

– An excerpt from the Athenian Constitution By Aristotle, same problem, different century (this quote is referencing 600 BC).

TIP: Consider reading a very closely related work, David Callahan’s The Givers: Wealth, Power and Philanthropy in a New Gilded Age. It describes the wealth gap in relation to Philanthropy and money in politics. It is no small part of what is dividing our nation and globe. In both cases, the solution can be said to be found in wealth taxes and smart regulations that curb abuses of power born from wealth. See the video below, it pairs well with our discussion on Thomas Piketty’s work.

The Givers: Wealth, Power, and Philanthropy in a New Gilded Age.

Some Major Take-Aways From the Book

The books Introduction is enough to give the average reader insight into the history of “political economy” and general economics, and the conclusions of the introduction are partly what we all know instinctively. Those conclusions, and a few more gleaned from later chapters include the following takeaways:

  • The wealth gap is born from the income gap over time as the rate of return on capital exceeds economic growth, year in and year out.
  • Generally the income and wealth gap between labor and capital is the biggest gap, next supervisory labor and non-supervisory, and finally this is happening inside countries more than between them (although there is a wealth gap between countries; the problem is global, not national).
  • The income gap is largely due to capital (ownership of the factors of production via direct ownership and stock). Income from capital is invariably much less evenly distributed than labor income. This means not just anyone, but capitalist only are the 1% both in terms of the income gap (and then logically also in terms of the wealth gap over time).
  • The wealth gap, paired with low estate taxes (and other taxes on wealth; like the capital gains tax) ensures that capital will be consolidated into fewer and fewer families over time.
  • The fact that capital growth exceeds economic growth ensures that those who have capital now, a Walton or Rothschild (to offer well known names; not to name names), will be the the “ruling” families of the future. Capital compounds faster than economic growth, so any family that can manage its money correctly has a compounding head start that is impossible to catch up with. TIP: The math behind the theory can be partly expressed as: r > g (where r is the rate of return to wealth and g is the economic growth rate).
  • In past eras, specifically after Wilson and FDR’s income tax and wartime tax hikes, inequality was curbed (due to many factors including a “fair” progressive tax).
  • “Since the 1970s, income inequality has increased significantly in the rich countries, especially the United States, where the concentration of income in the first decade of the twenty-first century regained—indeed, slightly exceeded—the level attained in the second decade of the previous century. It is therefore crucial to understand clearly why and how inequality decreased in the interim.”
  • There are two main ways for a government to finance its expenses: taxes and debt. In general, taxation is by far preferable to debt in terms of justice and efficiency. In America, and in many liberal countries, debt is rising rapidly while in America specifically taxes on wealth are falling. This can be said to be leading to an “oligarchy.”
  • The solution: A fair progressive tax (on income including capital gains), a fair estate tax (do you get why the Trump budget can be called “oligarchical” yet due to it eliminating the estate tax?), and a global wealth tax in general. The fair, not Marxian, redistribution of wealth from capital gains and estates of the 0.1% to the poorest. Literally, a Robin hood solution, which is sure to up-set some parties. “A rising tide lifts all ships,” but is that really an excuse not to offer assistance to the other ships? That is the question? The other question is, “do you want to test the waters like they did before the French Revolution, Civil War, or World Wars? People dislike extreme political, social, and economic inequality… and isn’t that exactly what is happening here in 2017 as we ignore the wealth gap? And, if it is that Piketty is right, that means the worst is yet to come.”

TIP: To keep with the theme here, below is another fabricated quote. Again, this is a play on a Marxian quote Piketty notes in his book (which is why we are doing the fake Marx quote thing).

“What Capitalists of the 21st Century therefore produces, above all, are its own gravediggers. The fall of the proletariat is inevitable; but so is the fall of the era of true Capitalism. Instead, if nothing is done, the future is dynastical oligarchy.”

Capital in the Twenty-First Century [Slides+Audio].

Could Piketty Be Wrong? OPINIONS

Above were the facts on the book, below are inferences (in the form of opinions) as to what could be wrong with Piketty’s theory.

First off, it is easy to poke holes in the gist of the theory, but much harder to poke holes in the nuances when read in-full with the data.

With that said, here is one way in which Piketty’s main suggestion, r > g over time, could be wrong:

If the correct taxes tax out wealth, if a new technology comes along, if massive inflation happens, if we get a Solon who removes all debts, or if we get a Teddy or FDR, etc… in other words , if r < g at some point, then “Piketty would be wrong” in the same way Malthus, or Ricardo, or Marx.

The problem with that statement on the economists above is, when you actually read their works, you realize in each case that they had a lot right, but just a few predictions wrong.

So does Piketty put too much weight on the wealth gap, maybe? But like it was for Malthus, or Ricardo, or Marx… there is a reason the thinkers of a time put emphasis on the problem of the time, that is because they have spotted it clearly and are warning us what will happen if nothing changes.

If “things change,” if the next cycle looks very different, then maybe we get something different.

However, if we bubble and bust our way to Vienna 1908 while corporate and estate taxes are lowered and regulations restricted, how can anything but unforeseen technology save us from what we already see happening in the populist quasi-revolutions of 2016-2017?

The factors of production changes each cycle, but the historical effects of wealth and income inequality do not.

TIP: Not only does wealth consolidate in fewer-and-fewer families over time as the wealth gap grows, but businesses tend to consolidate as well (through mergers, buyouts, stock holding, etc; see “the Consolidation Curve“).[5] However, like with population (see Malthus), or with landownership (Ricardo), or industrial capital (Marx) we can assume the trend will see a plateau. Malthus assumed population would never stop growing, but when people are secure they choose to have less kids, Ricardo was concerned about the long-term evolution of land prices and land rents, but today this is only true in areas with very high demand (like San Fran), Marx was concerned with “the Principle of Infinite Accumulation,” but as technology changed and policy changed it offset “capitalism become its own gravedigger.” Piketty, knowing all of this, issues his own version of Ricardo and Marx’s warning pertaining to modern times and the global wealth gap. Here we can note that even if nothing is done to address the gap, there are many factors that could cause it to plateau. This is to say, we should take his warning and solutions seriously, but we should not fully assume a doomsday.

OPINION ON A SOLUTION: Another solution is ensuring all citizens become capitalists. The globe aside, if every American had an HSA, 401K, IRA, or other market-based savings account, then they would all see some capital returns. This wouldn’t fix the wealth gap, but it would help slow its growth. If there was a global wealth tax, and that money went into market-based savings accounts of the poor, it would bestow not only the capital, but the capitalism onto the masses. A free-market is little more than buzzword if the many can’t vote with their capital.

Citations

  1. Thomas Piketty’s “Capital”, summarised in four paragraphs A very brief summary of “Capital in the Twenty-First Century
  2. Capital in the Twenty-First Century By Thomas Piketty 
  3. Piketty’s “Capital,” in a Lot Less than 696 Pages
  4. A Guide to Statistics on Historical Trends in Income Inequality
  5. the Consolidation Curve


"Capital in the Twenty-First Century By Thomas Piketty Explained" is tagged with: Capitalism, Economic Inequality, Socialism