Capital In The Twenty-First Century: A Review

Nov 01, 2014

Piketty has done his research. His 685-page book Capital In The Twenty-First Century collates substantial income and tax data for many different countries back into the 19th century. From this he concludes:

When the rate of return on capital exceeds the rate of growth of output and income, as it did in the nineteenth century and seems quite likely to do again in the twenty-first, capitalism automatically generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based.

The data show that the rate of return on capital and growth of output are likely to rest around 4-5% and 1-2% respectively. That this can cause unsustainable inequality is intuitive: any fortune growing at 4% is going to increase faster than wages growing at 1%, and so too the difference between them.

In suggesting potential solutions to this growing inequality, Piketty makes two assertions that stick in my mind. The first is that taxation works and is preferable to debt:

From the standpoint of people with the means to lend to the government, it is obviously far more advantageous to lend to the state and receive interest on the loan for decades than to pay taxes without compensation. […] for the general interest, it is normally preferable to tax the wealthy rather than borrow from them.

A possible counter-argument is that the rich with further capital will be more effective at general welfare than the public sector. I find this implausible, given the reputation of the nordic countries and my own observations living in and comparing Australia to the USA.

Piketty further suggests that in addition to existing taxation models, establishing a tax on overall wealth (as distinct from the more familiar income tax) is likely a sound option, though technically and politically difficult. More so than the other obvious alternative: inflation.

When it comes to decreasing inequalities of wealth for good or reducing unusually high levels of public debt, a progressive tax on capital is generally a better tool than inflation.

Such a progressive tax—one example he gives is 0% up to 1 million euros, 1% to 5 million, then 2% thereafter—has a large technically barrier however: how do you know how much wealth a person has? Existing taxes on capital, such as an estate tax, can succeed because they are easy to measure. I can see your house, and estimate its worth. In a global environment, with many different types of asset class, how can wealth be assessed accurately?

To start, banks need to share information:

Without real accounting and financial transparency and sharing of information, there can be no economic democracy.

Piketty spends some time discussing strategies for making this happen, including sanctions and the Euro, but it remains a difficult problem. This policy advice has predictably drawn much cogent criticism, which is important to read in conjuction.

Technology should make this easier, though ironically when looking for tax data from goverments:

I have also noticed a certain deterioration of the tax data after 1990. This is due in part to the arrival of computerized records, which in many cases led the tax authorities to interrupt the publication of detailed statistics, which in earlier periods they needed for their own purposes. This sometimes means, paradoxically, that sources have deteriorated since the advent of the information age (we find the same thing happening in the rich countries).

I am embarrassed for my industry.

Bill Gates wrote a review of the book, which contains some insightful criticism:

Piketty’s r > g doesn’t adequately differentiate among different kinds of capital with different social utility.

Imagine three types of wealthy people. One guy is putting his capital into building his business. Then there’s a woman who’s giving most of her wealth to charity. A third person is mostly consuming, spending a lot of money on things like a yacht and plane. While it’s true that the wealth of all three people is contributing to inequality, I would argue that the first two are delivering more value to society than the third. I wish Piketty had made this distinction, because it has important policy implications.

The policy implication being a greater consideration of consumption taxes, which of course still has its difficulties.

Overall this book contains important ideas and data, but is too detailed for a casual reader like myself. I’d recommend reading the introduction, then skimming everything up to Section 4 before reading to the end. The middle is useful technical analysis for those who care about that level of detail. I look forward to see what further research and policy follows from it.