What makes it so accessible to a non-economist is that it provides a new framework for thinking about the nature of economic inequality and related concepts such as wealth and income. When a new conceptual framework is first proposed, everyone must begin at square one, so to speak, and this (temporarily) places laypeople and specialists in the same position. This is what has happened with Piketty's book. In short, this is an historic opportunity for ordinary people to take a peek into the rarified world of economics.
Inequality of What? Inequality Between Whom?
As everyone who has heard of this book knows by now, the topic is "inequality". But inequality of what and inequality between whom? These related questions seem, at first glance, to have obvious answers: It's inequality of wealth between the upper economic classes and everyone else. But because Piketty is developing a new conceptual framework for these issues, we have to proceed cautiously. In fact, I'm pretty confident that a large proportion of the discussion of "Capital" is hurt by a misunderstanding of Piketty's goals for his overall project. This misunderstanding shows up right away, when commentators try to quibble with the question of who counts as "wealthy".
Let's consider two hypothetical people, who we will call "Robert" and "William". Robert is the fortunate recipient of a significant inheritance in the form of several well-appointed apartment buildings. William is the fortunate recipient of a good education and a skill set that's in demand by employers. Robert can make his living as a "rentier" -- a term that's unfamiliar to most non-specialists, but which simply refers to people who make money because they own something as opposed to working. The canonical example is a landlord, who is able to rent out buildings or land for money. The landlord is able to do this because she owns something, not because she works or produces anything. Of course, he may also work (e.g. to maintain the buildings or land), and he may have come to own the things he does because he's worked very hard in the past. But at this point in time, Robert is able to make money because he owns something, and that makes him a rentier. The money he receives is called, appropriate enough, a "rent".
William is in a different position. He's acquired a skill set and an education, and now he is able to trade his time and effort for money. In a metaphorical sense, he "owns" his own talent, but that's not relevant here. William has to work for his money; he gets paid because he works, not because he owns something. William is a "worker".
The difference between Robert the rentier and William the worker isn't necessarily that one makes more money than the other. William's skills may enable him to enjoy a salary that's much larger than Robert's rents. But for concreteness, let's say that they spend about the same amount of money to maintain their lifestyle (i.e. their consumption is about the same). Robert is able to save a percentage of his rents and reinvest them in order to eventually purchase new apartment buildings. William is able to advance in his career, acquire new skills, and increase his income. Piketty's question is, "Who is more likely to do better in the long run: the rentier or the worker?".
There's no simple answer to that question. There is no law that forces one to do better than the other. Robert could enjoy an astronomical salary eventually, and William might see real estate prices crash. Or Robert might stagnate in his career while William's property skyrockets in value. People often say that Piketty's is putting forward "laws" of inequality, but he is doing no such thing. That would be dumb, and Piketty is not dumb.
Instead, the answer to the question of whether William will do better than Robert or vice-versa depends on two numbers. The first is the rate of return on capital -- when Robert reinvests his money, at what percentage rate will it grow? Rentiers, on average, can't get more than the typical rate of return on capital. The second is the growth rate of the economy. Workers on average can't expect a salary increase greater than the growth rate of the economy. Piketty refers to the first number as r and the second as g. If r > g, then Robert the rentier will do better than William the worker. If g > r, then the opposite will be true. And there is no ironclad law that r > g or that g > r.
Piketty's massive work documents in excruciating detail that throughout history, across every country with enough data to measure, r > g the vast majority of the time. Rentiers do better than workers on average -- a lot better. Thanks to compounding interest, rentiers and workers diverge in their economic status very quickly, even if r is only a tiny bit greater than g. And the tendency to diverge is self-reinforcing in two distinct ways. If Robert the rentier pulls ahead of William, he will be earning a rate of return on an ever-increasing stock of capital. So the difference in the amount of money each possesses will increase. But also, Robert's rate of return -- that is, the value of r itself -- will increase, too. If Robert's fortune is sufficiently large, then he will be able to take advantage of more exotic kinds of investments that have a higher rate of return. So not only will Robert and William diverge, but they will diverge faster and faster over time.
We all know this phenomenon. Piketty makes a lot of references to literature, and so I'll do the same by making a reference to the not-quite equally erudite film, "Anchorman 2: The Legend Continues", starring Will Ferrrell. There is a character who is a very wealthy investor and describes himself as a self-made man. He inherited 300 million dollars, and he brags to everyone that in the decades that followed, he was able to increase that fortune to 305 million dollars. This is joke that everyone gets. A wealthy rentier with 300 million dollars could easily increase that fortune by a far, far greater amount with virtually no effort whatsoever. The fact that such a joke can be made in a film like "Anchorman 2" shows how pervasive the divergence between rentiers and workers is, and shows that this divergence is common knowledge.
So now we can return to the question of defining what counts as "wealth". The answer is pretty simple, even if there are subtleties in applying it. Wealth is anything that provides a rent to the owner. The inequality Piketty is concerned with is the inequality between those who get rents and those who work. Of course, lots of people fall in between those two extremes, but it's still a meaningful distinction.
Reading "Capital" as an American
About a quarter of the people who visit this blog are not Americans, so I'll clarify a few things to begin this section. I happen to be an American, born in 1972, which makes me a member of the so-called "Generation-X". My parents are "Baby Boomers", who grew up in the decades following World War II.
Like other members of my generation, I grew up learning that America was a highly upwardly-mobile society. The mere fact that you were born into a particular socio-economic class did not mean that you had to stay there. You could get ahead if you did the right things. "The right things" were simple to understand -- you had to go to college to get an education, and you had to work hard. You could get an entry-level professional position after college and rise through the ranks of the American workforce. Eventually, with enough hard work, you could do very well economically over the long run.
But is that true? That depends on the relationship between r and g. If g > r, then the growth rate of the economy (and therefore, of average wages) increases at a faster rate than the return on investment. Workers, especially skilled workers, will do best over the long run -- even better than people who are born wealthy. But on the other hand, if r > g, the opposite will be true. In such a world, the best way to get ahead is to be ahead already. The wealthy will become wealthier more quickly than workers' salaries can increase. The image that my generation grew up with was of an America in which g > r.
I mention my and my parents' generations because the Baby Boomers are unique in American history. During the years following World War II, the economy grew very quickly -- so quickly, in fact, that for a time, g was in fact greater than r. The people whose fortunes increased most rapidly were the workers, not the rentiers. This was temporary, of course. We now live in a world where r > g once again, as it was in the years leading up to the two world wars.
The interesting question here is "why?". Why did g outstrip r for the Baby Boomers? The romantic explanation is very common among Americans -- it's because of the hard work and highly moral character of the so-called "Greatest Generation", which grew up during the Depression and later defeated fascism in World War II. That generation led the world for a time into an era of prosperity for honest, hard-working Americans. This romantic vision has a corollary -- if we could somehow get back to the values that made the Greatest Generation so great, we could enjoy the kind of prosperity and upward mobility that the Baby Boomers enjoyed.
Unfortunately, the romantic explanation turns out to be false. In fact, Piketty buries this idealistic worldview under mountains of hard, quantifiable data. The Greatest Generation may have been great, but that era of upward mobility wasn't because of their wonderful character or hard work. It was because the calamity of World War II (and also World War I) had three effects that temporarily reduced the value of g, making the return on capital much lower than it would otherwise have been. First, the wars destroyed huge amounts of capital directly. There's nothing like a "Flying Fortress" (coincidentally, like the one my grandfather flew in), to destroy lots of capital. Second, it diverted capital into unproductive uses. Military spending on weapons is not nearly as productive to the economy as social spending, for example. And third, the governments' need for revenue led to a steeply (in fact, confiscatory) progressive tax that wiped out a large share of the wealth of the most wealthy Americans.
Furthermore, following World War II, the huge population increase (known as the Baby Boomers) stimulated the economy, as did spending on rebuilding Europe. The decades following World War II were therefore unique in history. Those factors temporarily caused g to be greater than r, making that era highly unusual in that the best way to improve your socio-economic status was by working.
This is why I, as an American member of Generation-X, was so struck by this discussion. I happen also to have been a professor at large state universities for about a decade. Like other faculty, I've noticed a dramatic shift in attitude among my students. When I went to college, I believed that I could get ahead and do better economically than my parents, and that this opportunity was due to the availability of a college education. Nowadays, students seem largely to not have this attitude. They seem to think that they'll be lucky if they tread water. College merely increases their chances of doing so, but they don't think that hard work will allow them to get ahead. I wish I could say that their cynicism was unfounded. But unfortunately, it's justified. Piketty shows -- again, with mountains of data -- that workers are having a harder time merely staying afloat, while the wealthy continue to amass larger and larger fortunes.
It's common to read so-called "experts" who allege that Piketty is against economic inequality. This is baffling to me, because Piketty says over and over again in the book that he is not against economic inequality per se, and that some level of inequality is necessary. Nothing he says contradicts this. The only way to read Piketty as being unequivocally against inequality is by not reading his book at all.
Indeed, Piketty's actual views on inequality are quite moderate. He states, repeatedly, that:
- Inequality is necessary to provide an incentive for people to work hard and innovate;
- there is no mathematical formula that reveals what level of inequality is harmful;
- only a democratic discussion among a well-informed citizenry should determine economic policy;
- such a discussion must be fueled by both data and our moral judgments; and
- at some threshold (which will be different for different societies) a severe enough level of inequality will lead to social instability, and this is something to be avoided.
He sees his book as providing two main services. First, it provides the hard data required to be informed about economic inequality. Second, it places the issue of inequality in front of the public. To be sure, he does have views about how to address the problem of vast levels of inequality, which come down to instituting an international progressive tax on capital, and building institutions that make financial transactions more transparent (which would have the effect of limiting the use of tax havens by large corporations and very wealthy individuals). People who are arguing in good faith will no doubt disagree on the first proposal. Personally, I don't see how anyone can seriously object to increasing transparency in international financial transactions by large corporations and the fabulously wealthy individuals who avoid paying taxes by stashing their money in Switzerland, the Cayman Islands, Ireland, or any of the other places where capital goes when it wants to keep a low profile.
But only a relatively small section of this massive book is dedicated to Piketty's positive proposals for addressing economic inequality. One gets the impression that his main purpose in putting forward these ideas is to get a conversation started, not to say the last word on the topic.