Monday, November 10, 2014

Summary of Capital in the Twenty-First Century by Thomas Piketty

Capital in the 21st Century by Thomas Piketty took the world by storm this last summer and became a surprise best seller.  But almost nobody actually read it.  I think this is because it is so dense.  Piketty's book is not that complicated, but it is really an academic work of social science more than popular non-fiction.    This summary (of the English translation by Arthur Goldhammer) attempts to capture the gist of the book.   Do buy the book and read it over time as the details and writing are fabulous.   But if you won't do that soon, please do read this page.  Piketty gives spoilers in the introduction so this page wont hurt you.  It will take about 15 minutes to get through.   Thanks to Professor Piketty for making his figures available online, some of which I use below.

Thirty Second Summary

For the last 2000 years economic growth has been low and the times of 5% growth many of us have experienced are a historical anomaly.   That growth combined with the shocks to the economy and taxation we got from the World Wars and the Great Depression gave rise to the propertied middle class which is also a historical anomaly.  We are now re-entering a more typical period of low growth where the rate of return on investment is bigger than the rate overall economic growth.  Thus wealth accumulates in the hands of investors, and the math and data both say that will not only continue, it will accelerate.  Some time in the 21st century, barring major shocks, the wealthy will have it the best they ever have in the history of the world including the Roman Empire and the Gilded Age.  

Fifteen Minute Summary

Key Quote for the book and its empiricism: 
To put it bluntly, the discipline of economics has yet to get over its childish passion for mathematics and for purely theoretical and often highly ideological speculation, at the expense of historical research and collaboration with the other social sciences.

Introduction Chapter.
Economists used to study inequity but stopped mid 20th Century and fell in love with abstract math.  Piketty and collaborators have spent the last decade gathering data from many countries.   The math and data together say inequity will get worse and the rise of the middle class was an effect of the shocks of the world wars and the great depression.  Now we are returning to a more historically typical situation, where growth is low and return on capital overcomes return on labor and inequity will surpass the gilded age unless we change some of the details of our tax system.
Key Quote: 
When the rate of return on capital significantly exceeds the growth rate of the economy (as it did through much of history until the nineteenth century and as is likely to be the case again in the twenty-first century), then it logically follows that inherited wealth grows faster than output and income.

Quote:The purpose of Part One of this book is to introduce certain basic notions.

Chapter 1: Income and Output
A chapter of definitions (translated into less technically precise but essentially the same).  These are not hard to understand: if you just substitute "personal" for "national" you will have exactly the right intuition.   Most of understanding Piketty's book is keeping these definitions handy.
  • National Capital: All things of value owned in nation that can be sold or exchanged.  Also called national wealth.
  • National Income : all the money made in nation by anybody and anything (there are two kinds see next two definitions)
  • Labor Income : money made from work
  • Capital Income : money made from investment
  • Capital Income Ratio : a number, BETA = (National Capital) / (National Income)
  • Rate of Return on Capital : an average number r (for example 0.05 if you get a 5% savings account)
  • Capital Share of National Income : a number, ALPHA = (Capital Income) / (National Income)
First Fundamental Law of Capitalism: ALPHA = r * BETA (this is an accounting identity and is true by defintion-- the share of income that is investment rather than labor is determined entirely by how much capital there is and what its average return is).

Piketty then summarizes the history of the world distribution of income and income inequity with this and many other interesting tables and figures.

Key Quote: Taking all these elements into account, what is the “right” split between capital and labor? Can we be sure that an economy based on the “free market” and private property always and everywhere leads to an optimal division, as if by magic? In an ideal society, how would one arrange the division between capital and labor? How should one think about the problem?

Chapter 2: Growth, Illusions, and Realities

Growth of national income comes from 1) population growth and 2) income growth per person.  Both growth rates are slowing.  This means we will not be seeing the huge annual growth rates we have seen in the past.  His projection is shown below:
Key quote: According to the best available estimates, global output grew at an average annual rate of 1.6 percent between 1700 and 2012, 0.8 percent of which reflects population growth, while another 0.8 percent came from growth in output per head.

PART 2:  The Dynamics of the Capital/Income Ratio.
Quote: The main purpose of Part Two is to understand how and why the capital/ income ratio varies from country to country, and how it has evolved over time.

Chapter 3:  The Metamorphoses of Capital
A history of the size and makeup of capital in Britain and France.  An examination of Jane Austin and HonorĂ© de Balzac show that capital and income in the eighteenth century were viewed as synonyms with an implicit multiplier because a constant return was available to owners of capital.  Both Britain and France show the same pattern where capital took it on the chin in the 20th Century due to shocks, and independently land stopped being the main type of capital, but capital has made a huge comeback of late.  Here is Britain:

Key quote: Broadly speaking, it was the wars of the twentieth century that wiped away the past to create the illusion that capitalism had been structurally transformed.

Chapter 4:  From Old Europe to the New World 
An examination of the history of capital in Germany, Canada, and the United States.  Each has a different pattern than England and France, and among themselves.   The differences of northern and southern US states are examined in light of slavery as capital.  The current trend is the same as England and France but with the value of capital not yet at the same heights.

Key Quote: Capital in the New World took some quite unusual and specific forms, in the first place because land was so abundant that it did not cost very much; second, because of the existence of slavery; and finally, because this region of perpetual demographic growth tended to accumulate structurally smaller amounts of capital (relative to annual income and output) than Europe did.

Chapter 5:  The Capital/ Income Ratio over the Long Run 
There are many detailed treatments of privatization and foundations and the stock asset values, so this chapter is somewhat technical.  However there is one key point: there is structure to the capital-income ratio.  Some key definitions:

  • Review: Capital Income Ratio : a number, BETA = (National Capital) / (National Income)
  • Savings Rate: a number s = fraction of total national image that is saved
  • Growth Rate of National Income: a number g = the amount the income grows per year

Second Fundamental Law of Capitalism: BETA = s / g
Unlike the First Fundamental Law which is always true by definition, the Second Law is asymptotic and only true in the long run for the stable case of a certain s and a certain g.  A key point is that BETA goes up if savings s is large and/or growth g is small.   And BETA seems to be going up a lot the last 40 years:

Key Quote: Given the strong, steady increase of the capital/ income ratio since the 1950s , moreover, it is natural to ask whether this increase will continue in the decades to come and whether the capital/ income ratio will regain or even surpass past levels before the end of the twenty-first century.

Chapter 6:  The Capital-Labor Split in the Twenty-First Century

Recall the First Law of Capitalism: ALPHA = r * BETA.   Here r is the rate of return.  What is that in practice?  Over the long haul it seems to like 4-5% 200 years ago and 3-4% now as evidenced in Britain (here the "observed" does not account for the labor involved in managing capital which Piketty counts as labor):
Since r is relatively stable and BETA is increasing, one would expect ALPHA (the share of income that is capital income) to be increasing, and it is:
So Piketty has now established that the share of income going to capital rather than labor is going up, and there are basic mathematical reasons for that.  But is that a key part of what is increasing inequity?  That is for Part 3.

Quote: For nineteenth-century novelists and their readers, the equivalence between wealth and annual rent was obvious, and there was no difficulty in moving from one measuring scale to the other, as if the two were perfectly synonymous.

PART 3: The Structure of Inequality 
Quote: How much has the structure of inequality with respect to both labor and capital actually changed since the nineteenth century?

Chapter 7: Inequality and Concentration: Preliminary Bearings 
Piketty makes a careful argument that distribution tables are preferable to simpler numeric measures of inequality.
Key Quote: Make no mistake: the growth of a true “patrimonial (or propertied) middle class” was the principal structural transformation of the distribution of wealth in the developed countries in the twentieth century.

Chapter 8: Two Worlds 
Income inequality in France and the US follow a U-shaped curve in the 20th century.  A characteristic that is new in modern times is that high salaries are an important part of the inequality story as evident in the bottom curve for the US below:

Key Quote: The shocks of the period 1914– 1945 played an essential role in the compression of inequality, and this compression was in no way a harmonious or spontaneous occurrence. The increase in inequality since 1970 has not been the same everywhere, which again suggests that institutional and political factors played a key role.

Chapter 9: Inequality of Labor Income 
Interestingly a century ago Europe was less equal than the US, but now the US leads the developed world in income inequality.  Labor income trends are influenced by culture and institutions, especially at the bottom and top of the income scales.   The bottom of the scale follows minimum wage which is very different in different countries.  For example France and the US.

The very highest earners or "supermanagers" are mainly an Ango-Saxon phenomenon and are not justified by any economic principles.

Key Quote: All signs are that the Scandinavian countries, where wage inequality is more moderate than elsewhere, owe this result in large part to the fact that their educational system is relatively egalitarian and inclusive.

Chapter 10: Inequality of Capital Ownership 
First the trends in Europe and the US in wealth inequality is reviewed, and we see the upward trend everywhere.
Then Piketty proposes the mechanism for why wealth naturally concentrates and why we had the fluke of a propertied middle-class in the 20th century, and why it wont last without external shocks or policy changes.  The return on investment is r.  The growth of income is g.   If r > g, then pools of wealth will grow faster than the economy does.  This math is so simple that few argue with it.  Instead they must argue with Piketty's data.  Almost all real arguments with the book are arguments over this graph:

Key Quote: To sum up: the inequality r > g has clearly been true throughout most of human history, right up to the eve of World War I, and it will probably be true again in the twenty-first century. Its truth depends, however, on the shocks to which capital is subject, as well as on what public policies and institutions are put in place to regulate the relationship between capital and labor.

Chapter 11: Merit and Inheritance in the Long Run 
A technical and detailed discussion of the math of inheritance and how it changes under increasing lifespans.  We are returning to more inherited wealth.
Key Quote: To recapitulate: the fundamental force for divergence, which I have emphasized throughout this book, can be summed up in the inequality r > g, which has nothing to do with market imperfections and will not disappear as markets become freer and more competitive. The idea that unrestricted competition will put an end to inheritance and move toward a more meritocratic world is a dangerous illusion . The advent of universal suffrage and the end of property qualifications for voting (which in the nineteenth century limited the right to vote to people meeting a minimum wealth requirement, typically the wealthiest 1 or 2 percent in France and Britain in 1820– 1840, or about the same percentage of the population as was subject to the wealth tax in France in 2000– 2010), ended the legal domination of politics by the wealthy.  But it did not abolish the economic forces capable of producing a society of rentiers.

Chapter 12: Global Inequality of Wealth in the Twenty-First Century 
This chapter examines the question of whether the wealthiest entities have a higher return r than do smaller entities.    If so, the forces of divergence will be even higher.  This is perhaps one of the most important and least talked about part of the book.  First Piketty studies billionaires and they do provide some subjective evidence for the hypothesis.  Unfortunately they are not subject to enough disclosure rules in their investments to know for sure.  Then sovereign wealth funds and US university endowments are examined.  University endowments are subject to disclosure rules and they imply that r is higher for larger investors (and mainly due to better strategies rather than cronyism).  The data is very impressive:

Key Quote: The inequality r > g, combined with the inequality of returns on capital as a function of initial wealth, can lead to excessive and lasting concentration of capital: no matter how justified inequalities of wealth may be initially, fortunes can grow and perpetuate themselves beyond all reasonable limits and beyond any possible rational justification in terms of social utility.

Part Four: Regulating Capital in the Twenty-First Century 
Quote: In the first three parts of this book, I analyzed the evolution of the distribution of wealth and the structure of inequality since the eighteenth century. From this analysis I must now try to draw lessons for the future. 

Chapter 13. A Social State for the Twenty-First Century 
A discussion of the social state, health, education, and pensions.
Key Quote: Can we imagine a twenty-first century in which capitalism will be transcended in a more peaceful and more lasting way, or must we simply await the next crisis or the next war (this time truly global)? On the basis of the history I have brought to light here, can we imagine political institutions that might regulate today’s global patrimonial capitalism justly as well as efficiently?

Chapter 14. Rethinking the Progressive Income Tax 
The history of the income tax and the current race to the bottom for top tax brackets as countries compete for capital.   Top tax rates may soon be regressive in many countries.  An optimal top tax rate is around 80% but this is politically unlikely.
Key Quote: That said, the history of the progressive tax over the course of the twentieth century suggests that the risk of a drift toward oligarchy is real and gives little reason for optimism about where the United States is headed.

Chapter 15. A Global Tax on Capital 
Piketty presents the idea of a global tax on capital he describes as a "utopian idea".  But he makes some practical suggestions on doing this regionally and improving global financial transparency.
Key Quote: But if democracy is to regain control over the globalized financial capitalism of this century, it must also invent new tools, adapted to today’s challenges. The ideal tool would be a progressive global tax on capital, coupled with a very high level of international financial transparency.

Chapter 16. The Question of the Public Debt 
We have large public debts and large debts favor the rich (better to lend the governments money than to pay taxes).  Reducing the debt requires some combination of taxation, inflation, and austerity. Piketty favors a tax on capital as the best tool.
Key Quote: Without real accounting and financial transparency and sharing of information, there can be no economic democracy. Conversely, without a real right to intervene in corporate decision-making (including seats for workers on the company’s board of directors), transparency is of little use. Information must support democratic institutions; it is not an end in itself. If democracy is someday to regain control of capitalism, it must start by recognizing that the concrete institutions in which democracy and capitalism are embodied need to be reinvented again and again.

Quote: The inequality r > g implies that wealth accumulated in the past grows more rapidly than output and wages. This inequality expresses a fundamental logical contradiction. The entrepreneur inevitably tends to become a rentier, more and more dominant over those who own nothing but their labor. Once constituted , capital reproduces itself faster than output increases. The past devours the future.