What if inequality were to continue growing years or decades into the future? Say the richest 1 percent of the population amassed a quarter of the nation’s income, up from about a fifth today. What about half?
To believe Thomas Piketty of the Paris School of Economics, this future is not just possible. It is likely.
In his bracing “Capital in the Twenty-First Century,” which hit bookstores Monday, Piketty provides a fresh and sweeping analysis of the world’s economic history that puts into question many of our core beliefs about the organization of market economies.
His most startling news is that the belief that inequality will eventually stabilize and subside on its own, a long-held tenet of free market capitalism, is wrong. Rather, the economic forces concentrating more and more wealth into the hands of the fortunate few are almost sure to prevail for a very long time.
It is possible to slow, or even reverse, the trend, if political leaders like President Barack Obama, who proposed that income inequality was the “defining challenge of our time,” really push.
“Political action can make this go in the other direction,” Piketty told me. But he also adds that history does not offer much hope that political action will, in fact, turn the tide: “Universal suffrage and democratic institutions have not been enough to make the system react.”
Piketty’s description of inexorably rising inequality probably fits many Americans’ intuitive understanding of how the world works today. But it cuts hard against the grain of economic orthodoxy that prevailed throughout the second half of the 20th century and still holds sway today. It was shaped during the early years of the Cold War by the Belarusian-born American economist Simon Kuznets.
Painstakingly assembling data from tax returns, Kuznets estimated that between 1913, when the income tax was first introduced in the United States, and shortly after the end of World War II in 1948, the slice of the nation’s income absorbed by the richest 10 percent of Americans declined sharply, to about a third, from a little under half.
In his presidential address at the annual meeting of the American Economic Association in Detroit in 1954, he sketched out what came to be known as inequality’s “Kuznets curve”: “Widening in the early phases of economic growth when the transition from the preindustrial to the industrial civilization was most rapid; becoming stabilized for a while; and then narrowing in the later phases.”
Kuznets’ conclusion provided a huge moral lift to capitalism as the United States faced off with the Soviet Union. It suggested that the market economy could distribute its fruits equitably, without any heavy-handed intervention of the state.
Today, of course, it’s far from obvious that the 19th century pessimists were entirely wrong.
Glancing back across history from the present-day United States, it looks as if Kuznets’ curve swerved way off target. Wages have been depressed for years. Profits account for the largest share of national income since the 1930s. The richest 10 percent of Americans take a larger slice of the economic pie than they did in 1913, at the peak of the Gilded Age.
This is not solely an American phenomenon. Across many other developed nations, the distribution of economic rewards in the 21st century is taking on decidedly 19th century features.
In “Capital in the Twenty-First Century,” Piketty offers a general theory of capitalism that returns distribution to the center of the analysis. Branko Milanovic, an expert on the global distribution of income at the City University of New York’s Graduate Center, called it “one of the watershed books in economic thinking.”
Like Kuznets’ analysis, Piketty’s is based on data. He just has much more: centuries’ worth, from dozens of countries. He distills from them a simple historical regularity. The rate of return to capital – understood broadly to include machinery, land, financial instruments, housing and everything else – is usually higher than economic growth.
This was particularly true before the Industrial Revolution, when economies didn’t really grow, but it prevailed even after economic growth took off in the 19th century.
This means that the income from wealth usually grows faster than wages. As returns from capital are reinvested, inherited wealth will grow faster than the economy, concentrating more and more into the hands of few. This will go on until capital owners decide to consume most of their income and stop reinvesting as much.
Kuznets’ misleading curve is easy to understand in this light. He used data from one exceptional period in history, when a depression, two world wars and high inflation destroyed a large chunk of the world’s capital stock. Combined with fast growth after World War II and high taxes on the rich, this flattened the distribution of income until the 1970s.
But this exceptional period long ago ran its course.
During the Gilded Age – a period of enormous concentration of income and wealth – the stock of the world’s privately held capital amounted to some five years’ worth of global income, by Piketty’s estimate. By 1950, it had fallen to below three, but by 2010, it was back at four. And by the end of this century, Piketty projects, it will amount to almost seven.
Is there a politically feasible antidote? Piketty notes that the standard recipe – education for all – is no match against the powerful forces driving inherited wealth ever higher.
Taxes are, of course, the most feasible counterweight.
Progressive wealth taxes could reduce the after-tax return to capital so that it equaled the rate of economic growth.
But politically, “the fiscal institutions to redistribute incomes in a balanced and equitable way have been badly damaged,” Piketty told me.
The holders of wealth, hardly a powerless bunch, will oppose any such move, even if that’s what is needed to preserve capitalism against the populist impulses of those left behind.
Piketty offers early-20th century France as an example. “France was a democracy and yet the system did not respond to an incredible concentration of wealth and an incredible level of inequality,” he said. “The elites just refused to see it. They kept claiming that the free market was going to solve everything.”