Capital in the Twenty-First Century (part 2)

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Having described the relationships among the main variables in Piketty’s analysis, I want to turn now to an overview of his historical description, focusing especially on Britain, France and America. What has happened to capital since the Industrial Revolution, especially in the most developed countries? In general, capital has undergone a metamorphosis in form without losing its economic importance in the economy or its value to those who control it.

National capital includes farmland, housing, other domestic capital such as corporate and government assets, and net foreign capital (the difference between a country’s ownership of foreign assets and foreign ownership of its assets). In theory, capital’s value lies in its provision of housing and its use as a factor of production, especially for investment in new technologies. The biggest change in the form of capital due to industrialization was the decline of farmland relative to other assets. Britain and France experienced declines in net foreign capital in the twentieth century due to the loss of their colonial empires.

The value of capital measured in years of national income (the beta discussed in the previous post) has fluctuated over history without taking a consistent direction. It was consistently high in Britain and France in the eighteenth and nineteenth centuries, and lower but rising in nineteenth-century America. It then moved in a U pattern in the 20th century, first falling and then rising. The share of national income that goes to capital rather than labor (alpha) tends to move in tandem with the capital/income ratio, so it too has fallen and then risen in the 20th century. It doesn’t usually fluctuate as widely, however, because a higher capital/income ratio increases the supply of capital and lowers the return on capital somewhat. There is certainly no consistent trend toward a lower valuation of capital relative to national output. Only under the exceptional conditions of the early 20th century did the relative value of capital fall, but it is rising again today.

When capital gets a larger slice of the economic pie, labor gets a smaller one. Labor’s share of national income is higher than it was in the 19th century but has been falling recently. The hope that workers could get ahead collectively as well as individually by enhancing their “human capital” has not yet been realized. Workers are becoming better educated and skilled, but that doesn’t increase their share of the rewards if job requirements rise as fast as they can meet them, or if wages increase too slowly to keep pace with returns on capital.

Before the twentieth century

In the 18th and early 19th centuries, European countries had very low rates of economic growth and thus very high capital/income ratios, as Piketty’s theory predicts. The novels of Jane Austen in England and Balzac in France describe a world in which the inheritance of land was the key to living a comfortable life. Lending money to the government could also be very remunerative, especially in England, where the government was seriously in debt from war spending. There was little inflation to erode the value of your bonds. Income from labor–even professional labor–was simply too low and growing too slowly to provide anything like the living available to those with capital.

The situation in early America was quite different, at least in the North. Just owning and renting out land didn’t provide as good a living, since land was plentiful and cheap. Inherited wealth counted for less because so many people came to America with very little. Both productivity growth and population growth were higher than in Europe. The capital/income ratio, which was around 7 in Britain in 1810, was only about 3 in America. In 1840, Tocqueville attributed American democracy partly to the lack of large fortunes. The South was a different story, however,  because the ownership of slaves dramatically boosted the capital of landowners. Piketty observes, “All told, southern slave owners in the New World controlled more wealth than the landlords of old Europe.” He goes on to describe the implications:

In fact, the New World combined two diametrically opposed realities. In the North we find a relatively egalitarian society in which capital was indeed not worth very much, because land was so abundant that anyone could became a landowner relatively cheaply, and also because recent immigrants had not had time to accumulate much capital. In the South we find a world where inequalities of ownership took the most extreme and violent form possible, since one half of the population owned the other half: here, slave capital largely supplanted and surpassed landed capital.

Over the course of the 19th century, economic output grew at a faster rate, due both to higher productivity and rapid population growth. Here I wish that Piketty had provided clearer connections between the history and the theory. Other things being equal, one would expect a higher growth rate to bring down the capital/income ratio at least slowly (since beta approaches s/g). In Britain and France, it remained up around 7 throughout the century. In America, it increased from about 3 in 1810 to about 5 in 1910. Piketty tends to lump the 18th and 19th centuries together and describe them as a period of relatively low growth and domination by capital, except for early America. I didn’t think he explained very clearly what made it possible for capital to maintain or increase its domination even as industrialization raised productivity and population growth peaked. His formulas would seem to require an increase in the savings rate to offset rising g, which I don’t believe he discusses in that context.

The twentieth century

In Europe, the twentieth century began with a dramatic collapse of European capital during World War I. Between 1910 and 1920, the capital/income ratio fell from around 7 to 3 in both Britain and France. After that, it remained low through the 1940s due to economic depression, declining income from foreign colonies, a lower saving rate, and public policies less favorable to capital. Then came the years of highest growth, the three decades known as the “Trente Glorieuses” in France, when Europe had a sustained rate of growth over 3%. This time the workers did receive the benefits, since capital’s share of income fell from around 35% to 20% in both France and Britain between 1910 and 1970.

The United States experienced a more moderate decline of capital, from a ratio of 5 to 4 times income. The New Deal strengthened the bargaining power of labor and increased the regulation and taxation of wealth. By 1975, capital’s share of income was a little above 20%.

So by midcentury, the potential of high economic growth to create a more egalitarian distribution of income had been realized, but only with the help of political conditions unfavorable to capital.

After 1980, however, things took a turn in the opposite direction. Growth of output and income slowed, due to slowdowns in both population growth and productivity growth. For the richer countries, the great demographic transition that had first exploded populations by extending longevity was now stabilizing them by reducing birth rates. Advanced economies were not getting the same productivity gains in service industries that they had been able to get in manufacturing industries. Piketty describes the results: 

At the beginning of the 1970s, the total value of private wealth (net of debt) stood between two and three and a half years of national income in all the rich countries, on all continents. Forty years later, in 2010, private wealth represented between four and seven years of national income in all the countries under study.  The general evolution is clear: bubbles aside, what we are witnessing is a strong comeback of private capital in the rich countries since 1970, or, to put it another way, the emergence of a new patrimonial capitalism.

Capital’s share of income has reversed course and is now rising again too, from a range of 15-25% in rich countries in 1970 to 25-30% recently.

In the poorer nations of the world, growth is often much higher. Many of them are still in the explosive growth phase of the demographic transition, with birth rates far above death rates. Productivity growth is often rapid too because of the speed at which economic innovations can be imported from more developed countries. As poorer countries come to resemble richer ones, however, their growth will almost inevitably slow as well, making it harder to alleviate traditional inequalities.

Economics in political context

One of Piketty’s central conclusions is that we cannot rely on economic growth alone to create a more egalitarian society. He makes this abundantly clear for the current historical situation, where economic forces are moving us in the opposite direction. His argument there is very clear: The higher the ratio of savings to economic growth, the higher the ratio of capital to income in the long run. And the higher the ratio of capital to income, the greater the share of income going to those with capital. Thus as the growth rate falls, the above ratios go up, and capitalists gain at the expense of workers, other things being equal. Since “there is no natural, spontaneous process to prevent destabilizing, inegalitarian forces from prevailing permanently,” democratic society has to intervene in some way to put things on a different course, if it has the will to do so.

At times, Piketty seems to overgeneralize his argument to any situation in which the return on capital r is higher than the growth rate g, which is almost always the case in a capitalist system. Recall from the last post that only because r > g can investors spend a portion of their returns and still see their capital and income grow at least as fast as the general growth rate. Piketty often talks as if inequality must inevitably grow:

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.

My understanding of Piketty’s own equations is this: The greater the difference between r and g, the higher the capital/income ratio and the higher the share of income generated by capital. But the capital/labor inequality only keeps increasing if g keeps falling, or if g has been falling and beta has not yet stabilized at a higher s/g, something that takes time. So r > g is a necessary condition of rising inequality, but it is not sufficient. The mathematical model certainly allows for situations when inequality is stable because the relevant rates are stable, or declining because the growth rate is rising, even though it remains below r, as it usually does.

The story Piketty most wants to tell is that the capitalist economy creates more and more inequality, but democratic government can take action to counteract that trend. That’s a powerful story for our time, when growth is slowing. For inequality in the 19th century, a more complex story may be needed. Rising industrial productivity and rapid population growth created a potential for greater economic equality, but that potential wasn’t realized until well into the 20th century. Somehow the capitalist class maintained its domination, and their influence over a conservative state may have helped them keep workers disorganized, hold wages down, and keep capital accumulating by means of a high savings rate. Only when the system collapsed in the crisis of the early 20th century did a more egalitarian society emerge, and that crisis was economic as well as political. While Piketty speculates that inequality would have kept growing in Europe if it hadn’t been for World War I and other political developments, one could use his own equations to argue that rising productivity was working against that. Labor’s share of income was too small to allow them to consume enough of the goods that a high-productivity economy could produce, and so extreme inequality just wasn’t going to work economically any more. In that situation, inequality may have been to a degree self-limiting, although that runs counter to Piketty’s main thesis, that only the democratic state can halt the spiral of inequality.


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