Capital in the Twenty-First Century (part 3)

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The structure of inequality

So far I have focused on Piketty’s discussion of the share of national income going to investors, which is highest when the rate of return on capital (r) is much higher than the rate of growth in output and income (g). That in itself would not have to result in very much overall inequality, since in theory every household could derive income from a combination of earnings and investment. Far more households do that today than in the early days of capitalism. But to the extent that the ownership of capital is highly concentrated, the class of capitalists can receive a share of national income out of all proportion to their numbers, and they do.

A quite different source of income inequality is inequality of earnings from labor, which is greater today than in previous centuries. That reinforces the capital inequality, because the highest earners can afford to invest not only a higher absolute amount, but a greater proportion of their earnings.

Piketty thus describes two different–but not mutually exclusive–ways for a capitalist society to generate extreme inequality. In the “hyperpatrimonial society,” more common before the 20th century, the inequality is primarily between the owners of inherited wealth and those who work for a living. In the “hypermeritocratic society,” more characteristic of the 20th century, the inequality is more a matter of differences in pay. Piketty uses the latter term somewhat ironically, since he thinks that the highest paid managers receive compensation far beyond any demonstrable merit.

If Piketty were only describing a transition from patrimony to meritocracy, he wouldn’t be covering any new ground. What he is actually doing is warning that capital accumulation and inherited wealth are on the rise again, so that both sources of inequality may be important once more:

What primarily characterizes the United States at the moment is a record level of inequality of income from labor (probably higher than in any other society at any time in the past, anywhere in the world, including societies in which skill disparities were extremely large) together with a level of inequality of wealth less extreme than the levels observed in traditional societies or in Europe in the period 1900– 1910. It is therefore essential to understand the conditions under which each of these two logics could develop, while keeping in mind that they may complement each other in the century ahead and combine their effects. If this happens, the future could hold in store a new world of inequality more extreme than any that preceded it.

The distribution of capital

Wealth is always more unequally distributed than earnings, since the most fully invested fortunes normally grow at a faster rate than the economy as a whole (r > g). While the top 10% of earners usually get 25-30% of the income from labor, the top 10% of owners has always controlled at least 50% of the wealth. The rest is almost entirely owned by the group between the 50th and 90th percentiles, since the lower half of the population owns practically nothing.

In the societies where wealth is most equally distributed (…the Scandinavian countries in the 1970s and 1980s), the richest 10 percent own around 50 percent of national wealth or even a bit more, somewhere between 50 and 60 percent, if one properly accounts for the largest fortunes. Currently, in the early 2010s, the richest 10 percent own around 60 percent of national wealth in most European countries, and in particular in France, Germany, Britain, and Italy.

In the United States, the share of the richest 10% rose from under 60% in 1810 to 80% in 1910. Then it fell to about 66% by 1940 and 63% by 1970, but then started rising again and was over 70% by 2010. US wealth inequality, traditionally less than that of Europe, has surpassed Europe’s since 1970.

The U-shaped trend in wealth inequality is consistent with Piketty’s earlier discussion of the 20th century. At first, the top decile’s share of the wealth declined, as the growth in earned income created a “patrimonial middle class” that now made enough money to accumulate some capital. Meanwhile, income and estate taxes took their toll on large fortunes. More recently, however, middle-class wage growth and capital accumulation have slowed down, while growth at the top continues, assisted by reductions in income and estate taxes.

The largest fortunes tend to grow the fastest, partly because their owners can afford to reinvest most of the earnings. In addition, they have access to the best financial management and the investments earning the highest returns. Smaller investors put more of their money in safe but low-return instruments, such as bank accounts.

The portion of wealth that is inherited has also followed a U-shaped curve. In France, the country with the best inheritance data, inherited wealth amounted to 80-90% of all private capital in the 19th and early 20th centuries, fell to just over 40% by 1970, but rose to about two-thirds in 2010. Piketty expects it to be approaching 80% again by the 2030s, a situation increasingly difficult to defend: “No matter how justified inequalities of wealth my be initially, fortunes can grow and perpetuate themselves beyond all reasonable limits and beyond any possible rational justification in terms of social utility.”

Although many people worry about new forms of global inequality, such as the ownership of too many global assets by China or Saudi Arabia, Piketty sees much greater potential for “the rich countries…to be owned by their own billionaires or, more generally…all countries…to be owned more and more by the planet’s billionaires and multimillionaires.”

The distribution of earnings

Earnings from labor are not as unequally distributed as are capital and the return on capital. But they are becoming more unequally distributed, and that trend is a major driver of increasing inequality in general. Bear in mind that we are talking only about income from labor, excluding any income from capital:

In countries where income from labor is most equally distributed, such as the Scandinavian countries between 1970 and 1990, the top 10 percent of earners receive about 20 percent of total wages and the bottom 50 percent about 35 percent. In countries where wage inequality is average, including most European countries (such as France and Germany) today, the first group claims 25– 30 percent of total wages, and the second around 30 percent. And in the most inegalitarian countries , such as the United States in the early 2010s (where…income from labor is about as unequally distributed as has ever been observed anywhere), the top decile gets 35 percent of the total, whereas the bottom half gets only 25 percent.

Mainstream economic theory rests on two main hypotheses about earnings: “First, a worker’s wage is equal to his marginal productivity, that is, his individual contribution to the output of the firm or office for which he works. Second, the worker’s productivity depends above all on his skill and on supply and demand for that skill in a given society.” This sets up a race between education and technology. New technologies increase the demand for new skills and reduce the demand for unskilled labor, and educational credentials have to keep up to justify decent wages. One implication is that egalitarian access to higher education, as in the Scandinavian countries, should be reflected in more egalitarian wage structures.

Piketty finds this theory too limiting, however, in that it leaves out “other factors, such as the institutions and rules that govern the operation of the labor market in each society.” In the US, most workers have little bargaining power, while “at the very highest levels salaries are set by the executives themselves or by corporate compensation committees whose members usually earn comparable salaries (such as senior executives of other large corporations). He also observes that the countries where executive salaries have skyrocketed are the same countries that have put an end to very high marginal tax rates on the highest incomes, so that managers now have a greater incentive to fight for higher pay. Corporate managers make up 60-70%of the very highest paid workers (the top 0.1% of the income hierarchy).

The distribution of total income

The distribution of total income in the United States is a combination of the distributions of both labor income and investment income, with the first contributing more than the second. The portion of total income received by the richest 10% was a little over 40% in 1900-1920, rose to over 50% in the 1920s before the stock market crash, and then declined until fluctuating in the range of 30-35% between 1950 and 1980. “Since 1980, however, income inequality has exploded in the United States. The upper decile’s share increased…to 45-50 percent in the 2000s–an increase of 15 points of national income.” So 15% of the national income was transferred to the top 10% from everybody else. Furthermore, “the bulk of the growth of inequality came from ‘the 1 percent,’ whose share of national income rose from 9 percent in the 1970s to about 20 percent in 2000-2010.”

Piketty believes that this growing inequality was a contributing factor to the financial crisis:

In my view, there is absolutely no doubt that the increase of inequality in the United States contributed to the nation’s financial instability. The reason is simple: one consequence of increasing inequality was virtual stagnation of the purchasing power of the lower and middle classes in the United States , which inevitably made it more likely that modest households would take on debt, especially since unscrupulous banks and financial intermediaries, freed from regulation and eager to earn good yields on the enormous savings injected into the system by the well-to-do, offered credit on increasingly generous terms.

Continued

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