The return of wealth: Thomas Piketty’s ‘Capital in the Twenty-First Century’

A century of growing inequality, as the gap rapidly widens between those who have assets and those who don’t: that’s the grim prediction of French economist Thomas Piketty, whose new work, Capital in the Twenty-First Century, is being hailed as this decade’s key economics tome.

In the recent debates about inequality, wealth has often been barely visible, a shadowy presence in discussions dominated by salaries, wages, benefits and taxes. Piketty’s achievement is to put wealth front and centre. In this task he has two weapons: a never-before-seen set of records on wealth, income and inequality, for some countries stretching back centuries; and the analytical ability to create a stunningly simple framework out of that vast mass of data.

What the data show is that we are rapidly returning to a world in which wealth and inheritance are just as important as they were in the extraordinarily unequal European societies of the late 1800s and early 1900s. Back then, there was a huge amount of accumulated wealth; that wealth was owned almost entirely by the top 10%; most of it was inherited; and the returns on it were very large. In particular, the average investment of capital produced an income worth 5% of its value each year, while wages and salaries were growing at just 1% a year. Inevitably, those with wealth pulled further and further away from the rest.

Then came two world wars, the Great Depression, and the welfare state consensus. Material wealth and assets were physically destroyed; the stock market crash wiped out financial assets; and wealth’s power was restrained by strong unions and high taxes on capital. At the same time, the economy, and with it wages and salaries, grew at record speed. The result was a period unique in the last 300 years, and probably before that: a time in which general income growth far outpaced the returns to be made investing capital. Workers were catching up with oligarchs.

Now, Piketty shows us, that process has gone into reverse. Everything to do with wealth is now in the upwards bit of a U-bend. In the 19th century, the total amount of accumulated wealth was about seven times greater than the income countries produced in any given year; that ratio fell dramatically by 1945, but is now about five or six times, and rising. The top 10% owned an astonishing 90% of all wealth in the 19th century; that figure fell to 30-40% after World War II, but is now at 70%, and rising.

Perhaps most worryingly, inheritance is becoming as important as it was when Jane Austen (who is liberally quoted in the book) was describing the landed gentry of her era. In the 19th century, 90% of all wealth was inherited; that figure fell to below 50% in 1970, but is now back up to 70% … and rising. To top it all off, average investment returns are back at around 5% a year, while economic growth is slow. In short, wealth is as important as it was in the Victorian era, it is just as concentrated (and likely to be inherited), and it is earning its owners just as much as it used to. Once again, asset owners are pulling away from the rest.

In this picture, wealth, and who owns it, is revealed as a key driver of inequality. It isn’t the only one, of course; as Piketty acknowledges, the bulk of the last decades’ rise in inequality is actually down to salary gaps, as so-called ‘super managers’ have pulled away from other workers. But those multimillionaire chief executives are rapidly accumulating capital to go along with their huge salaries, and so the 21st century may be, he warns, one that combines “the worst of two past worlds: both very large inequality of inherited wealth and very high wage inequalities”.

Piketty’s book also makes an important point – one already obvious to some, though not  to others – that there is no natural tendency in capitalism towards equality, as many economists have claimed. Without intervention, we can expect spiralling inequality.

There is of course a moral assumption embedded in all this: that wealth should not simply be regarded as the product of hard work and talent and thus left alone. Piketty’s argument (albeit it is sketched, rather than strongly defended) is that, first, even if wealth has been worked for, it then accumulates without any particular effort by its possessor, and this is problematic; and that, second, there is little justification for the very high salaries that at present are rapidly turning into large amounts of wealth. And he implicitly accepts that very large inequalities are bad for our societies, politics and economies.

Of course, it is not the case that Piketty’s analysis has been universally acclaimed. Questions have been raised, in particular, about his predictions of ever-widening inequality. Some economists argue that, if returns on investment continued to increase, wages will as well. Others argue that his definition of capital is very broad, and that only some kinds of returns on investment will increase. For non-economists, these questions are difficult to adjudicate; but certainly there has been no serious challenge, so far, to his data or his broad observations about the importance of wealth and its ability to spur widening inequality.

Piketty’s solutions

For Piketty, the path to a more equal world lies in restraining the income generated by capital. (He doesn’t talk about trying to turbocharge general economic growth so that it outpaces returns to capital – which may be just as well, given the environmental damage that is likely to imply.)

His principal method of doing that is a worldwide tax on wealth. Each year, he proposes, people with wealth of more than, say, €1 million should pay a tax worth, say, 1% of the value of their assets; those with wealth of over €5 million should pay 2%; and so on. This may or may not be a good idea, but it evidently has a couple of drawbacks. First, as he acknowledges, it is entirely utopian: that level of international co-operation seems extremely unlikely, although countries could impose their own versions individually.

Second, it ignores other options for reducing returns on capital much earlier in the process. If policy makers wanted to reduce the power of capital, they might try to support trade unions, for instance, which could help ensure that a greater share of profits goes to workers rather than people who own capital (investors, shareholders, banks and so on). Stronger unions would also help reduce income inequalities just among salary earners. (On that point Piketty does, at least, make a strong case for a top income tax rate much higher than at present.) A better regulated housing market, in which the value of housing was pushed down by greater homebuilding and there was less bank funding available to match soaring house price demands, would also see far less wealth concentrated in the hands of a few. Yet Piketty has essentially nothing to say on these subjects.

What does this mean for New Zealand?

Relatively little is known about wealth in New Zealand and how it is distributed, so the first point to be taken from this book is that the country might need to pay much more attention to wealth, and find ways of increasing research and statistics-gathering in this area.

There are a few things we do know, however. As elsewhere, wealth has a very unequal distribution in New Zealand: the top 1% have 16% of all the assets, the top 10% have over 50%, and the bottom half of the country have just 5%. (It’s not yet clear, however, whether those figures are directly compatible to the ones that Piketty has for other countries.) Less of that wealth may be inherited than in other countries, but it’s hard to know. Certainly, in New Zealand, more than almost anywhere, that wealth goes pretty much untaxed. We don’t have any annual wealth taxes. We no longer tax inheritance or gifts. We don’t even tax the income that people make from selling assets.

Piketty’s book will, in the New Zealand context, undoubtedly strengthen the hand of those who want to reduce the power of capital, through whatever means, and to redistribute that capital as well. At one end of the income spectrum, it strengthens the arguments for a capital gains tax or indeed a wealth tax, which Gareth Morgan and others have been promoting. It also highlights the absence of a conversation about restoring taxes on inheritances and gifts.

At the other end, it may lead people to think more about something called asset-based welfare, which involves redistributing not just income but also wealth. Big grants of assets to all people on reaching adulthood, and policies to help families build up assets for their children, both fall into this category.

But whether or not people feel inclined to act on the book’s message, its central conclusion – that wealth has to be paid far more attention than in the past – is difficult to avoid. The lavish praise the book has attracted seems largely justified. No one will ever look at inequality in quite the same way again.

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One comment on “The return of wealth: Thomas Piketty’s ‘Capital in the Twenty-First Century’
  1. Growing inequality in New Zealand is a concern but despite the figures you mention Max we are among the better performers when it comes to wealth transfer. I am appalled by the increase in the number of homeless in our cities and the number of people now living in poverty however the answer cannot be a return to tax and spend Government which nearly bankrupted godzone in the early 1980ies. The answer is learning the lessons of history to keep the tide rising for everyone. That means efficient Government in a competitive market economy.

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