‘Rock star economist’ or ‘inequality messiah’ French economist Thomas Piketty’s book Capital in the Twenty First Century has outsold every other book on the planet this year. The book is so popular because it floats the idea that money makes money, so the wealthy will forever become better and better off than the rest. The idea has sent shivers down the spine of the wealthy, appealed to the “Occupy” Movement, and stirred up the economics profession. But has he really discovered an immutable law of economics? We don’t think so, at least not yet.
Piketty’s basic idea
Piketty’s central thesis is that capital, wealth, assets (whatever you want to call them) make money faster than people can. This means that people who start out with a silver spoon in their mouth can stay ahead of any of their contemporaries without any effort at all. It is a bit like starting a running race with some of the kids poised right beside the finish line. It challenges the very idea we have of equality of opportunity that you can work hard and get ahead.
To some, Piketty’s idea might seem like the obvious. But our faith in globalisation, the market, capitalism, whatever you want to call it – is based on the idea that we all gain from it. Sure, some people will get rich, but as long as the rising tide lifts all boats, it’s okay, right? Well Piketty’s suggestion is that the way the economy naturally works makes the rich richer faster than anyone can catch up, which might threaten our acceptance of it.
The New Zealand Institute’s response to this conundrum is that education is the answer to social mobility – an idea echoed by the Treasury. But this completely misses the point – that some people could get a massive head start in life via inherited wealth. Our education system would have to offer intensive support to the poorest kids to reduce this gap, which isn’t on the cards anytime soon. If anything the middle and upper class make sure their kids end up doing better out of the education system too.
Picking holes in Piketty
In terms of its analyses Capital in the Twenty First Century has been subject to intense scrutiny, and some of the criticisms are valid. There are too many problems with the data for Piketty to claim he has discovered a natural law of economics.
In order to back up his claims, Piketty has assembled a data set going back centuries. It is an impressive undertaking, but also a reason for caution. We really can’t be sure that the numbers are based on a firm grounding. Also the big data anomaly in Piketty’s story is in the mid 20th century – the time for which he has the best data. He puts this anomaly down to two world wars, but if we ignore the dodgy long term data and focus on the twentieth century we could just as easily construct a different narrative.
Contrary to what Piketty suggests, the rising tide could be lifting all boats. It all depends on who you include in your analysis.
Piketty’s numbers solely look at the developed world – those areas for which he could get long-term data – basically Western Europe. In the middle of this century these countries got a lot more equal, but that fell away as the twentieth century neared its end. Piketty argues that improved equality came about through world wars (which affected the rich more) and because countries had policies that promoted equality. When these were removed, the economy reverted to the natural order of things (the rich getting richer).
Recent OECD data looks broader than just Western Europe and provides a different possible interpretation, one that suggests that capitalism has succeeded in improving the lot of everyone. Since 1980, inequality within countries has grown, while inequality between countries has dropped. Overall people are better off, and inequality is about the same as it was back then. This suggests that globalization may have hurt the working class in the developed world, but it has benefited the poor in developing countries far more. Surely that isn’t so bad – unless you think people in developing countries aren’t worth as much as people in developed countries?
In other words globalisation might actually be working as we hope – i.e. making us all better off. It’s just that we in developed countries haven’t seen it so much in recent years because the benefits have been realised in developing countries. As a result, when we look around it feels like we have growing inequality.
Piketty still has a point
But what Piketty has highlighted still rings true in part. The wealthy in developed countries have not faced the same competition as the working class have (at least, until recently). They have benefited from the cheap products that globalization provides, without any of the cost.
Globalisation has provided some with the opportunity to amass large fortunes. And once the fortune is in place the compounding return to capital can – in some circumstances – lead to a spectacular accumulation of wealth for the owner. It is pretty hard to disagree with this basic thesis. The critical questions are whether that consequence is harmful, equitable, or necessary.
What do we do?
On one hand we shouldn’t forget that accumulation of wealth is a necessary driver of a capitalist economy. There have to be rewards for effort, otherwise people will not bother to put in the hard work to achieve success. On the other hand, extreme polarization of wealth can cause social instability. As we have previously discussed, our main concern is equality of opportunity. This relies on all kids getting a fair start in life, which is not the case when it comes to inherited wealth. Squaring this circle isn’t easy.
Yet perhaps the greatest inequity we face is that not all accumulated wealth is subject to the same tax impost as other forms of accumulated wealth. In our next blog we will look at whether it is possible to deal with some of the issues Piketty has raised, without stunting the incentives to do better. We think so – we’ll look at how tomorrow.