Capital in the Twenty-First Century

How has wealth inequality changed over the previous few centuries and what does that tell us about the present? That is the rather large question that French economist Thomas Piketty attempts to answer in this book.

No doubt his writing is in a far more coherant and structured format than my description of it, but here goes.

H begins with a global outlook. Poor countries are gradually catching up with rich countries, and he notes that wealth inequality is primarily within a country. China is making rapid progress in catching up with Europe for example, while the working class of Europe are not making the same gains on the upper class.

Nevertheless, it is a long and hard struggle. Once one country has an advantage, it can essentially own another. This is how European nations managed to maintain colonial domination while running a trade deficit. We could simply put our colonies into debt and then force them to work for us to pay it off.

Once they do grow, they are unlikely to overtake us because as they become a first world country the growth levels off. They are also a long way behind. Europe has 2000% the wealth of China for example, so even growing at 8% a year, once you factor in that Europe is also growing, that is a long way to catch up.

The oil countries could see huge growth though because of their sovereign wealth funds.

Europe itself remains incredibly rich. Richer than anyone else in the world. Though admittedly the United States are the only real competition. However this wealth is all in private hands. European governments themselves are heavily in debt, mostly to their own citizens, and typically have a capital of 0, because their public assets only just cover said debts.

It is traditionally highly unequal wealth. Far from being the land of the financially free, it was the United States that pioneered high tax of the wealthiest and it is only in recent decades that America’s wealth inequality has become greater than Europe’s.

This wealth is very concentrated. One way is labour inequality. Some people are paid far more than others. Though this is not always the close. In 1970s Scandinavia the top 10% of earners claimed 20% of the earnings. This seems a reasonable level of inequality to me.

A much more pressing issue though is capital inequality. Even in the most equal societies the bottom 50% will typically own nothing. Before the World Wars 1% typically owned 50% and 10% owned another 40%. The Wars changed this, but only as far as to allow the next 40% to buy their own home, which is not much by comparison, and still leaving 50% without assets.

Capital inequality is typically inherited. Thus it is not a useful form of inequality because it does not provide motivation for people to earn money. The point of inequality is to motivate people to work hard and earn money, but there is no utility in allowing people to merely inherit large amounts of capital – in fact this encourages them to do nothing.

It is also worth noting that labour inequality does not necessarily provide this motivation either. This is because the differences in “super manager” compensation cannot be directly related to a persons output but rather by industry and non-talent based conditions (luck).

Once people are rich the problem of wealth inequality perpetuates itself. Inflation, which many assume would reduce wealth, actually makes the situation worse. This is because poor people see their savings eroded by inflation while large amounts of capital is able to better protect itself.

It does this in a number of ways. By being larger, the capital of American university endowments when compared to individual savers for example, can afford to spend far more on management. Harvard has around $30 billion, so can spend $100 million a year on management with that only being 0.3% of their capital, which will be more than made up for in growth.

Secondly, with a bigger fund you can diversity into more risky assets. This produces a less predictable short term but a more profitable long term. Thirdly, many options that Harvard invest in may simply be entirely unavailable to small amounts of capital, such as products which require a large minimum investment.

Thus the rich get richer and the poor get poorer with no relation to the work, productivity or utility of the individual. There is no self-correcting mechanism for this.

What can we do about this?

Free university could be one way. It seems to have reduced inequality in the Nordics, though this has not been entirely proven. Picketty also suggests minimum wage will not help in the long run.

He suggests a global tax on capital. This would be low, initially at 0.1% of total capital, progressively rising to 0.5% for the largest fortunes.

This would have to be done in a global level, or at least a European level and require cooperation from banks. Otherwise people would just hide their assets. Indeed, it should be noted that the balance of payments for Earth is currently negative! More wealth flows out that comes in. This is of course theoretically impossible, but could be accounted for by tax heavens not being transparent.

A global tax on capital would encourage people to generate money and become rich, which ensuring that these fortunes cannot be used by future generations to unfairly dominate the economic landscape.

In summary, the following points:

  • Capital inequality is the biggest form of inequality
  • The twentieth century saw some reduction in the importance of inheritance, but this is now returning
  • Large inherited fortunes serve no utility to society
  • Large fortunes are able to perpetuate themselves and thus the rich get richer and the poor get poorer
  • There is no natural self-correcting mechanism for this
  • The best way to tackle this would be with a global tax on capital

Capital in the 21st century

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This entry was posted on Thursday, July 16th, 2015 at 10:43 am and is filed under Books. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.