Capital in the Twenty-First Century

ELI5/TLDR

When Balzac sat Vautrin down with Rastignac in a shabby Parisian boardinghouse in 1835 and had him explain, with exact figures, why no amount of study could ever match the income of a well-chosen marriage, he was not writing melodrama; he was writing the most accurate political economy of his century. Over the very long run, the rate of return on capital, which I will call r, has consistently exceeded the rate of growth of the economy, g, and when this is so, wealth accumulated in the past grows faster than wages and output. The twentieth century, with its wars and its taxes and its three glorious decades of postwar growth, persuaded us otherwise. It was mistaken. The patrimonial capitalism of Jane Austen and Balzac is returning, and the question this book asks is whether democratic societies are prepared to do anything about it.

The Full Story

A debate without data

The distribution of wealth is one of the most widely discussed and least carefully studied questions of our time. For two centuries economists have argued about it with great passion and very little evidence. Malthus feared revolution and therefore saw overpopulation. Ricardo feared scarcity and therefore saw the landlord devouring the rest. Marx, with the misery of the English factory towns before his eyes, saw a principle of infinite accumulation that would end in apocalypse. Kuznets, writing in the warm light of the American postwar, saw a bell curve that bent gently back toward equality as if by the hand of Providence. Each of these authors, I believe, asked the right question. Each of them answered with the data he had, which in every case was thin, and with the political anxieties of his moment, which in every case were thick.

What I have tried to do in this book, with the help of Anthony Atkinson, Emmanuel Saez, Gabriel Zucman, and a small army of patient collaborators, is to reopen the question with better sources. We have assembled historical series on income and wealth covering more than twenty countries and, in some cases, more than three centuries. The World Top Incomes Database, built from tax records that only became available after the various countries of Europe and America adopted progressive income taxes in the years around the First World War, allows us to look back at the distribution of income with a precision Kuznets could only have dreamed of. For wealth, we have estate tax records, Parisian notarial archives stretching back to the Revolution, and national balance sheets of the kind Raymond Goldsmith pioneered. None of this is perfect. But it is vastly more than the economists of the twentieth century had when they declared the distributional question essentially solved.

Let me be clear at the outset: I do not believe that economics is, or ever will be, an exact science. The history of the distribution of wealth is always a political history, and it cannot be reduced to purely economic mechanisms. But it can be studied. And what one finds when one studies it is quite different from what the textbooks have been saying.

The capital/income ratio, β, and what it tells us

The simplest way into this history is to measure, for a given country at a given moment, the total stock of private wealth — land, housing, financial and professional capital, net of debt — and to express it in years of national income. This ratio, which I denote β, is the most neglected and in my view the most revealing variable in macroeconomics.

The historical record is quite striking. In Britain and France in the Belle Époque, on the eve of 1914, the capital/income ratio hovered between six and seven years of national income. In other words, the accumulated wealth of the nation was worth roughly seven years of everything the nation produced in a year. By 1950, after two world wars, the Depression, waves of inflation, confiscatory taxation, and the physical destruction of factories and cities, this ratio had fallen to two or three. Since then it has been rising, steadily and without any particular drama, and in the early twenty-first century it stands between five and six years of national income in most of Western Europe, and is climbing still. Private wealth in Germany, which started lower, is moving in the same direction. Japan, which I do not discuss at length here but which the data cover, follows the same trajectory.

This long U-curve is the central fact of the book, and almost everything else follows from it.

Two fundamental laws

To think about what β means, I find it useful to state two simple relations, which one might call the fundamental laws of capitalism. The first is an accounting identity:

α = r × β

where α is capital’s share of national income and r is the average annual rate of return on capital. If the capital/income ratio is 600 percent and the rate of return is 5 percent, then capital claims 30 percent of national income. This is tautological, as all good accounting identities are, but it becomes interesting when we realize that r has been remarkably stable over the very long run, fluctuating modestly around 4 to 5 percent across centuries and regimes. When β rises, α rises with it. Capital’s share of income grows, and labor’s share must shrink.

The second law is a dynamic relation that holds in the long run:

β = s / g

The long-run capital/income ratio equals the savings rate divided by the growth rate. A society that saves 12 percent of its income and grows at 2 percent a year will, in the long run, accumulate capital worth six years of national income. If growth falls to 1 percent, β rises to twelve. The arithmetic is merciless. Small changes in g produce enormous changes in the weight of accumulated wealth relative to annual output.

It is important to note that this formula is the mathematical expression of something that every society in slow-growing Old Europe already knew intuitively. In a quasi-stagnant world, the past devours the future. What your ancestors accumulated matters more than what you will earn. The more growth slows — and all signs are that global growth at the technological frontier will settle back toward 1 to 1.5 percent a year for the long haul — the more patrimonial wealth comes to dominate.

The central inequality: r > g

We can now state the fundamental force for divergence plainly. Over the very long run, the rate of return on capital r has consistently exceeded the rate of growth g. The historical record shows this to be true of every period for which we have sources, with the single exception of the twentieth century between roughly 1914 and 1975, which is precisely the period that shaped all modern economic intuitions.

When r > g, wealth accumulated in the past grows more rapidly than output and wages. The holder of capital need only reinvest a portion of his return to see his fortune grow faster than the economy as a whole. The entrepreneur, over time, tends to become a rentier, and the rentier’s heirs tend to become more dominant still, not because of any particular malice or genius, but because compound interest is patient and the economy is slow. This is not a market imperfection. Pure and perfect competition cannot alter the inequality r > g. It is a feature of the mathematics of accumulation in a low-growth world.

I will say this again, because it is the central claim of the book: the past devours the future.

The twentieth century as anomaly

It was natural, for those who lived through the postwar decades, to believe that capitalism had a spontaneous tendency toward equality. Kuznets, who in 1955 offered the world his famous bell curve, thought so. Solow, with his balanced growth path, thought so. A generation of economists was trained to believe that inequality was the disease of immature capitalism and that maturity would cure it. The trouble is that they were all reading the data of a single, unrepeatable episode — the compression of wealth and incomes between 1914 and 1945 — and mistaking it for a structural law.

The historical record shows, on the contrary, that the compression was the product of catastrophe. The wars physically destroyed capital on a massive scale. Inflation wiped out bondholders. The Depression ruined fortunes. And then, in response to all of this, the democracies invented genuinely progressive income and estate taxes, which for several decades took upper-bracket marginal rates in the United States and Britain above 80 percent. None of this was the natural consequence of industrial maturity. It was the response of political societies to traumas of a kind we should not wish to repeat in order to preserve equality.

Kuznets himself, let me add, was a serious and scrupulous scholar. In his 1953 book he warned the reader that the compression he had documented was largely accidental. It was in his 1955 presidential address, delivered at the height of the Cold War, that the warning became a prophecy, and the prophecy, handily, that underdeveloped countries could expect to stay “within the orbit of the free world” if only they were patient. One should not be too quick to mock this. But one should also not confuse it with a law of nature.

Vautrin’s lesson

To understand what the return of patrimonial capitalism means in human terms, one should set aside the statistical tables for a moment and return to Balzac’s Père Goriot, published in 1835. In the shabby Parisian boardinghouse where the novel is set, the shady convict Vautrin offers young Eugène de Rastignac a piece of advice about his future. Rastignac has come up from the provinces to study law. Vautrin, with merciless precision, lays out exactly what awaits him. By thirty he may be a judge earning 1,200 francs a year. By forty, if he is lucky, a royal prosecutor on 5,000. By fifty, if he has been exceptionally successful, one of the handful of lawyers in Paris earning 50,000. This is the summit of meritocratic ambition in the Restoration, and it is, Vautrin observes, a summit one reaches after decades of study, compromise, and intrigue.

By contrast, if Rastignac marries Mademoiselle Victorine, whose father is wealthy, he will at twenty lay hands on a fortune of a million francs, yielding at the customary 5 percent an annual income of 50,000 francs — ten times what the most prosperous Parisian lawyer of his day can hope to earn after thirty years of labor. The choice is clear. Vautrin points out, with the dry cynicism of a man who has seen the world, that the only obstacle is Victorine’s brother, who must first be killed. Rastignac, to his credit, balks at the murder. He does not, however, balk at the reasoning.

What is instructive about Vautrin’s lecture is not its immorality but its arithmetic. He is not wrong about the numbers. In nineteenth-century France, and in Jane Austen’s England, and almost everywhere in the Atlantic world before 1914, work and study simply could not match the standard of living provided by a well-chosen inheritance or a well-chosen marriage. The deep structure of the society was patrimonial. Democracy and meritocracy were ideals professed in the constitution; the actual distribution of comfort was another matter altogether.

The question I ask in this book is whether we are returning to that world. The answer, over the long run, is unfortunately yes, and the data on inheritance flows in France, which I have assembled with Gilles Postel-Vinay and Jean-Laurent Rosenthal and which extend in unbroken series back to the Revolution, are quite clear on the point. The share of inherited wealth in total wealth, which had fallen to something like 40 percent of the total around 1970, is rising again, and on current trends will approach the levels observed in the nineteenth century within a generation or two. Rastignac’s dilemma is coming back, and it is worth more, as economic analysis, than most of the twentieth-century growth models.

The Anglo-Saxon anomaly: the supermanager

There is, however, a second story, and it is distinct from the first. If one looks at the share of US national income claimed by the top decile, one sees a U-curve almost as sharp as the European capital/income ratio: roughly 45 to 50 percent in the 1910s and 1920s, falling to about 33 percent in the 1950s (this is the compression Kuznets documented), and rising again since 1980 to something like 45 to 50 percent in the 2000s. One might assume this is the same story as the return of European patrimonial wealth. It is not.

The American increase since 1980 is driven, to a surprising degree, not by the returns to accumulated capital but by an explosion of labor income at the very top — the phenomenon I call, for want of a less cumbersome term, the rise of the supermanager. Top executives at large American and, to a lesser extent, British firms have separated themselves from the rest of the wage distribution by a margin without precedent in the historical record. The orthodox explanation, which appeals to marginal productivity and the race between education and technology, is not adequate. It cannot explain why the phenomenon is confined largely to the English-speaking world, why it began precisely when top marginal tax rates were cut, or why the same technologies in Germany, France, Japan, and Sweden did not produce the same result.

The more plausible explanation is that in a large organization an individual manager’s marginal productivity is essentially impossible to measure with precision. Once social norms, progressive taxation, and bargaining constraints are loosened, top managers acquire considerable latitude to set their own compensation, and they use it. This is not a conspiracy. It is simply what happens when the countervailing forces weaken. It is a story about norms and institutions, not about the marginal product of capital.

It is worth noting that the two stories, the European return of patrimonial capital and the American rise of the supermanager, may yet come together. The supermanagers of one generation bequeath the capital of the next, and their children, as the first American fortunes now entering their third generation begin to demonstrate, will not need to be particularly productive to remain particularly wealthy.

Always more unequally distributed than labor

Let me mention one regularity that emerges from all of this work and that I have not been able to find a single counterexample to. In every country, at every period for which we have data, the distribution of capital ownership is always more unequal than the distribution of income from labor. The top decile of wage earners typically receives 25 to 35 percent of total labor income; the top decile of wealth holders typically owns 60, 70, or more than 80 percent of all capital. The bottom half of the wage distribution generally receives between a quarter and a third of total wages; the bottom half of the wealth distribution almost always owns less than 5 percent of total wealth, and often essentially nothing at all.

This is not a mathematical necessity. One can easily imagine societies in which it would not be so. It is an empirical regularity of capitalism as it has actually existed, and it is the reason why the question of capital matters. If the rising share of capital in national income simply meant that everyone was gradually becoming a small capitalist, it would be a minor concern. It does not mean that. It means that a small number of people — a very small number, the top centile and above — are becoming very much wealthier, while most of the population continues to own little more than what is needed to furnish a modest home.

What is to be done

The final section of the book takes up the question of what a democratic society might do about all of this. I have no particular enthusiasm for revolutions, and less still for the various twentieth-century experiments in the outright abolition of private capital, which we should now be able to assess with the historical distance they deserve. The challenge, rather, is to preserve the market and the incentives and the openness that have made modern prosperity possible, while preventing the logic of accumulation from concentrating wealth to a degree that hollows out democratic society from within.

I propose, therefore, a progressive annual tax on capital, levied on a comprehensive definition of net wealth — real estate, financial and professional assets, net of debt — with rates perhaps of 0.1 or 0.5 percent on fortunes below a million euros, 1 percent between one and five million, 2 percent between five and ten, and rising to perhaps 5 or 10 percent on fortunes measured in the hundreds of millions or the billions. I am aware, let me be clear, that such a tax would require a degree of international cooperation, transparency in financial flows, and automatic exchange of banking information that does not currently exist. I am aware that it is, in the short run, utopian. I propose it anyway, because the purpose of such a proposal is to name what would in fact be necessary, and because I do not believe democratic societies should resign themselves to being told that the only feasible policies are the ones their tax havens permit.

The proposal is not the only thing. A return to genuinely progressive income taxation, with top marginal rates in the range of 70 to 80 percent on very high incomes, would do considerable work on its own, particularly in the Anglo-Saxon countries where the supermanager phenomenon is concentrated. A serious accounting of the public debt, which I argue is better addressed by a one-time levy on the largest fortunes than by decades of austerity that fall on those who never owned any of the debt in question, is another piece. So is the preservation of the social state, which remains the principal democratic achievement of the twentieth century and which is under steady pressure almost everywhere.

Political economy, not economic science

Let me close with a word about my discipline. I dislike the expression “economic science,” which strikes me as terribly arrogant. It suggests that economics has attained a higher scientific status than history, sociology, or political science, which it plainly has not, and it invites economists to retreat behind mathematical models whose sophistication is often an elegant disguise for the thinness of their assumptions. I much prefer the old-fashioned phrase political economy, which conveys what I believe is the only thing that distinguishes economics from the other social sciences: its political, normative, and moral purpose.

What public policies and institutions, we should be asking, bring us closer to an ideal society? This is an unfashionable question among my colleagues, and it is the one that drew me to the field in the first place. The history of the distribution of wealth, which is what I have tried to write in these pages, is not a neutral chronicle. It is a record of choices made by identifiable political actors under identifiable political conditions, and it has lessons for the choices ahead of us. Refusing to deal with numbers, as some social scientists still do, rarely serves the interests of the least well-off. Those who have a lot of money never fail to defend their interests. The rest of us should at least understand what is being defended, and on what grounds, and in whose name.

That is the book. The sources, as I said, are imperfect. The conclusions are tentative. The policy proposals are, I freely concede, ambitious beyond the current capacities of our political institutions. But the historical record is unusually clear on one point, and it is the point with which I will end. When the rate of return on capital exceeds the rate of growth of the economy, capital accumulated in the past grows faster than the economy as a whole, and the distribution of wealth diverges. This has been true in almost every period for which we have records. It is likely to be true again in the twenty-first century. What democratic societies do about it is up to them.

Claude’s Take

Piketty did something genuinely rare: he put a piece of serious long-run economic history into the hands of general readers and made the empirical case that postwar equality was not the natural state of capitalism but a wartime anomaly. The historical work on the capital/income ratio, done with Gabriel Zucman, is the most important contribution and has held up well. The World Top Incomes Database (now the World Inequality Database) is a durable public good. The framing device r > g has its critics as a causal mechanism, but as a mnemonic for “compound returns on accumulated wealth eventually dominate labor income in a slow-growth economy” it is hard to improve on.

Where the book has taken real damage is in the specifics. The capital/labor elasticity assumption that does a lot of work in the β = s/g argument — that capital and labor substitute freely enough that a rising β translates into a rising capital share — has been contested by Matt Rognlie and others, who point out that most of the rising capital share is actually housing, which behaves very differently from productive capital. If you strip out housing, the story of twenty-first-century capital-driven inequality looks considerably less dramatic. Piketty’s own data have also been revised more than once, and the US top-income series in particular has been challenged by Gerald Auten and David Splinter, whose reconstruction using matched tax-return data finds that post-tax-and-transfer top-income shares in the US have been much flatter since the 1960s than the Piketty-Saez series suggests. The truth is probably between the two, but it is not where the original book placed it.

The global wealth tax proposal is the part of the book everyone wants to argue about, and it is the part Piketty himself labels utopian. He is right that naming what would be necessary has value independent of whether it is politically feasible. But the gap between “a harmonized capital tax regime” and anything resembling current international political reality is larger than the book’s final chapters fully acknowledge, and the intervening decade has made it larger still.

The weakest parts of the book are the treatment of the developing world, which is thin compared to the Franco-Anglo-American core, and the somewhat mechanical way Piketty sometimes moves from capital’s share of income to the inequality of persons, as if the two were interchangeable. They are related but not identical, and the distinction matters more than his presentation lets on.

What the book does that almost no other economics book of its generation does is refuse to be boring about an important subject. The Vautrin-Rastignac detour is not ornament. It is an argument that literature captured something about patrimonial society that twentieth-century economic models actively erased, and that we should pay attention to what was erased. The polemic against “economic science” in the conclusion is the most honest thing a prominent economist has written about his own discipline in a long time. Even the critics who have dismantled individual numbers tend to concede that Piketty reopened a question their profession had decided, prematurely, to close.

claude_score: 8/10

An essential book that changed the terms of debate about inequality, written with real historical patience and a voice unlike anyone else’s in the field. Loses a point for the capital elasticity argument being less robust than the book implies, and another for the gap between the policy prescriptions and any plausible political path to them. Retains considerable force despite a decade of pushback, which is more than most 700-page economics books can say.