The book that hit like a bomb

by Pattrick Smellie / 26 May, 2014
Thomas Piketty has forged game-changing insights into the self-perpetuating power of wealth. But is he right to push new global taxes for the better-off?
Thomas Piketty: proposes a global tax on wealth and income tax rates of 80% on the better-off. Photo/Ed Alcock

At its simplest, the groundbreaking work by French economist Thomas Piketty proves no more than what we thought we already knew: the rich get richer. Whether the poor also get poorer is another matter.

What would the taxi driver who took me across Beijing last year in a Toyota tricked out with three smartphones have said? Not so long ago, he was driving a three-wheeled, pedal-powered rickshaw.

It’s more a case of the poor getting richer too – but without political intervention, they’ll never catch the rich.

In the English-speaking world particularly, still reeling from the global financial crisis and growing tired of a managerial elite whose salaries appear unstoppably stratospheric, Piketty’s new, best-selling doorstop of a book – Capital in the Twenty-First Century – is altering the debate about wealth, income and the future of capitalism and is set to be Harvard University Press’s all-time best-seller.

Piketty has reframed the discussion by combining, for the first time, data sources spanning more than three centuries to prove that those with accumulated wealth are almost guaranteed always to become richer than those who work for a living.

The distinction between wealth and income is important. Although excessively high incomes for chief executives is a live political issue, and Piketty would tax them at a rate as high as 80%, the bigger issue is the inter-generational impact of wealth accumulation.

He proposes taxing such wealth at a rate of 0.1-0.5% for fortunes of less than €1 million ($1.6 million), 1% for fortunes from €1-5 million, 2% for €5-10 million and from 5-10% for fortunes in the hundreds of billions of euros.

Critics note that if he’s calling $1.6 million a fortune, then Piketty is putting many of the developed world’s homeowners in the same boat as the “one per cent” global elite.

However, most of the attacks on his findings focus on the proposed solutions rather than the quality of the research that animates his conclusions.

At the heart of Piketty’s findings is this historical fact: over long time frames, the rate of return on capital (let’s call it wealth in all its forms bar wages and salaries) will be higher than the rate of economic growth.

Capital tends to return, say, 3-5% a year, whereas economies rarely grow faster than 1.5% a year over the long term, after adjusting for inflation.

Why does that matter? Because owners of capital can expect always to pile up more wealth than those with no capital.

“Once constituted, capital reproduces itself faster than output increases,” Piketty writes. “The past devours the future.”

And when economies grow slowly, as they will everywhere when the world population stops expanding around the middle of this century, those without existing wealth will fall further and further behind those who do.

That may not always be the case in the short term. Piketty’s conclusions suffer today from the fact that returns on some capital are slightly negative, after inflation, in parts of the developed world thanks to historically low interest rates in the wake of the financial crisis.

He admits this, saying “divergence is not perpetual and is only one of several possible future directions for the future distribution of wealth. But the possibilities are not heartening.”


Assuming the trend is intact, only political action will break it, says Piketty, whose central idea is expressed in a simple equation:

r > g, where “r” is the rate of return on capital, and “g” is the rate of economic growth.

“When the rate of return on capital significantly exceeds the growth rate of the economy, (as it did through much of history until the 19th century and is likely to be the case again in the 21st century), then it logically follows that inherited wealth grows faster than output and income.”

This may seem self-evident to the person in the street. But a quite different view about the natural patterns of economic growth and wealth has prevailed since the mid-1950s, thanks to a predecessor of Piketty’s, American economist Simon Kuznets. Kuznets used income data from the early 20th century through to 1948 to suggest that wealth inequality would naturally rise early in an economy’s development before reversing, with the income gap narrowing, as the economy matured.

Piketty describes the profound influence of the so-called “Kuznets curve” on economic policy in the 1980s and 1990s, and to some extent still today, as “a fondness for fairy tales, or at least for happy endings”.

Although he applauds the “formidable statistical apparatus” that gave Kuznets’s work such status, Piketty simultaneously buries the American with his own statistical evidence, all of which has either emerged since he died in 1985 or has only been demonstrable through the power of modern computing.

Revolutionary thinking: Piketty’s study of inequality reaches back to the French revolution. Photo/Thinkstock

Piketty’s conclusions are devastating for the Kuznets curve. They show that the apparent levelling effect he observed was an aberration – Piketty calls it a “historical accident” – created by the massive destruction of wealth caused by two world wars and the Great Depression. During that period, inequality in developed economies shrank because the wealthy lost so much of their accumulated capital.

Instead of a “new normal”, in which societies became more equal, the postwar period was a one-off, Piketty concludes.

He shows that since the 1980s, rich countries have been tracking back to an “old normal”, where the ratio of capital to income “will quite logically rise and could approach 700% before the end of the 21st century”.

That is “approximately the level observed in Europe from the 18th century to the Belle Epoque”, a period of peace and prosperity in France between the 1870s and 1914 that was marked by vast wealth disparity, in contrast to the “Trente Glorieuses”, a 30-year period after World War II when inequality in France shrank before starting its inexorable rise again.

“By the year 2100, the entire planet could look like Europe at the turn of the 20th century, at least in terms of capital intensity,” says Piketty.

For a modern example of this phenomenon in action, look no further than Japan, which remains one of the world’s wealthiest economies despite a generation of apparently intractable economic stagnation.

Japan’s continued economic dominance is the product of an ageing population with very high private savings, which continue to earn returns higher than the country’s feeble rate of economic growth.

“With a savings rate close to 15% a year and a growth rate barely above 2%, it is hardly surprising that Japan has over the long run accumulated a capital stock worth six to seven years of national income,” says Piketty. “This is an automatic consequence of the dynamic law of accumulation.”


So this is what the future looks like. Economies in catch-up mode, such as China and Brazil, may beat the arithmetic of r > g for a while, but in the end, their wage and salary earners will never catch up to those who accumulate wealth, no matter how quickly they trade in their rickshaws for cars and the bush telegraph for a Samsung S5.

There’s a flaw in capitalism, Piketty says, and if we don’t fix it, the consequences are “potentially terrifying”.

Yet not all the underlying drivers of capitalism lead to inequality. Piketty acknowledges powerful forces of convergence as well as divergence. Most important in driving convergence are the rapid transfer of education, ­knowledge and skills. But these alone are insufficient to overcome the divergent forces “which are potentially threatening to democratic societies and to the values of social justice on which they are based.”

No wonder Piketty has become a poster boy for the Occupy movement, which popularised the idea of the “one per cent”, a super-wealthy global elite wielding illegitimate influence, while sending shivers down the spines of editors at rich-man’s bible Forbes magazine.

Yet it would be wrong to call Piketty an anti-capitalist. If anything, he’s a democrat first and a capitalist second.

“Of course, I am not saying capitalism is failing,” he says in our one frustratingly brief email exchange, which is all the man dubbed by New York magazine as “the rock-star economist” can manage as his overnight global fame engulfs him.

“It is working great. I am saying that it should be regulated and that progressive taxation is part of that regulation.”

In his book, he elaborates: “One could tax capital income heavily enough to reduce the private return on capital to less than the growth rate.

“But if one did that indiscriminately and heavy-handedly, one would risk killing the motor of accumulation and thus further reducing the growth rate. Entrepreneurs would then no longer have the time to turn into rentiers, since there would be no more entrepreneurs.”

He seeks a balance between ensuring economic incentives still work and the evidence that “immense inequalities of wealth have little to do with the entrepreneurial spirit and are of no use in promoting growth”.


If this seems like an argument from the left, then it’s worth noting Piketty has plenty of support from the traditional right as well.

The International Monetary Fund, for example, has taken up the cause of inequality, concluding in papers issued last month that lower inequality is “robustly” linked to “faster and more durable growth”, and that redistribution of wealth – for example, by using the tax system – appears “generally benign in terms of its impact on growth”.

“Thus the combined direct and indirect effects of redistribution – including the growth effects of the resulting lower inequality – are on average pro-growth,” the IMF says. Its president, Christine Lagarde – like Piketty, also French – has been championing the importance of this new focus on inequality.

Indeed, to the French, Piketty’s latest work is just the latest in a string of publications over the past 15 years in which, with other economists, he has constructed a new understanding of the self-perpetuating power of accumulated wealth.

Even his most sceptical critics agree his work on the World Top Incomes Database, which analyses tax returns from 29 countries for as long as records exist, moves the dial markedly on the debate.

The Economist magazine suggested in a four-part analysis of Piketty’s book that as impressive as it is, it “may ultimately prove less influential and significant than the World Top Incomes Database”.

“That and the data on the distribution and evolution of wealth represent an enormous achievement. Were it not for this effort, the ongoing discussion on inequality would not be as serious and relevant as it is.”

The American dream of self-betterment through hard work ends up looking like a myth. Photo/Thinkstock


For Americans, whose politics are increasingly fractured between an extreme libertarian tail that wags the Republican Party dog and a comparatively impotent Democratic Party, Capital in the Twenty-First Century has hit like a bomb.

A breathless account of a sold-out Piketty event in Manhattan in the organ of the liberal elite, the New Yorker, describes nervous wittering among the welcoming party of economists about pronunciation of the great man’s name. For the record, it’s “Pee-kett-ee”.

The event was the hottest ticket in town, attended by no fewer than three Nobel laureates: Paul Krugman, Edmund Phelps and Joseph Stiglitz.

Grumped Stiglitz on Piketty’s analysis of top income earners’ tax returns: “My PhD thesis was on this subject. It was published 45 years ago. But those articles were not part of the mainstream conversation then because there was no mainstream conversation on income inequality.”

Brian Easton, the Listener’s long-time economics columnist and self-described tender of “the lonely garden of the analysis of economic inequality” in New Zealand for more than 40 years, says Piketty’s is a book whose time has come.

“There has been increasing concern about the rising income shares of those at the top,” he says. Inequality as measured by top incomes is about twice New Zealand’s rate in the United States, and “since America’s wealthy set the ideological framework for the whole world, the ideological discourse may be revolutionised by the inequality issue.

“It is not at all obvious that the coalition between the American rich and the conservative and populist Tea Party will hold.”

This dynamic helps explain the combination of adulation and alarm with which Capital – a title that deliberately invokes Karl Marx’s mid-19th century treatise on capitalism’s inevitable self-destruction – has been greeted by economists, politicians and the commentariat alike.

Hail to the rock-star economist: clockwise from top left, Christine Lagarde, Joseph Stiglitz, Gillian Tett, Paul Krugman.

Financial Times columnist Gillian Tett suspects “the real reason for Piketty’s rock-star reception is not the quality of his numbers” but because it forces Americans to confront the evidence that their American Dream of self-betterment through hard work and entrepreneurial energy is “increasingly a myth”.

New Zealand’s equivalent has been the dream of an egalitarian society, which few would dispute has been eroded by a ­generation of economic reforms intended to restore the country’s global competitiveness.

Gabriel Makhlouf, secretary to the Treasury in Wellington, agrees there has “probably not” been enough economic analysis of income inequality, although it’s become an important focus in recent times.

“What Piketty’s doing is looking at wealth in a way that people probably haven’t done historically,” says Makhlouf. “That’s not to say he’s the first person to look at it, but I think we’ve tended to focus on income and distribution of income as opposed to how wealth has moved through the ages.

“This is a big topic. It deserves careful attention and it’s complicated. For the Treasury, this is an important part of our framework and we are going to carry on studying it.”

He fears recent local debate risks being trivialised by parties to the argument picking their numbers to suit their case.

Here, the best official statistics, prepared by economist Bryan Perry at the Ministry of Social Development, show income inequality widened sharply in the “Rogernomics” and “Ruthonomics” era between 1984 and 1994, but flattened out after that.

Government Ministers have used the MSD analysis to claim that although inequality is real, it has been static, while Opposition parties and income inequality activists have sought to label the issue a “New Zealand crisis”.

With proper statistics it would be possible to say who’s right, says Easton. “We just don’t have adequate long-term data on wealth in New Zealand. Sigh.”

Down and out Detroit. Photo/Thinkstock


However, Arthur Grimes, a senior fellow at economic consultancy Motu and adjunct professor at the University of Auckland, suggests Piketty’s analysis can be faulted for failing to consider the vast chunk of the human population not much covered by his research.

“The past 20 years have seen more people lifted out of poverty than ever witnessed before in human history, essentially as a result of the adoption of various forms of capitalism in China, other East Asian countries and, to a lesser extent, in South Asia,” says Grimes, who chaired the Reserve Bank of New Zealand until last year.

“As a result, the world is a now much more equal place than it was 20 years ago.”

Although that has engendered “huge expansion in incomes of the corporate and financial elites”, Grimes suggests this is an inevitable byproduct of such a large shift out of poverty and into relative wealth for at least a billion people within the space of a generation.

He regards as natural the fact that competition for talent will always make the top prize at Wimbledon much larger than the purse at the ASB Tennis Open.

Might the benefits of capitalism unleashed be so widespread that the resulting rise of a gaggle of plutocrats is a price worth paying, or at least not beating ourselves up about?

Support and scepticism for Piketty’s thesis: from left, Oliver Hartwich and Gabriel Makhlouf.

In thinking so, Grimes would find himself in good company. Harvard University professor of economics and public policy Kenneth Rogoff suggests Piketty has not considered other possible causes of the emerging capital/labour imbalance.

Rogoff, who is responsible for seminal thinking about the global financial crisis, wonders whether the imbalance might be explained by the influx of low-cost Asian labour into the global economy, in which case other economic theory suggests that “eventually capital stocks will adjust and the wage rate will rise”.

Or could it be because of the rise of automation, in which the downward pressure on labour’s share of income will fall, irrespective of the role of capital?

“In accepting Piketty’s premise that inequality matters more than growth, one needs to remember that many developing-country citizens rely on rich-country growth to help them escape poverty,” Rogoff says.

“The first problem of the 21st century remains to help the dire poor. By all means, the elite 0.1% should pay much more in taxes, but let us not forget that when it comes to reducing global inequality, the capitalist system has had an impressive three decades.”

As noted already, Piketty would not dis­agree. It’s just that the tendency for capital to return more than economic growth ­(r > g) “is not the consequence of any market imperfection”. On the contrary, that is the market at work. But we are not its servants.

“If we are to regain control of capitalism, we must bet everything on democracy,” he writes.

“The nation state is still the right level at which to develop new forms of governance and shared ownership intermediate between public and private ownership,” says Piketty, a committed disciple of the European Union. “Only regional political integration can lead to effective regulation of the globalised patrimonial capitalism of the 21st century.”

In other words, acceptance of a globalised economy requires its regulation by a globalised politics – an acceptance as contentious for the Occupy movement as the proposed regulation through thumping taxes on high incomes and wealth is to the prevailing economic orthodoxy.

But that is perhaps the nature of the beast.

“The history of income and wealth is always deeply politically chaotic and unpredictable,” says Piketty. “How this history plays out depends on how societies view inequalities and what kind of policies and institutions they adopt to measure and transform them.”

Three big Thomas Piketty ideas that change everything

Most of the torrent of commentary on Capital in the Twenty-First Century has concentrated on Piketty’s finding that wealth grows faster than incomes. But underpinning that conclusion are some other radical implications. Here are three:

Political parties promising high growth rates can’t deliver

Almost every political party promises higher rates of economic growth than its opponents. But Piketty shows developed economies rarely grow faster than an average of 1% a year, after inflation, over the long term. Only countries such as China that are in “catch-up” mode can sustain higher average annual economic growth rates over the long term. And when they catch up, growth will slow, as it is doing already in China.

One per cent annual growth over the long term is still fast growth

If an economy grows at an average 1% a year, after inflation, for 30 years, it is more than 30% larger at the end of those 30 years than it was to start with. The people who live through it may not really notice the change, but the difference is significant.

“Growth has in fact always been relatively slow except in exceptional periods, or when catch-up is occurring,” writes Piketty. “Furthermore, all signs are that growth – or at any rate its demographic component – will be even slower in the future.”

In contrast, the past 60 years or so have seen some of the fastest rates of population growth in history. This has underpinned growth rates for two generations, but can’t be assumed to do the same in the future. Yet much of our collective expectation about the future rests on our experience of the very recent past. Perhaps Piketty’s greatest contribution is to force a new,­ long-term view on a world ­dominated by short-term analysis.

That analysis shows there was virtually no economic growth in the 18th century, an average of about 0.1% a year. That rose to 0.9% on average in the 19th century, but it wasn’t until the 20th century, when the average rose to 1.6% a year, that “economic growth became a tangible, unmistakable reality for everyone”.

“Many people think that growth ought to be at least 3 or 4% per year,” says Piketty. “Both history and logic show this to be illusory.”

The world population will stop growing this century, with profound implications for the concentration of wealth

In the 300 years or so covered by Piketty’s research, the global population has grown from an estimated 600 million at the start of the 18th century to about seven billion today. Increasingly ageing populations and lower birth rates mean growth is forecast to peak in the middle of this century at about nine billion.

As a result, says Piketty, “global output will gradually decline from the current 3% a year to just 1.5% in the second half of the 21st century.” This can be expected to raise inequality in the ratio between income and capital to the kinds of extreme levels seen at the turn of the 20th century.

In other words, slower global economic growth will intensify the extent to which those who hold capital, which will still be getting perhaps 3-5% annual rates of return, will outstrip the wealth of those with less capital.

“Capital-dominated societies in the past, with hierarchies largely determined by inherited wealth … can arise and subsist only in low-growth regimes”, says Piketty. That is the implacable effect of his r > g formula.

A slowdown in world population growth therefore implies that “inherited wealth will make a comeback”.

Piketty’s answer: tax the rich

Here’s where Piketty runs into the most flak.

Although the quality of his research goes almost unquestioned – apart from by those who quibble that the past is not a guaranteed guide to the future – his answer to the problem of inequality is the blunt instrument of progressive taxes to target both very high incomes and personal, often inherited, fortunes.

“The right approach is a progressive annual tax on capital,” Piketty argues. “This will make it possible to avoid an endless inegalitarian spiral while preserving competition” and what he calls incentives for “primitive accumulation” of wealth by those who are not already wealthy.

An 80% tax rate on very high incomes and a graduated scale of tax on personal fortunes from 0.1% for holdings worth around $1.5 million through to 10% for fortunes in the billions of dollars would “contain the unlimited growth of global inequality of wealth, which is currently increasing at a rate that cannot be sustained in the long run and that ought to worry even the most fervent champions of the self-regulated market”.

Writing in the heavyweight US foreign policy journal Foreign Affairs, economist Tyler Cowen describes Piketty’s tax solution as “an unsatisfying conclusion to a groundbreaking work”.

For example, US Treasury bonds yield a negative return after inflation at present low interest rates, while shares routinely return about 7% a year, reflecting the element of risk involved in any investment – “a concept almost missing from the book”.

More generally, Piketty’s critics dismiss the idea of a globally agreed tax on wealth as unrealistically Utopian, as does Piketty himself.

Closer to home, the executive director of the right-leaning New Zealand Initiative, Oliver Hartwich, is sceptical of Piketty’s claim that although skills and education are a force for greater equality, the divergent force of capital accumulation will always win out.

“Education is a very powerful tool,” he says. “There have been big increases in middle-class incomes as a result of education and new skills.”

The Treasury’s Gabriel Makhlouf agrees, saying policies that encourage social mobility are the most important to get right.

“I do take some of the stuff that I’ve read with some care. It’s an incredibly important issue and sometimes people trivialise it by picking the facts they want to pick to make the arguments they want to make.

“My position on this is that for adults, it’s about work; for children, it’s about education and having a good safety net for people who can’t work or are between jobs.”

However, for all its apparent impracticality, the reality is that Piketty’s work has given oxygen to a fire that had already started.

As a reader in a Daily Telegraph comments thread on the impact of Capital in the Twenty-First Century put it: “Capitalists must learn to make a better case in defence of wealth creation.”

Piketty’s biggest idea: the myth of income equalisation

The central argument that makes Piketty’s work so important is the challenge, backed by fresh data and analysis that even critics of his proposed solutions have praised, to the mid-20th century belief that as economies grew, so wealth would cluster to the centre.

Getty Images

That politically attractive assumption was backed by the Piketty of a previous era, the economist Simon Kuznets, whose analysis of developed-economy income trends in the first half of the 20th century found exactly such a correlation.

Piketty both applauds the quality of Kuznets’s work and blows it out of the water not only with the evidence of the 60 years since, but also through analysing such data as is available for the economies of 18th and 19th century Europe and America.

This wider arc of history shows the “great levelling” that appeared to happen between 1914 and about 1970 was a historical aberration caused by the massive destruction of capital wealth of two world wars.

Critics, however, suggest Piketty is only right when he analyses inequality within countries, rather than across them, as the extraordinary rise from poverty of the Asian economies in the past 20 years shows.

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