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CHAPTER 3

The Book

The subject of income and wealth inequality has been Piketty’s topic for many years. That is why he could write right at the beginning of his new book: ‘This book is based on fifteen years of research (1998–2013) devoted essentially to understanding the historical dynamics of wealth and income.’¹ With that, Piketty’s guiding question is outlined: how do wealth and income develop long-term, and what are the driving forces of this development? The book is structured according to this question. It consists of four large sections:

•Income and Capital (p. 39ff)

•The Dynamics of the Capital/Income Ratio (p. 113ff)

•The Structure of Inequality (p. 237ff)

•Regulating Capital in the Twenty-First Century (p. 237ff)

In the first section, Piketty introduces the reader to the topic and discusses what capital and income are and how they can be measured. He then comes to the actual topic of the book: how does the relationship between wealth on the one hand and income (income from labour and earnings on capital) on the other hand develop in the long run? And why? What patterns can be recognized? Finally, Piketty ventures a prognosis about how the relation between wealth and income will develop, and on this basis he makes economic policy proposals for how the world could improve.

Where does Piketty get his data?

Piketty’s data set, which has been much praised, is based inter alia upon tax records that he and his research partners have sifted through and processed over the last few years. On the one hand, Piketty is surprised that this material has not been used previously, but at the same time provides an explanation: the statistical study of tax records is an ‘academic no-man’s-land, too historical for economists and too economistic for historians’.² That is surprising to the extent that tax records first make it possible to take a long-term analytical perspective.³ Most of Piketty’s data series thus begin with the twentieth century, when many Western industrial countries first implemented an income tax. More difficult than in the case of income is the data for income from wealth and the size of wealth. Whereas income is well documented by tax authorities, wealth is not.⁴ Piketty notes: ‘I trust the quantification of wealth for the year 1913 more than that of 2013. National income is recorded relatively well, but the distribution of income up to the highest tiers is another question.’⁵

The most important source for the book is the World Top Incomes Database (WTID), the result of cooperation between thirty scholars and many research institutes, which Piketty helped to build in the last ten years.⁶ The database now encompasses more than twenty countries and is constantly updated. The first evaluations of the data had already been published in 2007 and 2010.

Partially to make his book more readable, Piketty did without a comprehensive data annex. In the book, one finds almost exclusively graphics that more or less vividly depict the developments described. However, the ‘specialist audience’ has the possibility of scrutinizing the data material: Piketty has put all of it on the internet.⁷ The charts and illustrations featured or mentioned in the present book are also freely available as PDF files.⁸

At the centre: the ratio of capital to wealth and income to economic performance

At the centre of Piketty’s analysis is the capital–income ratio. Of what is it comprised?

•National income (or income for short) is defined ‘as the sum of all income available to the residents of a given country in a given year, regardless of the legal classification of that income’.⁹

•Capital, on the other hand, is defined ‘as the sum total of nonhuman assets that can be owned and exchanged on some market’.¹⁰ Under the term ‘capital’, Piketty subsumes all forms of real estate property (including owner-occupied housing) as well as finance capital and ‘professional’ wealth (factories, machines, infrastructure, patents, etc.) that is used by businesses or state agencies. Not ‘human capital’, however, since it can neither be owned by another person nor traded on the market. Piketty uses the terms ‘capital’ and ‘wealth’ synonymously,¹¹ and we will do so as well when describing his account.¹²

The two magnitudes capital and income provide the first and most important magnitude that Piketty works with: the capital–income ratio, abbreviated with the Greek letter β (beta). With this ratio, according to Piketty, inequality can be adequately examined over longer periods of time and depicted in a meaningful number. If, for example, the per capita wealth in a certain year amounts to 150,000 euro, and the annual average per capita income amounts to 30,000 euro, then wealth is five times income. The capital–income ratio is thus 5 (since 150,000:30,000 = 5). According to Piketty, the capital–income ratio in the Western industrial countries is at the moment actually between 5 and 6. However, both wealth as well as income change with the passage of time. Depending upon the direction in which the magnitudes change, the capital–income ratio becomes larger or smaller. Income on the one hand comprises income that comes from labour, such as wages, salaries or fees, and on the other hand by capital income such as profits, interest, rents and dividends that are all based in property in the form of means of production, real estate or securities.

Wealth grows when part of income is not consumed, but saved, which is to say used in order to increase a pool of wealth, for example by purchasing securities or real estate. It goes without saying that the only people who can build up or increase wealth are those who do not live hand-to-mouth, or who have rich parents – that is, who increase their wealth through inheritance. If the magnitudes capital and income grow unequally, the capital–income ratio β changes. Potentially, the inequality tracked by Piketty also increases.

Returns on capital and growth: r > g

What influences the movement of wealth and income? According to Piketty, the pool of wealth tends to increase more quickly than income, so that the capital–income ratio increases. Piketty says the reason for this is that returns on capital (usually abbreviated as ‘r’) are in terms of historical average much greater than the growth of economic performance or of income (‘g’ for ‘growth’).

Why is that the case? What influences the growth of wealth (r) on the one hand and economic growth (g) on the other?

•Growth of economic performance/income (g) is, according to Piketty, essentially dependent upon the development of the (working) population and upon technological progress.

•The rate of growth of wealth (r) in contrast depends strongly upon the risk that the owners of wealth are exposed to with their investments. The rate of growth of r changes with the form of investment and the degree of speculation connected with it: the higher the risk, the greater r is. Thus, on average, according to Piketty, riskier stock investments or other forms of shareholding yield relatively high returns of 7 to 8 per cent. Real estate, in contrast, yields returns of only 3 to 4 per cent. Savings and checking accounts pay interest on saved money at the moment with rates of barely more than 2 per cent.

Piketty comes to the conclusion that the yearly return on capital r – despite all fluctuations and differences – averages out over the long term at about 4 to 5 per cent. The long-term rate of growth of economic performance g in contrast averages out at 1 to 2 per cent, and is therefore much smaller than the return on capital. Piketty expresses this in a formula: r > g.

So, income grows slower than wealth. This fact alone, however, does not yet automatically mean that inequality also increases. The reason: if all people owned an equal amount of wealth, all of them would equally profit from a strong growth of capital. In fact, however, wealth is unequally distributed, according to Piketty. He does not explain why that is. Rather, he assumes inequality as a given, and examines its development over time. This demonstrates, according to Piketty, that the strong growth of wealth in contrast to that of income exacerbates an inequality characteristic of all societies: those who have, receive (more). The rich become richer. According to Piketty, increasingly inequality is not a coincidence, but rather inscribed into economic development. Piketty says this is the case not only under capitalism, but also in other economic forms. However, Piketty does not wish for this diagnosis of growing inequality to be understood as a call to class struggle: ‘To be clear, my purpose here is not to plead the case of workers against owners but rather to gain as clear as possible a view of reality.’¹³

Historical reconstruction: how inequality has developed

After the ‘explanation’ of growing inequality, Piketty turns to the history of inequality and the capital–income ratio: according to his calculations, the ratio r > g has been valid for the last 2,000 years. Before the assertion of capitalist relations, there was de facto no economic growth. Therefore, g tended to stand at zero until about the year 1700, and r was thus correspondingly larger.¹⁴ Why was g so low? Because, before the eighteenth century, there was no noteworthy technological progress. According to Piketty, economic growth was thus based solely upon population growth, and per capita growth of income was therefore zero. It was first around the year 1500 that growth slowly set in; it then developed abruptly with the beginning of industrialization and made a further great leap forward in 1913, on the threshold of world war. Up to then, according to Piketty, r was between 4 and 5 per cent, so r > g. However, for the period before the eighteenth century, Piketty has hardly any reliable material. Even for the eighteenth century, he draws upon information from novels.

The capital–income ratio now dominant in Western industrial countries is almost as high as that on the eve of the First World War. For Piketty, this phase before the First World War and the present characterizes the extremes of the long-term development of the capital–income ratio so far.

•In France and Britain, the capital–income ratio between 1700 and 1910 amounted to about 7, then fell until 1950 to about 2.5 in Britain and less than 3 in France. After that, it rose again and approached a value of 5 in Britain and almost 6 in France in the year 2010.

•In the US, things looked similar, even if the ratio was initially low and only rose to 5 until 1910. Then it fell rapidly, ultimately stabilized between 5 and 5.5, and fell again after 1929 to 4 (in the year 1950). Only from the 1980s did inequality in the US increase again, and in 2010 reached about 4.5 – with a tendential rise. The inequality curve in the industrial countries accordingly takes the form of a ‘U’, whereby 1913 and the present constitute the peaks so far for the Western industrial countries.¹⁵

How capital has changed

According to Piketty, in the last 200 years, not only has the capital–income ratio changed, but also the forms in which capital exists. The eighteenth and nineteenth centuries were not yet characterized by industrial capital. Back then, wealth existed primarily in the form of farmland and government bonds. Thus agricultural land was one of the most important investments for capital until the nineteenth century and yielded a ground rent between 4 and 5 per cent. Taxes and inflation were low, which made public bonds an important form of investment for regular income. Moreover, we know from novels or biographies of various figures that, during this period, inheritances were central for building wealth, among other things in order to pursue certain life paths. Not infrequently, some waited with longing for their inheritances to come due. At this point, Piketty could have quoted the penniless Karl Marx, who wrote in 1852 to his friend Friedrich Engels concerning his uncle: ‘If the cur dies now I shall be out of this pickle.’ Marx was hoping for an inheritance after he had come up ‘empty’ after the death of his father. Engels replied to Marx: ‘My congratulations on the news of the illness of the old Brunswick inheritance-thwarter; I trust the catastrophe will at last come to pass.’¹⁶