Reading "Capital": Chapter 1

By R.A. | LONDON

LAST year Thomas Piketty, an economist at the Paris School of Economics and a renowned expert on global inequality, published a book titled "Capital in the Twenty-first Century"—in French. It was released in English on March 10th. We reviewed the book earlier this year, but it is detailed and important enough, in our opinion, to deserve additional discussion. We will therefore be publishing a series of posts over the next few weeks—live-blogging the book, as it were—to draw out its arguments at slightly greater length. You can read the first two entries here and here.

FIRST on the agenda, a bit of housekeeping: Capital is now available for sale. Second on the agenda, this week's discussion, which is a look at Part 1, "Income and Capital", beginning with the first Chapter. I don't anticipate devoting a post to each chapter of the book, since that would keep us here a while, but in the early stages it's worth doing, to keep the posts at a manageable length.

Mr Piketty begins Part 1, Chapter 1 by defining terms. It's a useful exercise, but for our purposes the only thing worth calling out is the definition of capital itself, which he treats as equivalent to wealth, and which he considers to be sources of value that can be traded (so "human capital" doesn't count). He recognises that there is a difference between appropriatable wealth (like land or natural resources) and accumulatable wealth (like financial or industrial capital). There are times when it's useful to distinguish between the two, he notes, and times when it isn't necessary. Mr Piketty writes that in most of the rich world wealth is split nearly evenly between residential capital (housing mostly) and productive capital. A useful rule of thumb.

He then defines an important statistic for the book, β, or the ratio of capital in an economy to national income. It is a measure of the importance of capital in a society, and in Part 2 he describes why and how it varies across times and countries. And this all leads up to what he calls, rather grandly, the "first fundamental law of capitalism": α = r * β. This is basically an accounting identity that defines capital's share of income (α) as the rate of return on capital multiplied by the capital stock. Which makes it a useful way to calculate a quick and dirty rate of return, assuming you know the capital share of income and wealth as a share of output.

At this point I should mention another interesting habit of Mr Piketty's which some readers may find annoying, but I which I found quite endearing: his penchant for illustrating 19th century trends with examples from contemporary fiction. It turns out to be quite a useful device, as it happens, because many of the writers at the time (like Jane Austen, for instance) lingered over the details of characters' estates and took for granted (and understood that readers took for granted) that so much wealth was associated with x annual income, implying y rate of return. It's especially fun later when he discusses changes in the macroeconomic framework (toward systematic inflation, for instance) and identifies corresponding changes in the obsessions of contemporary writers. But I digress.

So does Mr Piketty. He wanders into a history of national accounts in order to make the point that figures like GDP are social constructs—which is true but somewhat tangential. He then discusses global inequality; real income per person ranges from about 150 euros per month in the poorest regions (like sub-Saharan Africa) to 3,000 euros per month in the richest. The geographical distribution of global output has been changing, of course. Europe's share peaked on the eve of the first world war, America's in the 1950s.

It does matter that he mentions this, I should say, since one classic method for deflecting expressions of concern about inequality is to point out that at a global level inequality has, at least recently, been falling. And Mr Piketty does have an interesting story to tell about global convergence. Those countries that have successfully completed much of the economic catch-up process have typically been economies that self-financed industrialisation on the back of high domestic savings rates. But in other regions, like Africa, a large share of industrial capital is foreign-owned. That may be due to the fact that domestic institutions, including the financial sector, are weak. But foreign ownership can also perpetuate institutional weakness, he writes, since it creates a strong incentive for governments to break contracts and expropriate foreign capital.

Mr Piketty uses this to argue that while there are gains from openness, those gains are almost entirely down to the transfer of knowledge, rather than the efficiency benefits of free trade and capital flows. The latter are mostly real, he suggests, but are generally modest. Or to put it somewhat differently: access to global goods and capital markets is useful to the extent that it facilitates an improvement in an economy's technological capabilities.

That's excessively pessimistic on openness for my taste. Maybe openness mostly entails foreign ownership that undermines institutional strength and delays convergence (counterpoint: maybe it doesn't!), but cutting the poor off from goods markets has historically been a good way to keep them poorer than they need to be and to reinforce cronyist regimes.

That said, Mr Piketty's emphasis on the importance of the diffusion of knowledge in influencing income distributions (across time, and both across and within countries) is dead on. As we shall see in later chapters.

You can read the previous entry in the series here. You can see the next entry in the series here.