Reading "Capital": Chapter 2

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 previous entries for: the Introduction parts one and two, and Chapter 1.

One of Capital's primary themes is that economic states we conventionally view as the norm are in fact historical abberations. Mr Piketty launches his book by saying that the natural tendancy of economies to become more equal as they mature is a myth, built on the unusually compressed distributions of incomes and wealth that prevailed in the middle of the last century. That period was actually an oddity that resulted from the unique historical circumstances of the tumultuous early 20th century; most of the time inequality is the norm rather than the exception.

In Chapter 2 Mr Piketty extends this revisionism to ideas about growth. The middle of the last century was unusual in its growth rates as well as in the distribution of income; the good times most of us see as our due as residents of rich economies were in fact a fleeting anomaly. Most readers will not be surprised to hear that growth prior to the Industrial Revolution was extremely slow. Mr Piketty argues that even within the industrial era growth has typically been slower than was generally the case in the postwar boom decades.

The growth analysis in Capital is built on a division of growth into two components: population growth and per capita growth. While that's as defensible a method of growth accounting as any other, it's worth remembering that the strict division is artificial; in practice, population growth rates and productivity growth rates influence each other. We will discuss later whether Mr Piketty relies too heavily on an inappropriately rigid distinction between the two.

But here's the broad point: over the last 300 years, economic growth has been roughly half attributable to growth in population and half attributable to growth in productivity. That is important, because the world is on the downslope of the great demographic convulsion of the past few centuries. Population growth rates soared from 1700 to the middle of last century, when global population growth peaked at an annual rate of 1.9%. But population growth rates are now falling and are expected to return to very low, pre-industrial rates by the end of this century.

Similarly, the rate of growth of per capital income also appears to be near what is likely to be a peak. In the 18th century output per person grew imperceptibly faster than in the long centuries of almost no growth before. In the century to the first world war growth sped up to about 0.9% per year on average (across the world as a whole), and in the century to 2012 growth averaged 1.6%. In the very recent past rapid emerging-market catch-up pushed the global rate of per capita growth above 2%, but that seems unlikely to be sustained. Mr Piketty sees forecasts from economists like Robert Gordon, who thinks a return to pre-industrial rates of per capita growth may be ahead, as too dire. He nonetheless thinks that global per capita growth will converge toward 1% by the end of the century.

Taking the two trends together an interesting picture emerges. In the long centuries leading up to Industrial Revolution total economic growth averaged no more than 0.2% per year. But global growth rates soared to an average of as much as 4% per year over the past 60 years. Yet a subtle deceleration has begun, which will ultimately bring global growth back to something like 1.2% by the end of the century.

Why does this matter? Because, Mr Piketty says, of the power of cumulative growth. At growth rates of 0.2% per year the economy expands by just 6% per generation, and by only 22% per century. In effect, society recreates itself almost unchanged, generation after generation. Culture, society, and class structures are stagnant over long periods of time. At 3.5% annual growth, by contrast, each generation has an economy 2.8 times larger than the last, and a century means a 31-fold increase in economic output. That means dramatic social change and the constant replacement of the old with the new. That was the world of the middle of last century.

And in between? At a growth rate of 1.2% each generation enjoys economic output about 50% larger than the previous, and a century leads to a three-fold increase in output. That is not nothing. Over the course of a millenium the resulting change is unimaginably significant. But at human timescales the permanence of society—its rigidity—is in many ways more similar to that of the pre-industrial era than the relatively recent past.

Growth is important for lots of reasons, but it is important for Mr Piketty's purposes because it governs the length of the shadow cast by the past on the present. As growth rates fall, that shadow will lengthen, strengthening the economic and social importance of past wealth and status.

But is that right? Is growth actually about to fall dramatically? And can we be sure that slowing growth in this modern era will have anything like the same economic and social effects of low growth rates in the pre-industrial era? We'll move on to Mr Piketty's evidence next week.

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