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Reading "Capital": Introduction, continued

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 will be 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. Last week, we began with the first half of the Introduction.

In the first half of Capital's introduction, Thomas Piketty lays out the intellectual background for the work. In the second he shares the main results of the book. The first is that levels of inequality represent the result of political choices, rather than deterministic technological or economic outcomes (a point reinforced by recent IMF research). Whether or not structural economic shifts generate rising or falling, low or high inequality is down to the structure of the political system and the way it chooses to accommodate those changes. "Skill-biased technological change" or "superstar economics" are incomplete explanations of rising inequality. They may actually leave out the more interesting half of the story.

The second result is that economies do not naturally evolve toward more equal distributions of resources as they mature. There are some forces pushing toward greater equality, like the spread of new technologies from rich areas to poor—what he calls "the principal force for convergence". And there are some forces pushing toward less equality, one of the most important of which is the ability of the rich to secure further economic and political benefits for themselves. Importantly, he notes, the equalising power of the diffusion of knowledge is closely linked to state policy: to investment in infrastructure, education, research, and a regulatory environment conducive to entrepreneurship and competition. It isn't a natural force for convergence at all, but must be actively cultivated (and may be resisted by those with wealth and power).

At the moment, Mr Piketty observes, the world is looking at two key dynamics pushing the world toward greater income divergence. One is soaring inequality in labour income. This trend is especially noticeable in America, where the top 10% of earners now captures close to 50% of national income, up from about 35% for the first three postwar decades. The second dynamic is the return of wealth.

Mr Piketty introduces a statistic that features prominently throughout the book: the ratio of private wealth in an economy to GDP. Across most rich countries this ratio was consistently high in the 19th century, tumbled during the interwar period, and has since rebounded back within shouting distance of 19th century highs. To explain this, Mr Piketty unveils a "fundamental force for divergence": r>g.

The r in r>g is the return on capital. It's worth mentioning now that capital in Capital is equivalent to wealth, and wealth means anything other than labour which generates income: land, financial assets, physical capital, and so on. (Human capital doesn't count, as that augments labour income.) R, then, is the income generated by that wealth (meaning rents, dividends, profits, and so on) as a share of total wealth. The g, on the other hand, is simply the growth rate of the economy.

If and when r>g, then, wealth grows faster than output, the ratio of wealth to output increases, and the share of capital income in total income rises. And there is an important corollary: a slowdown in overall economic growth is itself a force for greater concentrations of wealth. This relationship forms a critical part of the book's argument, though it is not necessarily intuitive: shouldn't lower g imply lower r? But we'll get to that. We should be clear, though, about what Mr Piketty is after: breaking much of modern economic history down into a few constituent forces that can be easily captured in statements like r>g. The value of his book will depend, in part, on how much we need to abstract away from the world to accept that r>g matters across times and places. The more reality you strip away from a model the easier it is to divine universal truths, and the less interesting the truths become.

It's worth mentioning that Mr Piketty very much wants to explain the real world. He closes the Introduction with an interesting discussion of his motivations, not easily summarised here, which includes the factoid that he left America to return to his native France because he found American economists too interested in theory and generally unconvincing. That's not particularly charitable—there are a lot of American economists working on a lot of different things! It is of a piece with the francophilia that suffuses the book, and which the author (rather unsuccessfully) argues has nothing to do with home-side bias. Nothing wrong with that, of course, but it is a recurrent and noticeable enough part of the book that it seems worth pointing out.

Next week: we dig into the details...

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

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