Five years after Thomas Piketty’s surprise bestseller, Capital in the 21st Century, captured the zeitgeist of an anxious age, Capitalisn’t hosts Kate Waldock and Luigi Zingales revisit the book to see how it holds up in the current political and economic climate. The verdict? Intriguing analysis, but limited impact.
Stephen Colbert: Welcome back, everybody. My guest tonight has a new book that blows the lid off income inequality. But don’t worry: it’s 40 bucks. Poor people will never know. Please welcome Thomas Piketty.
Kate: Hi, I’m Kate Waldock, a professor at Georgetown University.
Luigi: And I’m Luigi Zingales, a professor at the University of Chicago.
Kate: This is Capitalisn’t, a podcast about what’s working in capitalism today and, more importantly, what isn’t.
Luigi: Kate, you’re talking about capitalism, and it’s almost like we are forced to discuss this book that has become famous by Thomas Piketty, about capital in the 21st century.
Speaker 4: Where is the middle class going? That question is part of the reason why the surprise bestseller of the season is not a teen novel or a thriller, but an economic textbook of all things.
Speaker 5: It is being hailed as the first economic classic of the 21st century—
Speaker 6: A book written by a French economist, why is that book getting all this attention?
Speaker 7: Piketty? How do you say it?
Thomas Piketty: Piketty.
Speaker 7: OK, everybody is talking about this book—
Speaker 9: ... because it tries to answer what is perhaps the most pressing question of our time. What do we do about the fact that so few of us have so much, while so many of us have so little?
Kate: Yeah, I was in grad school when this book came out, and I remember seeing it everywhere. It was all the rage. If you didn’t have the book on your coffee table, or on your Kindle, if you couldn’t talk eloquently about it, then you weren’t cool. So in preparation for today’s episode, I discovered that I am in the 1 percent.
Luigi: 1 percent of what?
Kate: The bottom 1 percent of the wealth distribution, and that’s because I still owe a bunch of money in student loans. As I earn income from having a job, I plan on paying that debt down, and then eventually I will be in the black one day. But I feel like I deserve a T-shirt that says, ‘I’m in the bottom 1 percent.’
Luigi: I don’t know whether you deserve a T-shirt, but I think it’s very useful to indicate that some of these statistics are misleading, especially because they are temporary. Probably, a year and a half ago, before you started your job at Georgetown, you were not very well also in the income distribution.
Luigi: I’m sure you remember.
Kate: Definitely. I remember that all too well.
Luigi: But in expectation, you were worth a lot. You weren’t somebody poor in any sense of the word, even if you did not perform well in the statistics.
Kate: Yeah, that’s totally fair. But the point of this episode is not to talk about the permanent poor from a labor perspective. It’s actually to talk about the permanent rich, from a wealth perspective. People who are born, or inherited a lot of capital, a lot of wealth, and the ease with which they can just hold on to that. Piketty believes that inequality is something that can naturally arise as a result of capitalism. A lot of the reasons that people support capitalism are because they lead to higher growth and higher productivity, and those are good things. Those are things that benefit the whole society. But Piketty, according to his historical analysis, actually finds that except in several rare circumstances in history, most of the time, capitalism has been pushing us towards an unequal society.
Luigi: I would like to divide the book into three parts. There is a first part that reports studies on income distribution in the US and France and some other countries, certainly over the 20th century, sometimes even longer, showing that the fraction of income earned by the top 1 percent has changed dramatically, and was very high in the early part of the 20th century, up to basically the Great Depression, then went down constantly until the beginning of the 1980s, and then started to pick back up, and especially in the United States, that percentage has grown a lot. These are studies that have been published in many academic journals, and are very thorough, and I think contributed to our perception today that income inequality has gone up.
Then there is a second part of the book that looks at what Kate was referring to as the inevitability of this increasing concentration. The idea behind this is that if the return on capital is higher than the rate of growth, who has capital today will end up having more capital tomorrow. This leads inevitably to a higher concentration. Then there is a third part that is more about what to do about it. Let’s discuss this in stages. On the first part, I don’t have a lot to say, because those are facts, and I agree with the facts. There are only two caveats that I would like to bring up front.
In the United States, there has been a large rise, between 1980 and today, of the share of the top 1 percent. However, one-third of that rise, it has been shown, is due to just one thing, which is the tax reform of 1986, that changed the way people report things. I’m not saying the entire rise is explained by this, but one-third is explained simply by reporting standards. So I think we have to be careful when we mention this huge rise that takes place, because it’s affected by this.
The second is that the threshold for being rich is uniform across the United States. But if you make $250,000, you feel super rich in Chicago. You don’t feel as rich in New York, where the cost of living is twice as much as the one in Chicago. So I think that this common element is a bit misleading, given the enormous variation in income that there is within the United States, and the enormous difference in cost of living within the United States.
Kate: A lot of people, when they think about this book, they think of two letters, R and G. There’s R, which is the rate of return on capital. What is capital? According to Piketty, it’s anything that generates a return for you that’s not coming from labor. If you hold any type of asset, if you hold a bond, if you hold a stock, if you own a house, if you hold a valuable painting, anything that you own that earns money for you, that’s considered capital in his book, except for the job that you have. If you make income from your job working at a PR agency, that’s your labor income. But any other form of money that you’re making, that’s coming from your capital.
The other letter is G. G stands for growth. That letter represents growth in the overall economy. We think about GDP growth. This is something that we hear a lot about today in the policy discussion. You can think of that as the general rate at which everyone in your country is experiencing growth. If growth in China is 8 percent, and growth in France is 1.5 percent, you can think that on average ... I mean, it may be true that people in France on average are better off, but the rate at which people in China are getting better off is higher.
What’s really important to Piketty is the difference between these two variables. If R is greater than G, then that means that the people who have wealth—and wealth is usually saved in things that earn people a rate of interest—it means that they’re making more money than the average person in society, who is just growing at this general growth rate of G. Not only that, but if you have wealth, if you have a trust fund, if you are one of those few people who is lucky enough that mom and dad left you $5 million, you don’t need to live poorly. You can go out. You can go skiing. You can go to fancy restaurants. You don’t need to save all of that money. But even saving just a tiny fraction of that can actually grow your wealth, whereas this isn’t the case for most people. Most people are pretty hand to mouth. It’s actually hard to save on a regular basis. There’s this idea that once you start with wealth, it’s relatively easy for you to become even wealthier.
Luigi: A couple quibbles here. First of all, it’s not the standard economic approach to clap together all these different forms of capital. Your collection of stamps is not the same thing as your machinery that you’re using in your factory. In fact, the traditional thinking of capital is as a means of production. Your collection of stamps, or your van Gogh painting, is not part of this capital, so this is one distinction. When it comes to understanding the rate of return, as economists, we know and can predict much better the rate of return on means of production than the rate of return on van Gogh paintings.
The second is, we need to be careful when you talk about rate of return. What is the gross rate of return and the net rate of return, where the difference between the two is the depreciation? You might have a large increase in the return on the house, but you need also to fix the house. That capital depreciates over time, and needs to be factored into the equation.
The third aspect, which maybe is the most important, is there is no doubt that there is persistence in wealth, but if we look, especially at the tail of the wealth distribution, look at the big billionaires in the United States today, very few actually inherited wealth. You go from Gates to Zuckerberg to Ellison, and these people, to Bezos, all these people made their money. They didn’t make their money because the economy grew that fast. It’s because they were able to appropriate a lot through innovation. So I don’t think that the two things necessarily go hand-in-hand.
Kate: That is true. I mean, that’s kind of why he set out to answer this question, is because it’s not an obvious question, I don’t think. It’s not obvious that capitalism necessarily makes the problem of inequality worse. That’s something that you need to sit down and test. To your point about the people in the Forbes 400 list, 1 through 10 are basically all entrepreneurs. But 11, 12, and 13 are all Waltons, and especially as you go down that list, there’s more and more inherited wealth.
But I want to get back to this point of how do you test this question? You have this hypothesis. You have Marx on one end of the spectrum who thinks that capitalism is going to necessarily make inequality so bad, or he thought, that this would lead to an uprising of workers that would undermine capitalism. On the other end of the spectrum, you have someone like Kuznets, an economist, who thought that capitalism was great, because it leads to innovation, and it leads to growth and productivity. Therefore, it makes everyone better off. So I don’t think the answer is clear, and to come up with an answer to this question, you need data. I guess what we need to figure out as economists is, what’s the best data to be able to answer this question.
What we usually do in a micro-level analysis is to try and come up with these natural experiments. ‘Let’s come up with a setting where you randomly have some people who are endowed with wealth, and you randomly have some people who don’t. Let’s see if we can figure out whether the ones who were randomly given some wealth, that accumulates over time, and that leads to more inequality between them and the people who weren’t randomly given wealth.’ But there’s just zero way in which we can prove this causally. We can’t just randomly give some families $10 million and have them be super wealthy, and randomly make some people worse off, and then have this persist over generations.
Luigi: Actually, there are some studies like this, based on lottery winners. Basically, lottery winners is you randomly give some people $10 million. The way I remember the studies is that most people waste their money. There’s not a lot of persistence among lottery winners. They must come also with education on how to spend it, or connection on how to multiply that, or other things, because the wealth by itself is not enough to be persistent.
Kate: But anyway, I guess what I was getting at, before you came up with a pretty good counterargument, which is that, an alternative method of studying this question is let’s say we didn’t have lotteries, or let’s say we can’t necessarily trust what we know from lotteries, from an external validity perspective. What’s another way of answering the question? Well, you try and gather as much data as possible. You gather as much data as you can about the rate of return on capital. You gather as much data as you can about growth rates. You gather as much data as you can about inequality. Then you look at the correlations between those three variables. That’s essentially what Piketty did in his book.
Luigi: It’s true, and I certainly admire his effort. I’m certainly liable of trying things similar, so I’m the last one to throw stones. But I think we have to be very careful in going from this exercise that inevitably has a lot of shortcuts. I’m not criticizing that he did not do a good job, but when you have to collect data over 150 years in three or four countries, the data are not going to be very precise. Most importantly, a lot of things happen in 150 years, so it’s very hard to generalize. Now I think that what we need to understand is what are the economic forces at play that generate this inequality—
Kate: Not just economic, but also political, right?
Luigi: Absolutely. I say the two are quite connected with each other. I think that this is where I’m less excited about Piketty’s book, because I don’t think he spends much time in pointing out the complexity of this. He focuses mostly on capital, and I’m not even sure the capital is the biggest source.
Kate: Capital isn’t.
Kate: Sorry, too easy—
Luigi: But you’re right in pointing out that the 11, 12, and 13 of the Forbes list is part of the Waltons family. But who knows, pretty soon Walmart might not be worth much, with the Amazon competition, and so much of their wealth might disappear. So there is a lot of—
Kate: Bezos needs to start having babies—
Luigi: ... there is a lot of variability that is not really factored into the equation. I think that there is persistence in wealth. It’s not as big, in my view, especially in a country like the United States. But part of the reason is the United States, at least traditionally, had a fairly big inheritance tax, much bigger than the one of most countries in the world.
Kate: I thought he said in the book that inheritance taxes are lower in the US, even before the tax cut, than in other countries.
Luigi: I recently read a paper showing that the United States has one of the highest inheritance taxes in the OECD countries.
Kate: All right, I have the book right here.
Kate: Look at all this underlining. There’s stars ... OK, so maybe not in that part.
Luigi: OK, so here I found, this is a study of the Tax Foundation, and it says that the US has the fourth-highest estate tax in the OECD, at 40 percent. The world’s highest is 55 percent in Japan, followed by South Korea and France. Fifteen OECD countries levy no taxes on property passed to lineal heirs, which means direct descendants.
Kate: Yeah, I guess what I was thinking of in the book was not estate taxes, but he does have these graphs of the inheritance flow. He defines this as annual value of bequests and gifts, I guess to your kids, as a percentage of national income. Last he measured, in 2010, in England was 8 percent, in France was more like 14 percent, and in Germany was around 11 percent. Then the definition of inheritance in the US is a little different, but he says that inherited wealth accounts for 20 to 30 percent of total US capital. Note that that’s a fraction of capital, and not of national income.
If we go back to his comparison of rates of return on capital to the growth rate in society, he argues that throughout most of human history, the rate of return on capital has been significantly higher than the growth rate, which means that if you have a lot of capital, then you will continue to have even more capital in the future, assuming you don’t just consume everything that you make. I think that that is fair to assume. Then where I think he extrapolates a little too much is that he thinks that growth rates are going to fall in the next 20 to 50 years.
Luigi: As an economist, you should know that both the return to capital and growth are endogenous, so they are part of an equilibrium. If you invest more capital, the return on capital will go down. If you invest too little capital, the return to capital will be higher.
Kate: Yes, this is exactly his point. This is the fundamental point that he is trying to make, is that economists have these models and these theories for how the rate of return on capital should evolve and should potentially go down if it’s too high. But he finds that that is not the historical reality. The historical reality is that the rate of return on capital has been much higher than the growth rate for pretty much all of human history, except a few years in the mid-20th century.
Luigi: But this is where his aggregation creates problems, because as economists, we know the return of physical capital invested in productive activity should go down the more you invest. We don’t have the same theory for—
Kate: It doesn’t.
Luigi: ... van Gogh paintings. It depends on the future demand for impressionist paintings. We don’t have the same theory on housing. It depends on population growth. When you aggregate everything together, then you are basically missing the point.
Kate: I don’t think you’re missing the point, because no matter what, no matter what asset class you’re looking at, whether it’s van Gogh paintings, or housing, or machinery, the rates of return on all of those asset classes are still higher than the rate of growth. So whether you’re looking at a 1 percent return, a 3 percent return, a 6 percent return on stocks, they’re all higher than historical rates of growth, which have typically been less than half a percent. So it’s not an aggregation issue.
Luigi: It is an aggregation issue, because if you separate—the return on capital depends on how much capital there is. There are situations where the return on capital is very high and situations in which it is very low. Growth has been, in some period, especially over the 20th century, has been very high. Once you bring in also the depreciation of capital, then the things change. If he’s saying that he’s trying to refute neoclassical analysis just by using aggregate data over a century, or a few centuries, I think it’s not going to work. I think that he did great work at the beginning. Then he wanted to arrive at some conclusion and skipped the stuff in between.
Kate: I think you’re being too persnickety about Piketty.
Luigi: Let’s talk finally about his policy recommendation. His policy recommendations are nothing more than sock the rich.
Kate: No, I think that’s the one that the media has focused on. That’s the one that the critics have focused on. Yes, he also has chapters on a global wealth tax, and so we can talk about that if you want. But I think it is unfair to say that his only policy recommendation has to do with taxing the rich.
Luigi: It’s certainly his main policy recommendation.
Kate: I disagree.
Luigi: OK. I don’t think there is much ... What did he say, tell me, besides saying, “We need more education,” what does he say about how to reach a better education?
Kate: I knowledge that he does not have very concrete recommendations for how we should to improve our educational system, other than having it be accessible to everybody.
Luigi: OK, I grant that he believes in that. But in terms of recommendations, I think the wealth tax is the major one. I think that—
Kate: OK, fine, so let’s talk about the wealth tax.
Luigi: The problem with this is, number one, it’s difficult to implement. But number two, I think that the emphasis of his book, and that’s the reason why I dislike it, the emphasis is not on how to give more opportunities to people and basically elevate the vast majority of American people or French people to a high level of income. It is how to make sure that somebody does not have more than I have, because I’m very envious.
Kate: I think he believes that some inequality is good for society. I mean, that’s what capitalism is. It’s that if you’re smart, and you’re hard-working, and you contribute to society, you should be allowed to make more. But I think that what he doesn’t believe in is being able to sock all that money away, to earn a 6 percent return, and to have his legacy, and his children, and his grandchildren, continue to live off of that wealth ad infinitum.
Luigi: I think that for people who make more money and want to accumulate that return to allow themselves a better retirement, I don’t see why they should be heavily taxed. What is the rationale for that?
Kate: I think his rationale was that in the periods when we had really high marginal tax rates, that we experienced a lot of growth in those periods. So it’s not necessarily true that high taxes are inconsistent with growth.
Luigi: Oh, so correlation is equal to causation? Is that the basis of his thing?
Kate: No. He obviously doesn’t think that correlation is equal to causation. There is no way, at a very high level, when it comes to macroeconomics, when it comes to big questions of wealth and capital and rates of return, to know what causes what. The best that we can do is come up with the longest time series as we can and the most consistent numbers as we can. That is what he has done.
Luigi: I disagree that it’s the best that we can do. I think that microeconomic analysis can provide a lot of insights on what works and what doesn’t. Two of my colleagues, Zidar and Zwick, have a paper documenting where most of the 1 percent income is coming from. If you go through the list, you see those are doctors, they are car dealers, they are dentists, they are financial traders. Many of them rely on a lot of restrictions in the local market. Doctors have a license, have a healthcare system that is designed to give them a large source of income. The financial industry, as I’ve written, is too big and not sufficiently competitive. You can go on a lot of sectors to realize that what is the source of the problem is not necessarily that capital grows faster than the economy. It is that there is not enough competition. He’s completely silent on these important points.
Kate: Why are those necessarily incompatible?
Luigi: I didn’t say they’re incompatible. I’m just saying that he misses the point. Out of whatever, 600 pages of book, he misses the most important point for capital in the 21st century. A book called Capital in the 21st Century? It’s kind of a big miss.
Kate: So you’re saying the reason that inequality and the concentration of wealth persists is because of monopoly power and barriers to entry and regulation that favors one group over another. I don’t think this is necessarily inconsistent with his main findings. It’s just that he doesn’t have data on that. He doesn’t have a historical time series on shifts of bargaining rights and power and monopolies. I mean, that’s not his point. He wants to focus on the data that he does have, so he just points out a historical regularity. It could be entirely true that the mechanism through which capital is concentrated is the mechanism that you’re talking about, and not necessarily just the reinvestment of your capital income. OK? So maybe you’re both right.
Luigi: I think the real reason why this book became so popular is because there is a big sense of dissatisfaction in the average American. Not so much because there are a few people very rich, like Steve Jobs, or like Steve Jobs was, but it’s because the median worker has not seen an increase in real salary in the last 40 years. So there is a sense in society that something is not working, that the system, that capitalism is not working. I think that this book came at the right time, with a message that was appealing, even if, in my view, it was the wrong message. It’s not been a message that has brought a lot of useful political debate. In fact, if you look at the latest moves by the Trump administration, they go exactly in the opposite direction. They are trying to reduce the taxation of capital. They are trying to eliminate inheritance tax. So they’re going completely in the opposite direction, suggesting that his narrative has not been very convincing.
Kate: I think that his point is that yes, exactly, when growth is high, things are better for everybody. But we can’t just rub our hands together and deliver high rates of growth, especially rates of growth that we’ve seen in China, or in the United States in the mid-20th century. We simply cannot just fabricate high growth rates. I think it’s more reasonable to think that growth rates will converge to their historical averages, which have been pretty low. If that’s going to be the case, then that means that inequality is going to get worse.
Luigi: Actually, if the historical average is even before the Industrial Revolution, I think there is a change in regime. I think that the great thing about capitalism is the fact that it creates always new incentives to innovate and grow. This was not true in the pre-capitalistic world. It was not true in the rest of the world before they became capitalists, and it is true in the Western world. You know the famous joke about economists is they look for a lost key under the light, not because they lost the key under the light, but it’s the only place where they can see. For somebody like Piketty who makes fun of the economics class in general, you’re saying basically he follows the stereotype. He looks where there are the data, even if they are completely irrelevant to today’s 21st-century America. But this is the data he has, what he can measure, so he looks at that.
Kate: I think it’s a little rich to say that the history of humanity is irrelevant to today’s 21st-century America.
Luigi: The history of the last 300 or 400 years in three countries. I understand that that’s the world for you, but—
Kate: It’s more than three—
Luigi: ... it’s not the world for most people.
Kate: Hey, he talks about Italy, too. You’re just upset that Italy isn’t featured more prominently.
Luigi: Yeah, in the period where Italy was actually more prominent, at the end of the Middle Ages—
Kate: See, now the truth is coming out.
Luigi: Yeah, absolutely.