Thomas Piketty's 700-page tome on world income distribution has landed with a resounding thud in the middle of the already noisy debate on income distribution, to unanimous praise. Paul Krugman says: 'Piketty has transformed our economic discourse; we'll never talk about wealth and inequality the same way we used to.' The Financial Times' Martin Wolf calls it 'an extraordinarily important book.' World Bank Chief Economist Branko Milanovic (who had a head start by reading the French version, published last year) said 'we are in the presence of one of the watershed books in economic thinking'.
There was already wide agreement that income distribution has become much worse in most countries (both advanced and emerging) over the past three or four decades. In America, the top 1% of the income distribution pyramid has had a three-fold increase in income since 1979 while the average worker has had essentially no increase in real (inflation adjusted) income. Piketty's data tell the same story: the richest 1% own one-third of total wealth and get more than 20% of total income. And it's getting worse: they 'appropriated 60% of the increase in US national income between 1977 and 2007.' This link has some excellent graphs, including some Australian data.
What has Piketty added to the debate? First, rather than focusing just on income, he tells a story about wealth (his book is titled Capital in the Twenty-first Century, with a knowing wink at Karl Marx).
Second, he mines an often forgotten source of data: taxation records. This has the advantage of providing extended data series, giving his story broad historic sweep. The U-shaped arc of income distribution over the past century or so has gone from the grossly unequal distribution of the 19th century, through the shift towards greater equality in the 60 years to about 1975, followed by a reversion to inequality since then. He presents these data as readily comprehensible graphs focusing on what happened to the very rich over time, not the usual (and usually incomprehensible) Gini coefficients.
Unrepeatable circumstances (two world wars, a depression, bouts of sudden inflation, nationalisations, the end of colonies) eroded established wealth for a good part of the 20th century. By 1975 the share of the top 1% had been halved. But after 30 atypical years of redistributive actions following World War II (progressive tax regimes; expanded social security), the political environment changed. The incentive-destroying side-effects of nanny state socialism, high marginal tax rates and government-owned enterprise became more apparent. Margaret Thatcher and Ronald Regan orchestrated the conservative revolution which enfeebled progressive taxation and set up the economy for the 'greed is good' era. Incomes returned to the skewed distribution of a century earlier. The Gilded Age returned. [fold]
Piketty enlivens his story by seeing this as a return to the world of Balzac and Jane Austen, where the principal objective of the wealthy was to entrench their position. If you weren't born to wealth, your effort should be directed at worming your way into the wealthy elite, probably through a good marriage. Hard work had little place in this effort.
The third enticing element of Piketty's story is the analytical apparatus (the 'model') he builds to explain this evolution. At the heart of the narrative is the idea that wealth is self-perpetuating. If the return on capital is greater than the growth of the economy, those who own the wealth will get a larger share of GDP over time (provided they don't spent too much on high living). This process has no self-limiting equilibrium.
There is room for disagreement about this key element of Piketty's story.
First, the distribution of wealth, while hugely unequal, is arguably not as extreme as in the 19th century. Nor do its most prominent examples (Russian oligarchs and Middle East potentates in London) neatly fit the Piketty narrative.
More important, inherited wealth (Piketty's 'patrimonial' wealth) may still be the major component of wealth in Europe, but not in America. Lists of the US super-rich are dominated by two quite different types of wealth. One category obtained its status because of some natural talent. Technology has encouraged a winner-takes-all distribution among sports stars and entertainers: we only want to watch the very best singers and sports teams. Roger Federer and Mick Jagger are rich beyond the dreams of avarice, but not because of patrimonial wealth.
An overlapping but separate wealth category covers 'super-managers', including just about everyone in the financial sector. Many in this group see themselves as similar to the winner-takes-all superstars, having unique attributes which deserve to be recompensed grandly. But a more objective judgment would see their eye popping salaries (which have increased ten-fold as multiples of the ordinary worker's wage) as being a product of an institutional system which, unlike sport, does not subject its recipients to testing which continuously weeds out all but the most outstanding few. There are businesspeople (Steve Jobs, Bill Gates, Warren Buffett) who are closer to the superstar category, but many are simple journeymen who have relied as much on luck as on talent.
In short, the super-wealthy are not a homogenous group. Moreover, nature has an opposing model of its own. Just about every language has an equivalent to the 'clogs to clogs in three generations' dictum.
This is not the only place where Piketty is open to dispute. His 'model' of dynamic wealth perpetuation relies on the return to capital exceeding GDP growth. A plausible alternative argument suggests that as capital becomes more abundant, its return falls. Former Fed Chairman Ben Bernanke has long argued that for the past decade there has been a global glut of saving, driving down global interest rates. The post-2008 low-interest returns may well be the new normal, making life tougher for coupon clipping rentiers. For Japanese bondholders, the last few decades have been pretty thin.
Then there are plausible alternative explanations. There is a large literature on how globalisation has driven down wage incomes in advanced countries as China became manufacturer to the world. An alternative explanation is that technology was unhelpful to the workers, replacing their jobs with machines. Then there is the argument that technology has run its course and the future of capital accumulation (as well as growth) is bleak. None of this refutes the Piketty hypothesis that the rich have done well, but it provides alternative causation.
Related to this, the whole idea of 'capital' has become more complex since Jane Austen's day. There are certainly still huge physical enterprises (the resources sector provides spectacular examples), but a lot of capital is now ephemeral — intellectual property rights, brand names, unique skill sets and reputation — which enable its owners to obtain income without any conventional physical capital. The 'capital' that generates income for the superstars is transient and non-transferable. Even physical capital can spectacularly shift in value. Australia's wealthy class in the 19th century was predominantly agricultural, but shifting terms of trade radically changed their ranking.
What can be done? Because Piketty's model has capital at its centre, his key suggestion is to impose a progressive tax on wealth. It wouldn't have to be large but it would have to be near universal, to avoid the wealth owners shifting to low tax domains. Implementation would be hard but may be technically more feasible than Piketty suggests. Even mobile wealth (financial wealth) seems less secret these days, with Switzerland gradually divulging more information on its wealth management industries. There is still a long way to go (Luxembourg and Singapore seem only too ready to take over from Switzerland), but the OECD is chipping away at this, working towards near universal transparency.
To the extent that wealth is physical (eg. land), there seems no technical grounds to prevent effective taxation. The problem, of course, is political. The astonishing success of the Australian mining industry in emasculating the proposed resource rent tax might be grounds for deep pessimism, but when the Australian people realise that they themselves will have to pay significantly more tax if the miners don't pay a fair share, then there might be pressure to revisit this issue.
Closer examination of the true nature of capital will reveal more opportunities for wealth-modifying policy. Much capital is protected from competitive erosion by government rules and regulations. Intellectual property is an obvious example. The extension of the Disney copyright through the US 'Mickey Mouse Act' increased the value of some capital which otherwise would have soon become worthless. Similarly, governments create capital when they offer licenses and leases. Mexican entrepreneur Carlos Slim has risen to the very top of global wealth lists by exploiting a government-created telecommunications monopoly. We see many examples, even in Australia, where great wealth is the direct product of government largess, in the form of exclusive franchises and legally-enforced professional standards. All this rent seeking can be reduced if the political will exists.
In business, institutional arrangements for setting corporate salaries could be changed. Provided all corporate salaries come down roughly equally, few will resign: it's relativities that matter, not absolute salary levels. Michael Lewis' Flash Boys has demonstrated that part of the finance sector could disappear entirely (in this case, high frequency trading) with no loss, freeing up valuable resources to do something less well-remunerated but more useful to society.
The most socially divisive element in the Piketty story is the huge importance of inherited wealth. The key to softening the sharp edges of income distribution will be to limit the passing of wealth to the next generation. Inheritance taxes used to be effective, but any powerful tax creates equally powerful incentives for avoidance. Policy could aim to ensure, through universal high-standard education and active social mobility measures, that the very rich don't 'pull up the ladder' to exclude outsiders, and that their wealth is constantly subject to challenge from those wanting to displace them.
This is commentary on a rich and diverse narrative, rather than criticism of Piketty. He has added new dimensions and evidence to the debate. Above all, he tells us, loudly, that efforts to address these income distribution issues are bounded by politics, not technical economics. No one thinks capitalism will expire along the lines foreseen by Marx. It is unlikely that the people will rise up in righteous anger to correct the problems — the 'Occupy Wall Street' protest was inchoate and petered out. But if there are few who are rich and many who have been squeezed, the democratic process will eventually respond.
