Book review: Capital in the 21st Century by Thomas Piketty

February 6, 2016
Source: Jerome Kuseh
Book review: Capital in the 21st Century by Thomas Piketty

Thomas Piketty is a French economist and professor whose book, Capital in the 21st Century, published in French in 2013 and English in 2014, became an international bestseller. Piketty presents the most extensive review of wealth distribution ever attempted. Drawing from history and literature, he shows that the wealth of the world from antiquity has mostly been concentrated in the top centile (1%).

It started from the concentration of agricultural land in the era of low demographic and economic growth and with non-existent inflation. That is from antiquity to the 18th century. But now capital has transformed into industrial and financial capital. Yet the concentration of wealth has only changed due to the two world wars, the Great Depression and the fiscal policies that followed after that. The form capital takes does not matter, the concentration eventually tilts to about 60-70% owned by the top centile.

This is so because the rate of return on capital r, is greater than demographic and economic growth rate g. He suggests that the average historical rate of return of capital has been 4-5% while growth rate has been around 1%. To make things worse, higher capital has higher returns and even a few percentage point difference leads to a huge disparity over time due to the effect of compound interest.

For many developed countries, the total stock of private capital is between 4-7 times the value of national income. Public capital is almost zero because it is equal to public debt (which for developed countries could easily be cleared by taxing private capital). Demographic and economic growth has slowed in developed countries and Piketty expects those of developing countries to also slow as they catch up with the living standards of the developing countries.

Laws of Capitalism

The first fundamental law of capitalism is α=r x β, where α is the share of capital in national income, r is the rate of return on capital and β is the capital/income ratio. This is an accounting identity, so it is true always. The second fundamental law of capitalism is β = s / g, where s is the savings rate, g is the growth rate and β once again is the capital/income ratio. The second law is only true over very long periods.

So what does all this mean? It means that when the rate of savings exceeds the rate of growth (as is happening) then the total value of capital keeps growing bigger in relation to the total national income. And as this becomes bigger (looking at β in the first equation) then α, the share of capital in national income, becomes larger.

r > g

The expression r > g means the rate at which capital accumulates is greater than the rate of growth (economic and demographic) and from the laws of capitalism above, it means the share of national income going to owners of capital rises.

In simple terms, if the economy and population were growing rapidly, then existing capital will become less important because it will form a decreasing proportion of the total income. But if growth slows then the importance of capital as a share of total income becomes greater.

For example, if one were to leave GH¢1,000 to an heir in an economy of GH¢1 million, the heir would be worth 0.1% of the national income. Now if r is 5% and g is 1% then in 30 years’ time the heir’s fortune would be worth GH¢4,321.94 and the economy would be worth GH¢1,347,848.92. The heir’s fortune would now be 0.3% of national income. So imagine the effect of these diverging r and g values over centuries. (Ownership moves from 0.1% to a whopping 4.61% in a hundred years).

Capitalism versus Democracy

Piketty presents the fight against the obscene concentration of wealth as a fight to save democracy. One can imagine that a world in which only a few people own all the wealth will certainly not provide people with equal rights. Very few people would have control over virtually every policy. And one can also understand the potential for violence in such a situation. By looking at the long-term evolution of capital Piketty has managed mostly not to be bogged down by ideology and has stayed focused on finding the solution to prevent a total return to the era when only very few owned everything and the majority owned nothing.

Global Tax on Capital

In order to rein in capitalism from creating this inequality, Piketty proposes a global progressive tax on capital. The tax will involve a high level of co-operation among countries, as they would be required to share bank and other details with each other. The purposes of this tax would be to prevent the tax evasion and avoidance which is robbing governments of revenue, to reduce r in order to reduce its divergence from g and finally to promote transparency in wealth distribution so that democratic arguments on policies on capital would have a valid basis.

More thoughts 

Piketty’s book is clearly one of the most important economic books ever written. Its release was met with very positive and very negative reactions depending on ideology. Yet few will deny that the extensiveness of the research and the depth of the analysis is worthy of praise.

With this book Piketty not only established inequality as the central problem for economics but has provided as with the evolution of inequality and has suggested a way to control it. His drawing on other social sciences presents an encompassing analysis of inequality and gives a relatable understanding of its causes and impact.

To me the book reads like a more extensive and better researched and argued version of Paul Krugman’s The Conscience of a Liberal. Political economics books such as these present a rough guide through which to review political and economic events, policies and actions. There’s no doubt that I have learnt a whole lot from this books 685 pages and I am sure that it will have some impact on anyone who reads it.