´In a quasi-stagnant society, wealth accumulated in the past will inevitably acquire disproportionate importance´ - Thomas Piketty
Key points
- Capitalism lately is on steroids, shown by the ratio between capital and income (β) rising staggering fast in countries. This is a result of privatisation, Neo-liberalism and financialisation; accompanied by low growth and high savings rates.
- Picketty writes ´in a quasi-stagnant society, wealth accumulated in the past will inevitably acquire disproportionate importance´. Inheritance is therefore overly important in society in today’s economy.
-Today private wealth accounts for nearly all of national wealth everywhere, especially as there is a trend for countries to have such high levels of public debt (sometimes even exceeding public assets). This domination of private wealth has not always been the case.
- In Britain and France, β has doubled in little over half a century, after the second World War
- This resembles Britain and France back in the 19th century. However after, WW1 Britain and France’s β fell by nearly two-thirds in just thirty years. In effect, economically time has been reversed since. The wars shocked the economy into change, created the middle class, but then progress was not made and the economy reverted.
- In terms of financial freedom, we are living at record unequal levels.
A huge part of 'Capital in the 21st century´ is centred on deciphering the latest historical trends of the capital-income ratio in different countries, to understand the impact of capital on the economy as a whole. The statistics show that capital is on the rise relative to growth and our society is therefore becoming more capitalistic, more privatised and less meritocratic.
Income is defined as a flow, which on a global level is equal to global output, as it corresponds to the quantity of goods produced and distributed within a given period. National income is equal to domestic output plus the net income from abroad.
On the other hand, capital is a stock, which on a global level is equal to global private wealth and global public wealth, as it corresponds with the total market value of everything owned by individuals and governments, appropriated or accumulated in all prior years combined.
Whilst national wealth comprises of both private and public wealth, today private wealth accounts for nearly all of national wealth everywhere, especially as there is a trend for countries to have such high levels of public debt (sometimes even exceeding public assets). This domination of private wealth has not always been the case.
The makings and findings of the national capital/income ratio (denoted by β)
Picketty points out that ´in the developed countries today, the capital/income ratio generally varies between 5 and 6, and the capital stock consists almost entirely of private capital. In France and Britain, Germany and Italy, the United States and Japan, national income was roughly 30,000–35,000 euros per capita in 2010, whereas total private wealth (net of debt) was typically on the order of 150,000–200,000 euros per capita, or five to six times annual national income. There are interesting variations both within Europe and around the world. For instance, β is greater than 6 in Japan and Italy and less than 5 in the United States and Germany...´
As aforementioned, this resembles the past as in ´both Britain and France, the total value of national capital fluctuated between six and seven years of national income throughout the eighteenth and nineteenth centuries, up to 1914.´ The fact that in the beginning of this century the United States has a slightly lower β than Europe also resembles the past - ´in the nineteenth and early twentieth centuries... the capital/income ratio was 6 to 7 in Europe compared with 4 to 5 in the United States´
However, what´s interesting is the contrast of β found in developed countries in the middle 20th century to the times preceeding and following this time into nowadays. In Britain and France, ´after World War I, the capital/income ratio suddenly plummeted, and it continued to fall during the Depression and World War II, to the point where national capital amounted to only two or three years of national income in the 1950s.´ Picketty sums up, ´in short, what we see over the course of the century just past is an impressive “U-shaped curve.” The capital/income ratio fell by nearly two-thirds between 1914 and 1945 and then more than doubled in the period 1945–2012....´ This U-shaped curve applies to the economies of the United States, Canada and Australia, but is a bit more prounounced in Japan and Europe.
Historically, Picketty writes that ´the rate of return on capital, r, seems to have attenuated the evolution of the quantity of capital, β: r is higher in periods when β is lower, and vice versa, which seems natural. More precisely: we find that capital’s share of income was on the order of 35–40 percent in both Britain and France in the late eighteenth century and throughout the nineteenth, before falling to 20–25 percent in the middle of the twentieth century and then rising again to 25–30 percent in the late twentieth and early twenty-first centuries (see Figures 6.1 and 6.2). This corresponds to an average rate of return on capital of around 5–6 percent in the eighteenth and nineteenth centuries, rising to 7–8 percent in the mid-twentieth century, and then falling to 4–5 percent in the late twentieth and early twenty-first centuries.´
Captial/income ratio = Saving rate / Growth rate (β = s / g)
Picketty writes ´the capital/income ratio tends over the long run toward its equilibrium level β = s / g (possibly augmented by pure natural resources), provided that the average price of assets evolves at the same rate as consumption prices over the long run... the law β = s / g describes a growth path in which all macroeconomic quantities—capital stock, income and output flows—progress at the same pace over the long run. Still, apart from the question of short-term volatility, such balanced growth does not guarantee a harmonious distribution of wealth and in no way implies the disappearance or even reduction of inequality in the ownership of capital.´
Therefore, low growth—affected by demographic growth— and high savings rate are responsible for high levels of β. Indeed, demographic growth more or less perfectly explains why America has a lower β than Europe and Japan.
Picketty explains this all mathematically: ´for a savings rate on the order of 10–12 percent and a growth rate of national income per capita on the order of 1.5–2 percent a year, it follows immediately that a country that has near-zero demographic growth and therefore a total growth rate close to 1.5–2 percent, as in Europe, can expect to accumulate a capital stock worth six to eight years of national income, whereas a country with demographic growth on the order of 1 percent a year and therefore a total growth rate of 2.5–3 percent, as in the United States, will accumulate a capital stock worth only three to four years of national income. And if the latter country tends to save a little less than the former, perhaps because its population is not aging as rapidly, this mechanism will be further reinforced as a result.´
Indeed, this is probably the case as the US has a relative low saving rate. In developed countries - ´the private savings rate generally ranges between 10 and 12 percent of national income, but it is as low as 7 to 8 percent in the United States and Britain and as high as 14–15 percent in Japan and Italy.´
Picketty sums up the neatness of this long run equation (β = s / g) citing Japan as a clear example - ´the fact that private wealth in Japan rose from three years of national income in 1970 to six in 2010 is predicted almost perfectly by the flow of savings. One particularly clear case is that of Japan: with a savings rate close to 15 percent a year and a growth rate barely above 2 percent, it is hardly surprising that Japan has over the long run accumulated a capital stock worth six to seven years of national income. In Italy, private capital rose from 240 percent to 680 percent of national income between 1970 and 2010, while public capital dropped from 20 percent to −70 percent.´
Picketty pertinantly comments that given the demographic situation, ´the US case is in some sense not generalizable (because it is unlikely that the population of the world will increase a hundredfold over the next two centuries) and that the French case is more typical and more pertinent for understanding the future.´ He writes ´I am convinced that detailed analysis of the French case, and more generally of the various historical trajectories observed in other developed countries in Europe, Japan, North America, and Oceania, can tell us a great deal about the future dynamics of global wealth, including such emergent economies as China, Brazil, and India, where demographic and economic growth will undoubtedly slow in the future (as they have done already).´
All in all, it appears the slowing of the growth rate of the economy and the rise in private savings has been central in the resurgance of capital and widening inequality levels in developed countries in the latter part of the 20th century. It is likely developing countries will follow suit. As Picketty puts it ´in a quasi-stagnant society, wealth accumulated in the past will inevitably acquire disproportionate importance´.
What explains capital´s importance, and its 20th century fall and resurgence?
Picketty writes that´over the very long run, agricultural land has gradually been replaced by buildings, business capital, and financial capital invested in firms and government organizations. Yet the overall value of capital, measured in years of national income, has not really changed.´ This is quietly quite remarkable, and will be more so if this continues now the effects of capital valuation in an economy is better understood. Previously so important, ´agriculture in the eighteenth century accounted for nearly three-quarters of all economic activity and employment, compared with just a few percent today´.
However, the statistics show that ´this collapse in the value of farmland (proportionate to national income and national capital) was counterbalanced on the one hand by a rise in the value of housing, which rose from barely one year of national income in the eighteenth century to more than three years today, and on the other hand by an increase in the value of other domestic capital, which rose by roughly the same amount (actually slightly less, from 1.5 years of national income in the eighteenth century to a little less than 3 years today)´. Therefore, thanks to greater valuation of housing and other domestic capital, the overall value of capital has hardly changed despite advancements made in the agricultural industry and its fall in importance in everyday people´s lives.
However, this paints an incomplete picture, because there have been great shocks to capital over the last century, principally the cataclysms of two world wars and the great depression, and these shocks significantly led to greater equality levels. There was clearly tremendous physical destruction in Europe caused by the wars, and whilst Britain suffered less physical destruction than say France or Germany, the British empire was dismantled at this time and Briftish net foreign capital dropped from two years of national income on the eve of World War I to a slightly negative level in the 1950s. The wealthy in Europe, so accustommed to a certain standard of living, in most cases were forced to sell off part of their capital to mantain their lifestyles, as their income dwindeled in this period with foreign portfolios collapsing, and this symbolised a very low savings rate characteristic of the time. The great depression of the 1930s had bankrupted thousands of businesses and banks; wiped out millions of savings accounts and saw incomes plummet, particularly across the sea in America where it originated.
The great depression especially affected the most afluent: ´Most of the income of “the 1 percent” came in the form of income from capital, especially interest and dividends paid by the firms whose stocks and bonds made up the assets of this group. That is why the top centile’s share plummeted during the Depression, as the economy collapsed, profits fell, and firm after firm went bankrupt.´ This contributed to the ´sharp reduction in income inequality in the United States between 1913 and 1948. More specifically, at the beginning of this period, the upper decile of the income distribution (that is, the top 10 percent of US earners) claimed 45–50 percent of annual national income. By the late 1940s, the share of the top decile had decreased to roughly 30–35 percent of national income. This decrease of nearly 10 percentage points was considerable: for example, it was equal to half the income of the poorest 50 percent of Americans. The reduction of inequality was clear and incontrovertible.´
In France and Germany following the World Wars savers that lent massively to their governments lost out as they were only ultimately expropiated by inflation. High inflation meant people saved less and consumed more quickly, further reducing inequality levels in a chaotic manner. To combat inflation, rent control policies were adopted throughough the world, and this reduced real estate prices. New policies of financial regulation were also adopted worldwide that reduced stockholders´ power and share prices, already hugely shaken by the loss of confidence in the aftermath of the Depression and by the common nationalisations of industries across the developed world. Picketty emphasises that ´real estate values and stocks fell to historically low levels in the 1950s and 1960s relative to the price of goods and services, and this goes some way toward explaining the low capital/income ratio.´
Capital returned with a bang in the 1970s, 1980s and 1990s as ´financialisation´ of the global economy took place and a conservative revolution led by the likes of Margaret Thatch and Ronald Reagan took place, with great emphasis placed on owning property and free markets. Picketty points out - ´inequality began to rise sharply again since the 1970s and 1980s, albeit with significant variation between countries, again suggesting that institutional and political differences played a key role.´ Take Scandenavian countries as an example. Overall, financial globalisation and deregulation had a huge effect in returning capital´s importance to its previous levels, with American and British political and academic movements leading the way for Capital´s comeback.
By far the simplest way to understand why inequality has risen so much in developed countries in the last fifty years, as shown in part 1 of this blog, is to recognise that this coincides with the fact that ´capital income absorbed between 15 percent and 25 percent of national income in rich countries in 1970, and between 25 percent and 30 percent in 2000–2010.´ Capital´s importance returned with a bang, and at the same time the distribution of income from labour came to more and more resemble that of capital´s income distribution, so so did overall income inequality unwelcomely return.
Does the modern tax system mean we are living in the most inegalitarian society ever recorded?
Picketty notes ´in most countries, the total amount of financial assets and liabilities in the early 1970s did not exceed four to five years of national income. By 2010, this amount had increased to ten to fifteen years of national income (in the United States, Japan, Germany, and France in particular) and to twenty years of national income in Britain, which set an absolute historical record. This reflects the unprecedented development of cross-investments involving financial and nonfinancial corporations in the same country (and, in particular, a significant inflation of bank balance sheets, completely out of proportion with the growth of the banks’ own capital), as well as cross-investments between countries.. much more prevalent in European countries, led by Britain, Germany, and France.´ Thus, the total amount of financial assets and liabilities held by households, corporations and government agencies increased much more rapidly than net wealth.
Appertaining to β, it´s insightful to contemplate that ´capital/income ratio would have attained even higher levels—no doubt the highest ever recorded—in the rich countries in the 2000s and 2010s if (Picketty) had expressed total private wealth in terms of years of disposable income rather than national income...
To go from national income to disposable income, one must deduct all taxes, fees, and other obligatory payments and add all monetary transfers (pensions, unemployment insurance, aid to families, welfare payments, etc.). Until the turn of the twentieth century, governments played a limited role in social and economic life (total tax payments were on the order of 10 percent of national income, which went essentially to pay for traditional state functions such as police, army, courts, highways, and so on, so that disposable income was generally around 90 percent of national income).
The state’s role increased considerably over the course of the twentieth century, so that disposable income today amounts to around 70–80 percent of national income in the rich countries. As a result, total private wealth expressed in years of disposable income (rather than national income) is significantly higher.´ Arguably this shows that inequality is as high as ever before and that the poor are as poor as ever before, although this is simplistic given taxes raised have allowed the poor in many, but not all, developed countries to enjoy access to decent education and medical services. Yet, in terms of financial freedom, there is no doubt we are at record unequal levels.
References
Capital in the Twenty–First Century, 2014, Thomas Piketty
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