Written by Keith Quincy   

Piketty’s book is a hard read. There is considerable mathematics, followed by a flood of statistics. I suspect few have read further than the initial chapters, deciding that, whatever gems might follow, digging them up is not worth the effort. This is a pity, for the book contains important discoveries. In what follows, I will try to distill the book’s essentials.



PIKETTY IS NOT A MARXIST
Piketty is no Marxist. He embraces capitalism as the only workable economic system. He is not against high incomes: if all incomes were equal, there would be no incentive to excel. Nor is Piketty an enemy of capital: we need capital (property, factories, equipment, patents, and stocks and bonds) for the simple reason that it is the victual on which the economy feeds.

There is a problem, however, when capital become highly concentrated. This is when its share of national income skyrockets, leaving less for the rest of us; especially those in the middle and upper-middle classes. In short, a rising tide no longer lifts all boats. It sinks the fleet.

For those who worship free markets as the cure-all for every conceivable problem, Piketty has a disturbing message. The growing inequality in wealth and income is not an aberration of free markets. It is the natural tendency of capitalism. It is how free markets work.

Piketty is not the first capitalist economist to warn that, in the long run, free markets tend to have very bad results. Writing in 1817, David Ricardo, whose day job was a wealthy stockbroker, was the first to reveal this curious result.

A few decades later, John Stuart Mill, a top executive the East India Company, the largest corporation to ever exist, arrived at a similar conclusion in his Principles of Political Economy—the standard text for generations of Cambridge and Oxford students.

Not to be outdone, the American economist, Henry George, took up the baton with his 1879 book Progress and Poverty. With sales of more than three million books, it is the most popular economics text ever written. And George’s message? Free markets eventually create mass poverty.


CONCENTRATION OF INCOME AND CAPITAL
How do things stand in America today? By Piketty’s calculations, the top 10 percent get half of all income and own more than two-thirds of all private wealth. By 2030, the momentum of this trend will deliver sixty percent of income to the top decile; and the bottom fifty percent will be forced to survive on a measly 15 percent. One can only imagine the fate of small businesses when their customers can spend so little.

An additional concern is that most of this wealth is inherited rather than earned. Presently, inherited wealth accounts for 70 percent of all private capital. By 2030, this could rise to 80 percent, making America a haven for the idle rich.


WHY SO MUCH CONCENTRATION?
What is the force that drives all of this? According to Piketty, the crucial factor is the difference between the rate of return on capital (r) and the GDP growth rate (g). When the gap between r and g is small, capital earns less and concentration slows or declines. When the gap is large, those with wealth receive a larger share of national income. This gives them extra income to purchase even more capital. Capital concentration increases.


THE IMPORTANCE OF ECONOMIC GROWTH
For most of recorded history, economic growth has been negligible. It is why wealth was always in the hands of a very few, creating a panorama of inflated opulence astride mass poverty.

It was not until technology increased productivity that things changed. The sudden spurt of economic growth narrowed the gap between r and g, and the share of national income going to the wealthy fell, leaving more for everyone else. This is the point in history when a rising tide lifted all boats.

Indeed, if g is large enough, the trend of increasing capital concentration can be reversed. Such is the power of economic growth.


So, there is a way out. The bad news is that since the 1980s, the GDP growth rates of developed economies (Europe, US, and Japan) have fallen. Why?

There are two elements of economic growth: (1) improved technology, and (2) population growth.

Historically, population growth accounts for half of the total. Yet, population growth has plummeted in the developed economies (U.S., Europe, and Japan). The populations of Europe and Japan are nearly static. The U.S. fares only slightly better—not because of internal growth but from immigration.

What about the first element of growth—technology? Would a breakthrough in new technology, or the discovery of truly cheap energy, help. Of course it would. But it is impossible to predict when this will occur. It is like waiting for a miracle.

Only America appears to be in a position to rapidly increase growth—not through technology but with population. Unlike Europe and Japan, we can expand our population almost overnight. While Europe and Japan are famously xenophobic, America has a long tradition of immigration. By opening our borders, we can quickly increase our population.

To be sure, most of the newcomers will swell the ranks of the least skilled, and be the lowest paid. Yet, each immigrant will produce something. And each will require services: more teachers, hospital staff, police, etc. In sum, increased immigration creates additional jobs, from the lowest levels on up. The economy will produce more than before. It will grow. Just as important, the gap between r and g will be smaller.


A POLITICAL REMEDY
Perhaps America has room to maneuver, but Piketty worries about the rest of the world. He projects that the economic growth rate worldwide will eventually settle at a rate of 1% to 1.5%. At this low rate, the concentration of income and capital will continue to rise. Eventually, the majority will be poor, and a tiny minority will be incredibly wealthy.

Piketty suggests politics may be our only hope. What is needed is a steeply progressive income tax on all forms of income, including capital gains. If the wealthy earn less (after taxes) from their investments, the rate of return (r) on capital falls. This will narrow the gap between r and g. Concentration will be slowed or reversed.

How high should these taxes be? Piketty recommends a top rate of 80 percent on all income over, say, $500,000, or $1 million. In the past, America, Europe, and Japan had steeply progressive income taxes. In fact, America’s top rate was once 94 percent—higher than Piketty recommends. A steeply progressive income tax is neither radical nor new.

On the other hand, Piketty breaks new ground by also recommending a tax on capital. The rate he suggests is not high—somewhere between one and two percent. Even so, by nibbling away at capital, year after year, concentration will be reduced. Politically, this is the most direct route to shrinking large fortunes. It also increases the slice of the national income pie that goes to the middle class. This will provide the middle class with the extra income that can be used to purchase capital. More people will be able to afford a home (the principal source of middle class wealth), and own stocks and bonds. And more small entrepreneurs will acquire wealth. Remember, Piketty is not against wealth. He simply prefers more owners, not less. After all, this is what makes upward mobility real, rather than a myth.

Piketty is honest. There are problems with a tax on capital. Fearing capital flight, no nation would dare embrace it. Only if many nations joined together to apply a uniform tax on capital could any one nation be persuaded to try. And such cooperation seems doubtful.

These leaves Piketty’s income tax as the only possible solution. This might happen in Japan and Europe, but what is the chance such a tax will become the law in America? Certainly not high in the present political environment.


THE DISASTER CURE
There is another force that can reverse capital concentration, and Piketty covers the topic in some detail. Though he does not recommend it as a remedy. The reason for this will soon become clear.

In America, the years of shared prosperity following the Second World War was made possible by a destruction of capital so severe it nearly finished off the nation’s wealthy elite. Great fortunes disappeared in the bonfire of the ’29 crash, languished during the Great Depression, and were denied a comeback by the creation of a steeply progressive income tax needed to finance the wars against Japan and Germany.

With capital reduced, and no longer concentrated, the vast majority, instead of a limited few, received the lion’s share of the national income. All of a sudden, many Americans earned enough to purchase capital, whether in the form of a home, small business, or stocks and bonds. Capital had become democratized.

Piketty is no monster. Great wars and depressions are not what we should long for. Yet, it is ironic that, by Piketty’s own assessment, it is the force that tamed capital in America and nudged free markets onto the right track.



OBSERVATIONS
It should come as no surprise that Piketty has been attacked by free market enthusiasts. But his book also has implications that might evoke criticism from both the right and left.

Take Piketty’s enthusiasm for population growth. This will not endear him to zero-population growth advocates. Moreover, the importance he attaches to immigration must displease both Republicans and Democrats. The Republican majority in the House is firmly opposed to increased immigration, both legal and illegal. As for the Democrats, is it mere coincidence that the economy did not rebound after Obama mounted a crackdown on illegal immigrants? If immigration is as important as Piketty argues, both parties are making matters worse.

Nor will Reagan’s admirers warm to Piketty’s claim that it is no coincidence that the concentration of income and capital worsened after Reagan launched his campaign to lower taxes on the wealthy. By lowering taxes on the very rich, the return on capital increased, and with it the concentration of income and capital.


CONCLUSION
Perhaps Piketty’s income tax will have its day. If not in America, possibly in Europe or Japan. But I would suggest that the book’s real influence will be ideological, not practical. Piketty has severely wounded neoliberalism. More free markets are not the solution, they are the problem. Furthermore, if we cannot count on economic growth, the only thing that will save us is politics.