growing inequality -- 4/25/14
Today's selection - from Capital in the Twenty-First Century by Thomas Piketty. Amid increased concern over growing inequality, a European economist has garnered global attention and stirred controversy with his recent claim that the world is entering a period of inequality similar to what existed in Europe prior to 1914. Added to that controversy is his recommendation that a progressive tax on capital is the solution. In one quote, his assessment of recent U.S. income tax cuts is that they will "eventually contribute to rebuild[ing] a class of rentiers in the U.S., whereby a small group of wealthy but untalented children controls vast segments of the U.S. economy and penniless, talented children simply can't compete....there is a decent probability that the U.S. will look like Old Europe prior to 1914 in a couple of generations." His explanation of the cause is very simply that "r > g," in other words that "when the rate of return on capital exceeds the rate of growth of output and income, as it did in the nineteenth century and seems quite likely to do again in the twenty-first, capitalism automatically generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based":
"The overall conclusion of [my] study is that a market economy based on private property, if left to itself, contains powerful forces of convergence, associated in particular with the diffusion of knowledge and skills; but it also contains powerful forces of divergence, which are potentially threatening to democratic societies and to the values of social justice on which they are based.
"The principal destabilizing force has to do with the fact that the private rate of return on capital, r, can be significantly higher for long periods of time than the rate of growth of income and output, g. The inequality r > g implies that wealth accumulated in the past grows more rapidly than output and wages. This inequality expresses a fundamental logical contradiction. The entrepreneur inevitably tends to become a rentier, more and more dominant over those who own nothing but their labor. Once constituted, capital reproduces itself faster than output increases. The past devours the future.
"The consequences for the long-term dynamics of the wealth distribution are potentially terrifying, especially when one adds that the return on capital varies directly with the size of the initial stake and that the divergence in the wealth distribution is occurring on a global scale.
"The problem is enormous, and there is no simple solution. Growth can of course be encouraged by investing in education, knowledge, and non polluting technologies. But none of these will raise the growth rate to 4 or 5 percent a year. History shows that only countries that are catching up with more advanced economies -- such as Europe during the three decades after World War II or China and other emerging countries today -- can grow at such rates. For countries at the world technological frontier -- and thus ultimately for the planet as a whole -- there is ample reason to believe that the growth rate will not exceed 1-1.5 percent in the long run, no matter what economic policies are adopted.'
"With an average return on capital of 4-5 percent, it is therefore likely that r > g will again become the norm in the twenty-first century, as it had been throughout history until the eve of World War I. In the twentieth century, it took two world wars to wipe away the past and significantly reduce the return on capital, thereby creating the illusion that the fundamental structural contradiction of capitalism (r > g) had been overcome.
"To be sure, one could tax capital income heavily enough to reduce the private return on capital to less than the growth rate. But if one did that indiscriminately and heavy-handedly, one would risk killing the motor of accumulation and thus further reducing the growth rate. Entrepreneurs would then no longer have the time to turn into rentiers, since there would be no more entrepreneurs.
"The right solution is a progressive annual tax on capital. This will make it possible to avoid an endless inegalitarian spiral while preserving competition and incentives for new instances of primitive accumulation. ... This would contain the unlimited growth of global inequality of wealth, which is currently increasing at a rate that cannot be sustained in the long run and that ought to worry even the most fervent champions of the self-regulated market. Historical experience shows, moreover, that such immense inequalities of wealth have little to do with the entrepreneurial spirit and are of no use in promoting growth. Nor are they of any 'common utility,' to borrow the nice expression from the 1789 Declaration of the Rights of Man and the Citizen with which I began this book."
|Capital in the Twenty-First Century|
|Copyright 2014 by the President and Fellows of Harvard College|