Understanding Capital in the 21st century - Part 1 (Inequality)

This blog - separated into three parts because of the sheer scale of data covered - is centred on the work of Thomas Picketty ´Capital in the 21st century´, published in April 2014, following 15 years of groundbreaking research on Capital and in total can be considered a short summary of the famous economics book focused on its relation with inequality.

Key Points

- Inequality is systematic and historically part of society, even in developed nations.

In all known societies half the population have owned little more 5 % of total wealth, whilst the wealthiest decile have owned generally between 60 and 90% of total wealth.

- There is great inequality amongst the top, most wealthy decile, with the top 1% owning on average over a quarter of the wealth.

- The middle class is a relatively modern phenomenon, and emerged only after WW2 when capital was physically destroyed as well as colonialism, and that new class began owning sizable capital, in the form of property.

- Inequality is more a class issue than a generational issue.

- The reason inequality is inevitable in capitalism and historically always existed in an extreme form, is that capital provides returns higher than average growth and therefore labour. This has led to a technocratic class.

- Nations are converging, and inequality between nations is getting less as inequality within nations increases. Developing nations mirror developed nations and are unlikely to ever catch up completely.

- Countries are accumulating a large percentage of foreign assets relative to their national income (over 50% of their national incomes) in a somewhat obscure return of colonialism.

The issue of inequality in developed countries - what the data says

Picketty sums up that inequality is prevalent in today's society and has always been, writing that ´in all known societies, at all times, the least wealthy half of the population own virtually nothing (generally little more than 5 percent of total wealth); the top decile of the wealth hierarchy own a clear majority of what there is to own (generally more than 60 percent of total wealth and sometimes as much as 90 percent); and the remainder of the population (by construction, the 40 percent in the middle) own from 5 to 35 percent of all wealth.´ Despite technological advancements and modern comforts, this feature of society is prevalent even in the developed nations. Picketty writes ´currently, in the early 2010s, the richest 10 percent own around 60 percent of national wealth in most European countries, and in particular in France, Germany, Britain, and Italy... In France, according to the latest available data (for 2010–2011), the richest 10 percent command 62 percent of total wealth, while the poorest 50 percent own only 4 percent. In the United States, the most recent survey by the Federal Reserve, which covers the same years, indicates that the top decile own 72 percent of America’s wealth, while the bottom half claim just 2 percent. Note, however, that this source, like most surveys in which wealth is self-reported, underestimates the largest fortunes. As noted, moreover, it is also important to add that we find the same concentration of wealth within each age cohort.´

Further analysing the figures, Picketty highlights that there is great inequality amongst the top, most wealthy decile, noting  ´when the upper decile claims about 60 percent of total wealth, as is the case in most European countries today, the share of the upper centile is generally around 25 percent and that of the next 9 percent of the population is about 35 percent. The members of the first group are therefore on average 25 times as rich as the average member of society, while the members of the second group are barely 4 times richer.´

Frankly put, this all makes rather grim reading; the statistics show a sharp divide between the haves and the overwhelming majority of have-nots. Whatever your political persuasion, it is safe to say the numbers are not pretty, and it is apparent that inequality seems embedded in capitalist societies.

Numbers may not hit as hard as reality, but without a doubt there must be a giant sense of shame at humanity's core that there have generally just been a replacement of a ruling class, by modern and largely-tech or oil billionaires or extremely powerful aristocratic families instead of the 'divinely appointed' monarchs and robber-barons of the past, as opposed to any tangible liberal advancement sought by leaders of the enlightenment movement in the 18th century, for the people to not be so ruled by so few.

The emergence of a middle class - a relatively novel phenomenon

However, relevant recently there have been promising improvements showing inequality is at least starting to be less stark, instigated by the devastation of the Great Depression and two World Wars, with the public policies that followed from them playing a central role in reducing inequalities in the twentieth century. Picketty notes ´the emergence of a “patrimonial middle class,” that is, an intermediate group who are distinctly wealthier than the poorer half of the population and own between a quarter and a third of national wealth. The emergence of this middle class is no doubt the most important structural transformation to affect the wealth distribution over the long run´ .

Picketty points out that there was no middle class just over a century ago, using Europe as an example, writing that in ´the decade 1900–1910: in all the countries of Europe, the concentration of capital was then much more extreme than it is today... In this period in France, Britain, and Sweden, as well as in all other countries for which we have data, the richest 10 percent owned virtually all of the nation’s wealth: the share owned by the upper decile reached 90 percent. The wealthiest 1 percent alone owned more than 50 percent of all wealth. The upper centile exceeded 60 percent in some especially inegalitarian countries, such as Britain. On the other hand, the middle 40 percent owned just over 5 percent of national wealth (between 5 and 10 percent depending on the country), which was scarcely more than the poorest 50 percent, who then as now owned less than 5 percent.´

To be clear, the middle class is far from powerful, it ´has four times as many members as the top decile yet only one-half to one-third as much wealth´ and rather shell–shockingly, the poorer half of the population are as poor today as they were in the past. Nevertheless, the emergence of a middle class nevertheless represents a significant improvement in the alocation of resources, even if inequalities in the ownership of capital remain extreme.

Picketty notes too ´the rise of a propertied middle class was accompanied by a very sharp decrease in the wealth share of the upper centile, which fell by more than half, going from more than 50 percent in Europe at the turn of the twentieth century to around 20–25 percent at the end of that century and beginning of the next. All available sources agree that these orders of magnitude—90 percent of wealth for the top decile and at least 50 percent for the top centile—were also characteristic of traditional rural societies, whether in Ancien Régime France or eighteenth-century England. Such concentration of capital is in fact a necessary condition for societies based on accumulated and inherited wealth, such as those described in the novels of Austen and Balzac, to exist and prosper.´

Moreover and somewhat surprisingly, despite the rise of superior pensions Picketty states the statistics show that inequality very much remains a class issue as opposed to a generational one, which is sometimes piped by the modern media. He summarises - ´to be sure, older individuals are certainly richer on average than younger ones. But the concentration of wealth is actually nearly as great within each age cohort as it is for the population as a whole. In other words, and contrary to a widespread belief, intergenerational warfare has not replaced class warfare.´ The implication of this finding is that inheritance will not play any kind of equality-inducing role in society despite its increased importance as the older individuals are now wealthier than older individuals were in the past.

Thus, just as the age of feudalism ended, so has the age of traditional, rural agricultural society ended and modern urban, industrialised and financialised society come about, and this is marked by the birth of a middle class and a slight decrease in the top 1%'s power. The question is where is the economy heading now, and the data shows some worrying trends.

What is capital?

This is the first question needing to be answered first though and Picketty defines it ´as the sum total of nonhuman assets that can be owned and exchanged on some market´. This includes ´all forms of real property (including residential real estate) as well as financial and professional capital plants, infrastructure, machinery, patents, and so on) used by firms and government agencies.´

Why the world economy is reversing to 18th and 19th century levels of inequality thanks to overly-high levels of capital returns (r>g)

Crucially, Picketty shows through recording countries´ capital/income ratios (denoted as β) that the world economy has been reversing since the late 20th century, somewhat back to a similar state to the world economy in the 18th and 19th century, having been transformed in the early 20th century by shocks such as the World Wars and the Great Depression, which led to the creation of the middle class.

This is primarily a result of changes to the growth rate of economies and saving rates inside them: the higher the savings rate and the lower the growth rate, the higher β.

Private savings have been growing while the growth rate of economies has been decreasing in developed and developing nations over the last decades, albeit to different extents. In short, the phrase money makes money is overly poignant in today's capitalist system (that is - private savings) and it can be added, it is clear this is not leading to overall growth but simply higher levels of inequality.

Picketty underlines how ´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.´

Picketty therefore uses a simple formula to state what is particularly provoking the current levels of inequality experienced in the capitalist societies of today to be so high and increasing : the formula : ´r > g (where r stands for the average annual rate of return on capital, including profits, dividends, interest, rents, and other income from capital, expressed as a percentage of its total value, and g stands for the rate of growth of the economy, that is, the annual increase in income or output).´ This is no doubt one of the most important economic realities there is to know, given what it implies in accordance with available historic data.

How inequality originated

Picketty emphasise that 'Economic growth was virtually nil throughout much of human history: combining demographic with economic growth, we can say that the annual growth rate from antiquity to the seventeenth century never exceeded 0.1–0.2 percent for long.

Despite the many historical uncertainties, there is no doubt that the rate of return on capital was always considerably greater than this: the central value observed over the long run is 4–5 percent a year.'

In other worlds, the world has always been organised to value capital over labour and our economies always capitalistic, long before Adam Smith verbalised what he viewed to be a viable economic capitalist system in the 16th century.

Picketty continues 'In particular, this was the return on land in most traditional agrarian societies. Even if we accept a much lower estimate of the pure yield on capital—for example, by accepting the argument that many landowners have made over the years that it is no simple matter to manage a large estate, so that this return actually reflects a just compensation for the highly skilled labor contributed by the owner—we would still be left with a minimum (and to my mind unrealistic and much too low) return on capital of at least 2–3 percent a year, which is still much greater than 0.1–0.2 percent.

Thus throughout most of human history, the inescapable fact is that the rate of return on capital was always at least 10 to 20 times greater than the rate of growth of output (and income). Indeed, this fact is to a large extent the very foundation of society itself: it is what allowed a class of owners to devote themselves to something other than their own subsistence.'

That last point is considerable, whereas before it was accepted that a privaliged minority be granted freedom from capital returns so that they could add to society, now the point stands less firm. Society has changed considerably and if honest, the middle class can admit to a certain extent that they can live like the kings of the past (in terms of being able to devote themselves to something other than their own subsistence), despite not being the beneficiaries of capital like the kings of the past. However, they are far less powerful and unable to mold society like those kings etc and the question remains, won't the economic system have to change to address this change in realities from the one it originated from. If so, now is the time for it to do so.

Picketty sums up - 'the inequality r > g has clearly been true throughout most of human history, right up to the eve of World War I, and it will probably be true again in the twenty-first century. Its truth depends, however, on the shocks to which capital is subject, as well as on what public policies and institutions are put in place to regulate the relationship between capital and labor.' Picketty further explains why he believes there have never been a society in which the 'the rate of return on capital fell naturally and persistently to less than 2–3 percent' due to there being a 'notion of “time preference”' (usually denoted θ)'...For example, if θ = 5 percent, the actor in question is prepared to sacrifice 105 euros of consumption tomorrow in order to consume an additional 100 euros today. ' This seems set as a realistic human preference and explains why the rate of return on agricultural land in traditional societies was around 4-5%, similar to real estate in today's society (3-4%).

Inequality between nations

Picketty writes that ´global inequality ranges from regions in which the per capita income is on the order of 150–250 euros per month (sub-Saharan Africa, India) to regions where it is as high as 2,500–3,000 euros per month (Western Europe, North America, Japan), that is, ten to twenty times higher. The global average, which is roughly equal to the Chinese average, is around 600–800 euros per month.´ Whilst it is obvious that inequality between nations is severe, there are many reasons for developing countries to be uplifted that this will not be so extreme in the long term. This is principally because the developed nations have experienced slower economic growth than developing nations in the past few decades.

Picketty concludes this noting that ´from 1900 to 1980, 70–80 percent of the global production of goods and services was concentrated in Europe and America, which incontestably dominated the rest of the world. By 2010, the European–American share had declined to roughly 50 percent, or approximately the same level as in 1860. In all probability, it will continue to fall and may go as low as 20–30 percent at some point in the twenty-first century. This was the level maintained up to the turn of the nineteenth century and would be consistent with the European–American share of the world’s population...

In other words, the lead that Europe and America achieved during the Industrial Revolution allowed these two regions to claim a share of global output that was two to three times greater than their share of the world’s population simply because their output per capita was two to three times greater than the global average. All signs are that this phase of divergence in per capita output is over and that we have embarked on a period of convergence. The resulting “catch-up” phenomenon is far from over, however. It is far too early to predict when it might end, especially since the possibility of economic and/or political reversals in China and elsewhere obviously cannot be ruled out.´

 The issue of inequality in developing countries - what the data says

Picketty writes that data on wealth and income distributions for developing countries tends to be sketchier and less complete. However he writes, for ´four countries—South Africa, India, Indonesia, and Argentina—we have tax data going back, respectively, to 1913, 1922, 1920, and 1932 and continuing (with gaps) to the present. Several points deserve to be emphasized. First, the most striking result is probably that the upper centile’s share of national income in poor and emerging economies is roughly the same as in the rich economies.

During the most inegalitarian phases, especially 1910–1950, the top centile took around 20 percent of national income in all four countries: 15–18 percent in India and 22–25 percent in South Africa, Indonesia, and Argentina.

During more egalitarian phases (essentially 1950–1980), the top centile’s share fell to between 6 and 12 percent (barely 5–6 percent in India, 8–9 percent in Indonesia and Argentina, and 11–12 percent in South Africa).

Thereafter, in the 1980s, the top centile’s share rebounded, and today it stands at about 15 percent of national income (12–13 percent in India and Indonesia and 16–18 percent in South Africa and Argentina).´

Picketty further writes that ´in China, the top centile’s share of national income rose rapidly over the past several decades but starting from a fairly low (almost Scandinavian) level in the mid-1980s: less than 5 percent of national income went to the top centile at that time, according to the available sources. This is not very surprising for a Communist country with a very compressed wage schedule and virtual absence of private capital.

Chinese inequality increased very rapidly following the liberalization of the economy in the 1980s and accelerated growth in the period 1990–2000, but according to my estimates, the upper centile’s share in 2000–2010 was 10–11 percent, less than in India or Indonesia (12–14 percent, roughly the same as Britain and Canada) and much lower than in South Africa or Argentina (16–18 percent, approximately the same as the United States).

Colombia on the other hand is one of the most inegalitarian societies in the WTID: the top centile’s share stood at about 20 percent of national income throughout the period 1990–2010, with no clear trend (see Figure 9.9). This level of inequality is even higher than that attained by the United States in 2000–2010, at least if capital gains are excluded; if they are included, the United States was slightly ahead of Colombia over the past decade.´

From all this data it can be inferred that developing nations mirror developed nations, and that is to no surprise as developed nations tend to politically dominate developing nations who equally are quite simply prone to copy political, social and economic trends set by developed nations.

Meanwhile these emergent economies are growing faster than developed economies as inhabitants within them get greater access to education and healthcare, becoming more skilled and generating greater output, whilst technology becomes more accessible and widely used globally, also permitting the smaller economies to catch up. They may be less innovative nations, but equally many developing nations have great natural resources and are strongly equipped to benefit from technological advances due to their rapidly improving education systems.

However, it must be said that developing nations populations are likely to never to get nearly as wealthy as the developed countries' populations in the short run and long run for two main reasons: the first being that in developing countries, the population is increasing much faster so the countries total income has to be shared between more inhabitants; and the second, above all, as capital and wealth is predominantly split amongst the developed nations, they have a very large head-start to grow their overall wealth from a bigger pot and recieve larger returns.

Is colonialism returning - are developing countries starting to be owned again by developed ones?

Picketty concludes ´the reality is that inequality with respect to capital is a far greater domestic issue than it is an international one. Inequality in the ownership of capital brings the rich and poor within each country into conflict with one another far more than it pits one country against another.

This has not always been the case, however and it is perfectly legitimate to ask whether our future may not look more like our past, particularly since certain countries—Japan, Germany, the oil-exporting countries, and to a lesser degree China—have in recent years accumulated substantial claims on the rest of the world (though by no means as large as the record claims of the colonial era)´

Picketty writes ´In the early 2010s, Japan’s net foreign assets totaled about 70 percent of national income, and Germany’s amounted to nearly 50 percent.

To be sure, these amounts are still substantially lower than the net foreign assets of Britain and France on the eve of World War I (nearly two years of national income for Britain and more than one for France).

Given the rapid pace of accumulation, however, it is natural to ask whether this will continue. To what extent will some countries find themselves owned by other countries over the course of the twenty-first century?´

Thus, whilst certainly inequality remains a huge domestic issue in all nations primarily, there remains potential for the issue to become more complicated, with an international angle perhaps soon to come to people´s attention, reminscent of the past once more.

References

Capital in the Twenty–First Century, 2014, Thomas Piketty