Capital in the 21st century - Further Analysis (Part 3 - The Capital-Labour Split)

What part 1 and 2 of this blog showed was that broadly speaking, the rate of the returns on capital and on growth determine the shape and trend of global inequality levels depending on how much they coincide or diverge. However, on a subtler but equally transparent (data-backed) level, so does the structure of an economy, regarding whether wealth is mostly generated through income from labour or through income from investments within it, have massive implications on the levels of inequality an economy holds, with the possible exception of the United States most recently - a country with a troubling new trend.

Key points

- Inequality from labour is separate to inequality from capital, as components of income inequality.

- Labour income inequality is historically much smaller than capital income inequality - ‘the upper 10 percent of the labor income distribution generally receives 25–30 percent of total labor income, whereas the top 10 percent of the capital income distribution always owns more than 50 percent of all wealth (and in some societies as much as 90 percent).’

- More pertinently, ‘the bottom 50 percent of the wage distribution always receives a significant share of total labor income (generally between one-quarter and one-third, or approximately as much as the top 10 percent), whereas the bottom 50 percent of the wealth distribution owns nothing at all, or almost nothing.’

- Therefore, the more labour based the economy, the greater the equality of that society would normally be. Substituting labour for capital leads to greater inequality, and therefore technology poses a great risk to society.

- Developed countries differ. In Scandinavian countries, ‘between 1970 and 1990, the top 10 percent of earners receive about 20 percent of total wages and the bottom 50 percent about 35 percent’. Whilst, in ‘the United States in the early 2010s (where, as will emerge later, income from labor is about as unequally distributed as has ever been observed anywhere), the top decile gets 35 percent of the total, whereas the bottom half gets only 25 percent. In other words, the equilibrium between the two groups is almost completely reversed.’

- Britain, like the US, has seen an explosion in increased labour inequality over the last 15 years.

- ‘Only since the end of the twentieth century have (Economists) had the statistical data and above all the indispensable historical distance to correctly analyze the long-run dynamics of the capital/income ratio and the capital-labor split.´ Now there are no excuses not to listen to modern economists regarding inequality.

How the structure of an economy, derived from the proportion of income received from capital and labour, explains inequality levels

Picketty explains that income inequality contains two components: inequality of income from labor and inequality of income from capital. From the historical records he infers -'The first regularity we observe when we try to measure income inequality in practice is that inequality with respect to capital is always greater than inequality with respect to labor. The distribution of capital ownership (and of income from capital) is always more concentrated than the distribution of income from labor. Two points need to be clarified at once. First, we find this regularity in all countries in all periods for which data are available, without exception, and the magnitude of the phenomenon is always quite striking. To give a preliminary idea of the order of magnitude in question, the upper 10 percent of the labor income distribution generally receives 25–30 percent of total labor income, whereas the top 10 percent of the capital income distribution always owns more than 50 percent of all wealth (and in some societies as much as 90 percent).

Even more strikingly, perhaps, the bottom 50 percent of the wage distribution always receives a significant share of total labor income (generally between one-quarter and one-third, or approximately as much as the top 10 percent), whereas the bottom 50 percent of the wealth distribution owns nothing at all, or almost nothing (always less than 10 percent and generally less than 5 percent of total wealth, or one-tenth as much as the wealthiest 10 percent).

Inequalities with respect to labor usually seem mild, moderate, and almost reasonable (to the extent that inequality can be reasonable—this point should not be overstated). In comparison, inequalities with respect to capital are always extreme.´

This shows that the greater percentage worth of capital and the higher its returns relative to labours returns and the overall income/output within an economy, the higher the levels of inequalities that economy will produce. Thus, the relevance of the makings and findings of the national capital/income ratios in different countries is apparent.

Is labour´s share of income growing?

The promising news is that in this age of technology, better health and better education, the importance of labour has never been higher. Picketty writes ´it seems plausible to interpret in this way the decrease in capital’s share of income over the very long run, from 35–40 percent in 1800–1810 to 25–30 percent in 2000–2010, with a corresponding increase in labor’s share from 60–65 percent to 70–75 percent. Labor’s share increased simply because labor became more important in the production process. Thus it was the growing power of human capital that made it possible to decrease the share of income going to land, buildings, and financial capital.´

There is however discouraging news from two angles relative to the proportion of income being derived from capital and from labour today, that need to be shared. First, this may be reversed. Picketty writes ´an important characteristic of contemporary economies is the existence of many opportunities to substitute capital for labor. It is interesting that this was not at all the case in traditional economies based on agriculture, where capital existed mainly in the form of land. The available historical data suggest very clearly that the elasticity of substitution was significantly less than one in traditional agricultural societies

The relevant question is whether the elasticity of substitution between labor and capital is greater or less than one. If the elasticity lies between zero and one, then an increase in the capital/income ratio β leads to a decrease in the marginal productivity of capital large enough that the capital share α = r × β decreases (assuming that the return on capital is determined by its marginal productivity). If the elasticity is greater than one, an increase in the capital/income ratio β leads instead to a drop in the marginal productivity of capital, so that the capital share α = r × β increases (again assuming that the return on capital is equal to its marginal productivity).´

Whilst before, an increase in  β led to a significant drop in the return on capital, Picketty stresses ´modern technology still uses a great deal of capital, and even more important, because capital has many uses, one can accumulate enormous amounts of it without reducing its return to zero. Under these conditions, there is no reason why capital’s share must decrease over the very long run, even if technology changes in a way that is relatively favorable to labor.´

It is predicted that now ´the predictable rise in the capital/income ratio will not necessarily lead to a significant drop in the return on capital. There are many uses for capital over the very long run, and this fact can be captured by noting that the long-run elasticity of substitution of capital for labor is probably greater than one. The most likely outcome is thus that the decrease in the rate of return will be smaller than the increase in the capital/income ratio, so that capital’s share will increase. With a capital/income ratio of seven to eight years and a rate of return on capital of 4–5 percent, capital’s share of global income could amount to 30 or 40 percent, a level close to that observed in the eighteenth and nineteenth centuries, and it might rise even higher.´

Thus to conclude, along with the emergence of a middle class, labour has in the long run become more important to the economy relative to capital, but capital's comback in the later part of the 21st centrury plausibly will continue and the return from increased investment in capital likely will remain high, and this threatens to completely reverse the capital–labour split back to where it was. However, this is far from set in stone, after all 'an important characteristic of contemporary economies is the existence of many opportunities to substitute capital for labor. It is interesting that this was not at all the case in traditional economies based on agriculture, where capital existed mainly in the form of land.´

Is labour inequality rising? Comparing the US to Scandinavia.

The second point for economists to grapple with is whether the capital–labour split (or capital–labour income ratio) is losing its relavance due to the fact that the distribution of income from labour is becoming as unequal as the distribution of income from capital in modern capitalism. This is not the case now but trends in the US show this may be in the future.

Picketty writes 'in countries where income from labor is most equally distributed, such as the Scandinavian countries between 1970 and 1990, the top 10 percent of earners receive about 20 percent of total wages and the bottom 50 percent about 35 percent. In countries where wage inequality is average, including most European countries (such as France and Germany) today, the first group claims 25–30 percent of total wages, and the second around 30 percent. And in the most inegalitarian countries, such as the United States in the early 2010s (where, as will emerge later, income from labor is about as unequally distributed as has ever been observed anywhere), the top decile gets 35 percent of the total, whereas the bottom half gets only 25 percent. In other words, the equilibrium between the two groups is almost completely reversed. In the most egalitarian countries, the bottom 50 percent receive nearly twice as much total income as the top 10 percent (which some will say is still too little, since the former group is five times as large as the latter), whereas in the most inegalitarian countries the bottom 50 percent receive one-third less than the top group. If the growing concentration of income from labor that has been observed in the United States over the last few decades were to continue, the bottom 50 percent could earn just half as much in total compensation as the top 10 percent by 2030.´

The fact that the developed countries in Scandinavia as late the 1980s could hold such different wage distribution averages to the developed country of the United States in 2010 shows how significant factors such as government policies can make to their nation´s population. Picketty emphasises this, writing that ´for the least-favored half of the population, the difference between the two income distributions is therefore far from negligible: if a person earns 1,400 euros a month instead of 1,000—40 percent additional income—even leaving taxes and transfers aside, the consequences for lifestyle choices, housing, vacation opportunities, and money to spend on projects, children, and so on are considerable. In most countries, moreover, women are in fact significantly overrepresented in the bottom 50 percent of earners, so that these large differences between countries reflect in part differences in the male-female wage gap, which is smaller in northern Europe than elsewhere. In concrete terms, if the average wage is 2,000 euros a month, the egalitarian (Scandinavian) distribution corresponds to 4,000 euros a month for the top 10 percent of earners (and 10,000 for the top 1 percent), 2,250 a month for the 40 percent in the middle, and 1,400 a month for the bottom 50 percent, where the more inegalitarian (US) distribution corresponds to a markedly steeper hierarchy: 7,000 euros a month for the top 10 percent (and 24,000 for the top 1 percent), 2,000 for the middle 40 percent, and just 1,000 for the bottom 50 percent.´

Overall, the policy decisions of American politicians, the flawed theories of American economists such as Simon Kuznets and Milton Friedman, and above all the rise in power of corporate executives have overseen a drastic return to income inequality in the United States. It is of note that Scandinavian countries had a far more inclusive and egalitarian education system than their counterpart the United States. Moreover, whilst in Scandinavean countries there is no minimum wage, these countries boast powerful trade unions that represent their workers. By contrast unions membership declined in the US from 1954 to 2007 and whilst the US has a minimum wage, in terms of purchasing power, the minimum wage reached its maximum level all the way back in 1969, at $1.60 an hour. To show the effects of minimum wage, consider that in France wage inequality reduced considerably between 1968 and 1983 (with the share of the top decile dropping from 37 to 30 percent) at the same time that ´the minimum wage was officially (if partially) indexed to the mean wage´ ... with ´the purchasing power of the minimum wage accordingly increased by more than 130 percent between 1968 and 1983, while the mean wage increased by only about 50 percent, resulting in a very significant compression of wage inequalities.´

Picketty writes dammingly the statistics, showing how ´the top decile share in US national income dropped from 45–50 percent in the 1910s–1920s to less than 35 percent in the 1950s (this is the fall documented by Kuznets); it then rose from less than 35 percent in the 1970s to 45–50 percent in the 2000s–2010´ and warns ´the United States may set a new record around 2030 if inequality of income from labor—and to a lesser extent inequality of ownership of capital—continue to increase as they have done in recent decades. The top decile would them claim about 60 percent of national income, while the bottom half would get barely 15 percent.´

Picketty further remarks ´this spectacular increase in inequality largely reflects an unprecedented explosion of very elevated incomes from labor, a veritable separation of the top managers of large firms from the rest of the population... this phenomenon is seen mainly in the United States and to a lesser degree in Britain, and it may be possible to explain it in terms of the history of social and fiscal norms in those two countries over the past century. The tendency is less marked in other wealthy countries (such as Japan, Germany, France, and other continental European states), but the trend is in the same direction.´ 

Growth is traditionally small (0.1-0.2%) and we are returning to closer to that historic base rate now that population is rising at a slower rate, as shown by Europe

Picketty writes that 'the twenty-first century may see a return to a low-growth regime. More precisely, what we will find is that growth has in fact always been relatively slow except in exceptional periods or when catch-up is occurring.the twenty-first century may see a return to a low-growth regime... there is no doubt whatsoever that the pace of growth was quite slow from antiquity to the Industrial Revolution, certainly no more than 0.1–0.2 percent per year. The reason is quite simple: higher growth rates would imply, implausibly, that the world’s population at the beginning of the Common Era was minuscule, or else that the standard of living was very substantially below commonly accepted levels of subsistence. For the same reason, growth in the centuries to come is likely to return to very low levels, at least insofar as the demographic component is concerned.'

It is known most GDP growth and population growth comes from Africa and Picketty writes that this parallels America beforehand, pointing out that 'the growth rates of 1.5–2 percent a year attained by Asia and Africa in the twentieth century are roughly the same as those observed in America in the nineteenth and twentieth centuries (see Table 2.3). The United States thus went from a population of less than 3 million in 1780 to 100 million in 1910 and more than 300 million in 2010, or more than a hundredfold increase in just over two centuries, as mentioned earlier.' He adds 'furthermore, all signs are that growth—or at any rate its demographic component—will be even slower in the future.... In slowly growing economies, past wealth naturally takes on disproportionate importance as the rate of return on capital remains significantly above the growth rate for an extended period of time (which is more likely when the growth rate is low, though not automatic), then the risk of divergence in the distribution of wealth is very high.'

It is worth reflection that it has been predicted by 2050 according to the United Nations, 'Africa's population will reach close to 2.5 billion. Such a figure would mean that more than 25 percent of the world's population will be African.' The United Nations predicted that 'more than 8 out of 10 people in the world will live in Asia or Africa by 2100.'

Growth, Savings, Capital, Labour and Inequality all link - what the data says

Picketty points out how groundbreaking the current research from which he draws his deductions are, when stating ´the truth is that only since the end of the twentieth century have we had the statistical data and above all the indispensable historical distance to correctly analyze the long-run dynamics of the capital/income ratio and the capital-labor split.´ The mechanisms of capitalism, such as Capital, Labour, Consumption and Savings, all intertwine and produce growth and income but also a certain level of inequality, and the manner in which they relate is only now crystal clear.

For example, using the capital/income ratio β and the capital-labour income split, Picketty assertains capital's rate of return, pointing out that - ´In the wealthy countries around 2010, income from capital (profits, interests, dividends, rents, etc.) generally hovered around 30 percent of national income. With a capital/income ratio on the order of 600 percent, this meant that the rate of return on capital was around 5 percent.

Concretely, this means that the current per capita national income of 30,000 euros per year in rich countries breaks down as 21,000 euros per year income from labor (70 percent) and 9,000 euros income from capital (30 percent). Each citizen owns an average of 180,000 euros of capital, and the 9,000 euros of income from capital thus corresponds to an average annual return on capital of 5 percent.´ This of course is much higher than the growth rate of wealthy countries around 2010, so of course inequality reached higher levels in these years.

The truth is modern inequality levels are devastatingly worrying and seemingly completely provoked by the capital-labor split and current capital/income ratios in countries today, which resemble the past only with an added depressive point that Western countries like the US have somehow permitted income from labour to be nearly as destructively unequal as income from capital, when previously it had a more evening effect. It would be a crying shame if the only way progress gets made in terms of meritocracy is through war and great depressions and yet historically, that seems to have been the case. Its time now for an intellectual revolution, sparked by the emergence of the middle class, to bring humanity finally out of the feudal ages, and not war nor depressions, particularly given the nuclear threat and the fact we are living in the information age. Otherwise, there is no point in denying western culture has let itself become irredeemably fascist, corporate and mechanical.

References

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

Our world in data https://ourworldindata.org/region-population-2100

International Monetary Fund https://www.google.com/url?sa=t&source=web&rct=j&opi=89978449&url=https://www.imf.org/-/media/Files/Publications/Fandd/Article/2023/September/Picture-this-0923.ashx&ved=2ahUKEwiB86mk5N6KAxWTV0EAHd7yNn4QFnoECBkQAw&usg=AOvVaw1pi43SgeKmQ0ILKYyg1mbX