Capital in the Twenty-First Century: Notes
- modernglitch
- Dec 28, 2020
- 15 min read
Here are my notes for Thomas Piketty's Capital in the Twenty-First Century. I read the book hoping to gain a better understanding of economics and inequality and I guess this book does do that to a certain extent.
I have divided the notes by chapter and section. The majority of the first two parts aim to define various economic terms and laws, whereas the latter two aim to define and address the evolution of inequality and where we would/should go from here on. Piketty's main reform is to introduce a global tax on capital.
p.s. : I have recently purchased Verso's "Thomas Piketty’s Capital in the Twenty-First Century :An Introduction" and hope to have my notes from there up as soon as I finish the book. It essentially critiques Piketty's thesis and addressed the hype surrounding it.
Email me at modernglitch99@gmail.com if you want any pdfs and if you have any comments at all.:)
Introduction
Young: feared growing inequality because he feared revolution
Malthus: welfare assistance to the poor must be cut. Reproduction by the poor must be halted to prevent chaos
Ricardo: when population and output growth increases, land becomes scarce and land prices skyrocket. This leads to inequality which can only be circumvented via a large tax on landowners. Otherwise landowners would have a claim on the whole population.
Note: it is important to understand that the interplay of supply and demand does not rule out the possibility of divergence in the distribution of wealth linked to extreme changes in certain relative prices.
Marx: capital prospered in the 1840s and industrial profits grew but labor income stagnated. What was the good of technological innovations if the conditions of the masses were still just as miserable as before?
Sought to distinguish himself from bourgeois economists who saw the market as a self regulated system.
Marx took the Ricardian scarcity model as the basis of a thorough analysis of capital.
Principle conclusion: principle of infinite accumulation: tendency of capital to accumulate and become concentrated in fewer hands with no natural limit to the process.
Piketty claims Marx had neglected the possibility of durable technological progress and steadily increasing productivity, which is a force that can to some extent serve as a counterweight to the process of accumulation and concentration of private capital.
Kuznets curve:
Income inequality would automatically decrease in advance phases of capitalist development as more people partake in the fruits of economic growth. Viewed the evolution of inequality as a bell curve. Antithetical to the Marxist and Ricardian idea of an inegalitarian spiral.
Aimed to maintain underdeveloped countries within the orbit of the free world: a product of the Cold War .
Note: the sharp reduction in inequality during the 1900s was due to the world wars and its consequent economic and political shock and little to do with the tranquil process of intersectoral mobility described by Kuznets.
Part 1: Income and Capital
Chapter 1
>GDP: measures the total of goods and services produced in a given year within the borders of a given country
>national income: subtract from GDP the depreciation of capital that made this production possible: wear and tear on buildings, infrastructure, etc. this amounts to around 10% of GDP.
then: one must add income from abroad/ subtract net income paid to foreigners.
hence: a country whose firms and assets are owned by foreigners may well have a high domestic product but a much lower national income, once profits and rents flowing abroad are deducted from the total.
>all income must be distributed to either labour or capital
labour: wages, salaries, etc : those who contributed labour to the process of production
capital: payments to the owners of capital used in the process.
>national wealth: private wealth +public wealth
most developed countries have negative public wealth due to public debt. therefore private wealth accounts for nearly all of national wealth almost everywhere.
in Europe, America and Asia, wealthier countries in each bloc receive a positive flow of income from capital, which is partly cancelled by the flow out of other countries, so that at the continental level, total income is more or less equal to total output.
Africa is an exception as nearly 20% of African capital is owned by foreigners.
>Best way to measure capital is to divide capital stock by the annual flow of income.
This gives us the capital/income ratio: β
>first fundamental law of capitalism: 𝛼= r x β
𝛼 = share of income from capital in national income
r = rate of return on capital.
high capital/income ratio → slow growth of economy → past wealth becomes more important → r is more than the growth rate of the economy and thus inherited wealth grows faster than output income.
>On the use of purchasing power to compare inequality between nations instead of currency exchange.
prices tend to be higher in certain countries
purchasing power is more stable than exchange rates.
>what favours convergence?
classical economic theory: wealthy countries will obtain a better return on their investment by investing abroad and the poor countries will increase their productivity and thus close the gap between them and the rich countries.
issue:
convergence of output =/= convergence of income. a wealthy country will own the poorer country and the per capita national income of the wealthy country will remain larger than that of the poorer country. (example: refer to the example of africa above)
Chapter 2
>growth : either population growth or increase in per capita output (this increases the standard of living)
other things being equal, strong demographic growth plays an equalising role as it decreases the importance of inherited wealth.
the other factor would be the transmission of skills: increased social mobility (does not imply decreased income inequality, but in theory does limit amplification and reproduction of inequalities of wealth)
*Charles Dunoyer: consequence of industrial regime is that it destroys artificial inequalities but highlights natural inequalities:
Hence, superior abilities of certain individuals leads to higher ec growth and this can be used to justify rejecting state intervention.
>societies with growth of 0.1% reproduce themselves: occupational and property structure is the same.
Part 2: The Dynamics of the Capital/Income Ratio
Chapter 3
>government bond: claim of one portion of the population( those who receive interests) on another(those who pay taxes). it should therefore be excluded from the national income and included solely in public wealth.
>Britain
huge amounts of debt post WW2 and Napoleonic wars.
borrowed without limit to finance these wars.
Britons with means lent what the state demanded without reducing private investment . This led to an increase in private savings and thus increased inequality.
>France
huge debt
impose land tax
defaulted on ⅔ of loan + issued paper money that triggered inflation
in the 20th century: debt was drowned by inflation and repaid with money of decreasing value.
>note: in both countries, stagflation of 1970s demonstrated post-war keynesian consensus and led to deregulation and liberalisation of the 80s.
>>Germany
drowned public debt in inflation between 1913-1950
Now germany has very anti inflatist attitudes: in contrast to Britain that allows central bank to buy portion of debt even if it means slightly higher inflation now
relatively lower private wealth: why?
low price of real estate: german reunification: brought about a large number of low-cost houses
difference in the low stock market valuation of german firms: generally people use book value( subtract firm’s debt from cumulative value of investments): purely accounting difference.
>> lower market value due to the Rhenish capitalism/ stakeholder model whereby representatives of workers sit on the boards of directors.
>>USA
so much land that market value was very low: price effect counterbalanced by volume effect.
post war: handled mainly via taxation, not so much nationalisation, inflation and growth.
Enjoyed an overall much more stable capital/income ration and explains why Americans take a benign view of capitalism.
Slave capital: since one half of population owned the other, slave capital supplanted and surplassed landed capital.
Chapter 5
>>2nd law of capitalism: β = s/g
s=savings rate, g= growth rate, β= capital/income ratio.
country that saves a lot and grows slowly will accumulate enormous stock of capital>>> wealth accumulated in the past acquires disproportionate importance
note: this formula only applies in the long run: several decades
valid only if one focuses on those forms of capital that human beings can accumulate(not natural resources)
valid if asset prices evolve on average in the same way as consumer prices
>> as long as one believes once can sell an asset at a higher price, individually rational to pay a good deal more than the fundamental value of the asset = speculative bubble in real estate and stocks
important to note that price of capital is a social construct: regulations,policies. laws affect stock market prices: refer to the above example of germany and rheinish capitalism.
Ratio of market value/ book value: Tobin’s Q
Japanese Bubble of 1999: private capital artificially rose due to speculation in the early 90s.
>>now: comeback of patrimonial capitalism
slow demographic growth
higher rate of saving
privatisation of wealth in the 80s
example: Italy
national wealth increased between 1970-2010 but this reflected a growing debt that one portion of population owed to another.
Chapter 6
>real assets: directly related to economic activity. Therefore , price evolves as related activity evolves
>nominal assets: value is fixed at nominal initial value and is thus subject to inflation
>pure return on capital: r = marginal productivity of capital: output
What is capital used for?
scenario 1: capital is of no use in production (no investment can increase productivity). Hence, capital plays role of a pure store of value
scenario 2: capital income ratio = 0, therefore all national income goes to labour.
>capital market = perfect when each unit of capital earns a maximal marginal product; however financial institutions and stock markets that allow for a diversified portfolio are a source of speculation, instability, etc.
>too much capital kills r
elasticity of substitution between labour and capital. if elasticity=1, return on capital decreases in exactly the same proportion as capital/income ratio and 𝛼 does not change. This is known as the Cobb-Douglas production function
>marxist economists show that capital’s share is always increasing while wages are stagnant.
generally: decrease in capital labour split during war and rise during 80s
>Marx:
did not use mathematical models but piketty explains his theses using β =s/g where g is very close to 0
output increased because every worker was backed by more machinery not because of actual productivity growth.
note: now we know that long term structural growth is possible only because of productivity growth and this was not obvious to Marx due to lack of data.
as s increases, capital's share of income devours all of national income.
>Two Cambridges debate
Harrod + : β is fixed by available tech and thus any increase in growth is due to savings. always too much or too little capital.
Solow: in the long run capital/income ratio adjusts to the savings rate and structural growth rate of the economy rather than the other way around.
neoclassical growth model.
balanced growth does not guarantee a harmonious distribution of wealth and in no way implies the disappearance or even reduction of inequality in ownership of capital.
>> technological changes over the long run will favour human labour over capital, thus lowering return on capital and capital share. Compensated by forces in other directions such as international competition for capital and financial intermediation.
Part 3: The Structure of Inequality
Chapter 7
>inequality is primarily due to inequality in income from labour and income from capital
>distribution of capital ownership always more concentrated than that of labour.
>Modigliani: wealth is accumulated primarily for life-cycle reasons then everyone would be expected to accumulate a stock of capital more or less proportional to their wage level.
inequality of wealth would just be inequality of income from labour.
this is not the case due to intergenerational wealth
>>inequality with respect to labour: 1 percent who earns the most =/= one percent who owns the most.
>>capital inequality: bottom 50% own only 4% of total wealth while the richest 10 own 62%.
>>patrimonial middle class: all the middle class managed to get hands on crumbs of the upper decile while poorer half of the population are as poor today as they were in the past.
>>How did this level of inequality come about?
hyper patrimonial society/society of rentiers + inherited wealth attains extreme levels and income hierarchy dominated by very high incomes from capital.
2nd way: largely created by the US: hypermeritocratic society: supermanagers, peak of income hierarchy dominated by income from labour not capital.
>> problem with Gini coefficient: does not differentiate income from capital and labour. distribution tables show the concentration of wealth and doesn't sanitise the inequality present within it.
Chapter 8
>>during interwar years: high school teacher belonged to 9% but now one has to be a college professor or senior government official to make the grade. to reach the top 1% one has to own a substantial amount of assets.
>>Top 9% - income primarily from labor, top 1% - income primarily from capital.
>>The structure of wage inequality did not change though the labour market changed.
>>rise of supersalaries:
an increase in wage inequality is identical in all cases no matter what reference period is chosen.
The vast majority of top 0.1% are supermanagers, only 5% are athletes and celebrities: pay packagers of top managers of large firms contributes to this inequality.
Chapter 9
>>theory= wage inequality is a race between tech and education
worker’s wage is equal to marginal productivity: individual contribution to output.
worker’s productivity depends above all on skill and supply and demand for that skill.
Why is this theory limited? : productivity is not an immutable quantity and relative power of different social groups determines wages.
>>democratisation of education did not equalise wages as all skill levels progressed at the same pace and these inequalities were simply translated upwards.
>>long term: increase average productivity and invest in education so that more people have access to a certain skills.
>>minimum wage: goal is to make sure no employer can exploit their competitive advantage beyond a certain limit: David Card and Alan Krueger showed that between 1980-2000, min wage had fallen so low that it could be raised without loss of employment, indeed at times with an increase in employment as in the monopsony model.
>>rise of supermanagers: too few people have been affected by it in Europe and Japan as compared to the US. A disproportionate share of growth in output has gone to the most highly remunerated individuals. Compensation package is set by senior executives themselves.
tech and skills set limits within which wages must be fixed. but certain supermanagers and their job functions become difficult to replicate, and thus the margin of error in estimating the productivity of any given job becomes larger.
This explosion signifies what Piketty calls meritocratic extremism, the need of modern societies to designate certain individuals as winners and to reward them all the more generously if they seem to have been selected on the basis of their intrinsic merits rather than birth or background.
Chapter 10
>>USA : 1910-20 pioneered progressive estate tax on large fortunes as these were deemed incompatible with us egalitarian values,
>>Piketty predicts that rate of return on capital will exceed growth rate of world output, assuming no significant political reaction, etc.
The only time r was below g was due to high tax rate during the interwar years(1913-1950).
>>introduces the concept of time preferences and how this theory explains why r has been stable at 4-5%; ultimately psychological because it reflects the average person’s impatience and attitude towards the future.
if r were less than g: economic agents realising that future income will rise faster than they can borrow, will feel infinitely wealthy and will wish to borrow without limit in order to consume immediately (until r rises above g).
>>r-g measures the rate at which capital income diverges from average income if none of it is consumed and everything is reinvested in capital. greater the difference, greater the divergent force.
>>Discusses primogeniture.
>>financial globalisation increases correlation between return on capital and initial size of investment portfolio: capital markets become more perfect and disconnected from individual characteristics and cut against meritocratic values, reinforcing the logic of r>g.
Chapter 11
>>economic flow of inheritance as a proportion of national income = B= µ x m x β, where
µ=ration of average wealth at time of death to average wealth of living
m is mortality rate,
β=capital income ratio.
>>in a society where the primary purpose of wealth is to finance retirement(Modigliani), µ=0 since everyone aims to die without capital.
>>inheritance occurs later in ageing societies but wealth also ages and latter compensates the former.
>>21st century= flow of inheritance expected to increase till pre war levels
>>society in which inheritance predominates income from labour: high capital.income ratio + inherited wealth extremely concentrated (top centiles inherit more)
explains why the top centiles of inherited wealth and earned income are almost balanced in France today.
>>meritocratic extremism: proponents of high pay argued that without it only heirs of large fortune would be able to achieve true wealth.
lays groundwork for greater and more violent inequality
combines the worst of two past worlds: very large inequality of inherited wealth and very high wage inequality justified in terms of merit and productivity.
race between supermanagers and rentiers, to the detriment of those who are neither.
Chapter 12
>>Example of Lakshi Mittal and Teodorin Obiang to illustrate the problem people have over fortune when owned by non-white people. illustrate limits of courts and highlights the need for global tax on capital.
>>example of university endowments to understand unequal returns on capital
Harvard has a larger endowment because they can afford better financial advisors and have a larger starting capital.
>>Inflation:
inflation does not reduce the average return on capital because the average asset price tends to rise at the same pace as consumer prices. inflation actually changes distribution of average return among individual citizens.
though inflation the enemy of the rentier, it is enough to invest in real assets to escape inflation tax entirely. financial advisers can be paid to mitigate effects of inflation.
Statistics suggest that the redistribution due to inflation is to the detriment of the least wealthy and to the benefit of the wealthiest
>>Sovereign wealth funds
There is a potential of sovereign wealth funds owning 10-20% of global capital by 2030-2040. Depends on supply and demand
>>when one adds up positions of all wealthy countries net position with respect to the poorer countries = -4%global gdp + poorer countries have a net negative GDP too.
statistical anomlay: more money leaves countries than enters them.
net position of rich countries relative to the rest of the world is in fact positive but this is masked by the fact that the wealthiest residents of the rich countries are hiding assets in tax havens.
Part 4: Regulating Capital in the Twenty-First Century
Chapter 13
>>declaration of rights of man: equality is the norm and inequality is acceptable only if based on common utility. similar to the difference principle introduced by John Rawls in Theory of Justice and capabilities approach favoured by Amartya Sen.
>>intergenerational reproduction lowest in nordic countries and highest in the us: sharp contrast to American exceptionalism and the prevalent view of high social mobility in the us.
>>retirement:
PAYGO system: contributions deducted from wages of active workers are directly paid out as benefits to retirees.
in contrast to capitalised pension plans: nothing is invested
intergenerational solidarity: rate of return is equal to the growth rate of the economy.hence, the contributions available to pay tomorrow’s retirees will rise as wages rise.
relying on capitalized system: risk of one generation of retirees being left with nothing + risk of investing all retirement contributions in the global financial market.
challenges: each individual is different. labourer vs someone with an intellectual occupation have different needs with regards to pension.
Chapter 14
>>Tax
proportional when its rate is the same for everyone: flat tax
progressive when rate is higher for some than for others
regressive when rate decreases for richer individuals: poll tax margaret thathcher,
>>2010 french taxes: top centile paid lesser as they were exempt from progressive taxation of their capital income
>>overall income measured each person’s ability to contribute and progressive taxation offered a way of limiting the inequalities produced by industrial capitalism while maintaining respect for private property and forces of competition
progressive tax puts an end to such incomes which lawmakers have found as socially unacceptable and economically unproductive.
>>no statistically significant relationship between the decrease in top marginal tax rates and rate of productivity growth in developed countries since 1980.
Chapter 15
>>previous attempts to tax properties but financial assets are ignored and property is taxed at market value regardless of debt.
>>global tax on capital will provide democtatic and financial transparency: generate information about distribution of wealth.
prevent tax havens from maintaining bank secrecy.
the closest attempt so far is the Foreign Account Tax Compliance Act (FATCA ) in the US in 2010.
Previous EU directives akin to FATCA were limited in its jurisdiction (Europe only) and Austria and Luxembourg were exempted from automatic data reporting.
unpredictability of return on capital: makes more sense to tax heirs not once and for all at the moment of inheritance but based on capital income and value of capital stock.
>>Marx: when r = 0, present reasserted its rights over the past and worker lost his chains. Piketty states that capital plays a useful role in coordinating actions of individuals and it is not easy to do so without it. Example: Soviet command economy and centralised planning.
>>Redistribution via immigration: simpler to allow wages to move where it is higher.
does not mean capital regulation isn't important
>>global tax on capital will benefit poorer countries
Africa: outflow of capital has always exceeded flow of foreign aid by wide margin. If fiscal cooperation exists, can tax foreign companies and stockholders, who are at least as guilty as unscrupulous African elites.
Chapter 16
>>how to reduce public debt
capital
inflation
austerity
>>inflation
hard to control once started
tax idle capital and encourage dynamic one. but small savers get savings wiped out too.
>>Europe
public wealth= public debt, so Europeans own virtually nothing.
>>how do we reduce this debt?
the solution would be to privatise all public assets. Instead of holding debt via financial investment, wealthiest Europeans will own schools, hospitals, etc.
exceptional tax on private capital: flat tax of 15% yield enough to wipe out a year of public debt.
>>issues:
1. Tried out in Greece in 2010-2011. Bondholders forced to accept haircut, price reduced by 10-20%. This triggered a banking crisis + people with the largest portfolio were able to restructure their assets and it negatively impacted small savers.
no guarantee that financial assets of the wealthy alone would be targeted
global tax on capital is better as individuals pay not financial institutions
>>role of central bank
During the period of the gold standard they did not have much to do
during the great depression, banks refused to create liquidity for dying banks. so now central banks are lenders of last resort, in the absence of a gold standard.
Friedman believed that the restrictive policy of the Fed caused great depression.
Friedman and other Chicago school economists believed that a strong Fed is all that is needed.
This was the intellectual climate in which conservative revolution of the 80s became possible.
>>fed creates liquidity but cannot control consumption. Sometimes they just delay collapse.
>>euro created because of the stagflation in the 70s and Europe believed that the central bank should be independent of politics. That is why Europe created a currency without a state and a central bank without a government.
>>European Central Bank: main aim is to keep inflation low.
not allowed to purchase newly issued government debt as they must first allow private banks to lend and then purchase on the secondary market.
needs to deal with 17 separate national governments, difficult to maintain consistent monetary policy.
Piketty recommends a European budgetary parliament. International cooperation and tax can be imposed based on where assets are instead of where the person resides.
>>growth
r=g is the golden rule. This is known as capital saturation where so much capital is accumulated that rentiers have nothing left to consume since they must reinvest all of their return if they want capital to grow.
>>Piketty’s main point: basically a global tax on capital ensures that instead of lending money via public debt, the top centile will pay taxes instead.
This ensures that public debt is no longer used to redistribute funds from poor to rich.
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