This is the first in a two-part review by Fred Thompson of Thomas Piketty's book: Capital in the 21st Century. The second part will be posted tomorrow.
Thomas Piketty’s Capital in the 21st Century is a marvel without precedent: serious economic scholarship – a dynamic model of economic growth and the distribution of wealth – that is also a runaway best seller.
Piketty’s basic conclusion is that capitalism is biased in favor of capitalists – no big surprise there. His model consists of an identity, two mechanisms, and a mathematical inequality (the same as the modern Darwinian synthesis, probably our best known dynamic model). The identity links the stock of capital (K) or wealth to the flow of income (Y). The stock of capital includes all forms of explicit or implicit return-bearing assets: housing, land, machinery, financial capital in the form of cash, bonds and shares, intellectual property, etc. The identity is expressed by the ratio between K and Y, or β. The share of capital incomes in total national income (α) is equal to the rate of return, in real terms, on capital (r) multiplied by β.
The mathematical inequality links the rate of return (r) and the rate of growth of the economy (g) to income inequality – if r>g, which Piketty argues is the natural state of things, then α increases by definition, driving up the share of capital (wealth) in national income. As Nobel Laureate Robert M. Solow observes: “This is Piketty’s main point, and his new and powerful contribution to an old topic: as long as the rate of return exceeds the rate of growth, the income and wealth of the rich will grow faster than the typical income from work.” Consequently, Piketty concludes that in the long run the economic inequality that matters won't be the gap between people who earn high salaries and those who earn low ones, it will be the gap between people who inherit large sums of money and those who don't.
Over the long span of history surveyed by Piketty, the only substantial period in which g>r was between 1910 and 1970 (in the U.S., 1933-1973, the period Goldin and Katz call the “Great Compression”). Piketty ascribes this to the destruction and high taxation caused by the two world wars and the Great Depression. He is dismissive of deliberate policies: “Neither the economic liberalization that began around 1980 nor the state intervention that began in 1945 deserves much praise or blame. The best one can say is that they did no harm.” Consequently, he is indifferent to most of the literature on the political economy of this era, with its attention to regimes of (capital) accumulation and modes of regulation (the institutions, policies, and practices governing the operation of accumulation regimes). Moreover, the French case matches up with his formulation quite nicely. Capital-income ratios held steady at about seven from 1700 to 1910, fell sharply from 1910 to 1950, reaching a low of a bit less than 3, then began to climb, by 2010 to about 6. Furthermore, Piketty provides pretty compelling evidence that in France increased wealth led increased income inequality.
Certainly, recovery from war and depression, as well as deep structural factors related to demographics and technology, help explain the burst of rapid economic growth following World War II. Nevertheless, it is a mistake to account for the mid-20th Century period of shared growth exclusively in terms of large, impersonal economic forces. Politics and institutions also mattered. Indeed, I would argue that the political and economic arrangements of the postwar era were qualitatively different from those that preceded and followed it and that this distinctive set of policies profoundly influenced the pace and content of economic development and the subsequent distribution of income, consumption, and wealth.
This view of the postwar era assigns a key role to organized labor, which was then at the apex of its power, not only in the social-democratic states of Northern Europe, but throughout the industrialized West. Organized labor was politically decisive in its support the welfare state, Keynesian full-employment policies, high inheritance and income tax rates, heavy reliance on payroll taxes, and capital and foreign exchange controls. The upshot of these policies included a vast expansion of mass production and consumption, widely-shared wage gains and “profitless growth” – what Michel Aglietta calls the Fordist regime of capitalist accumulation in A Theory of Capitalist Regulation: The US Experience (2000).
Mass production thrives on economies of scale. Consequently, as Robin Marris explained in The Economic Theory of Managerial Capitalism (1964), under mass production, most output is supplied by a smallish number of large enterprises, usually publicly held corporations, where managerial control is separate from ownership. Marris argued that in the immediate postwar era managers exercised considerable discretion, which they used primarily to grow their enterprises rather than to maximize shareholder wealth, since they generally got higher salaries and greater status from running bigger businesses – hence, profitless growth. He also argued that this was socially desirable: growth-seeking firms make countries grow faster (g up, r down).
Obviously the postwar boom couldn’t go on indefinitely. Declining population growth, satisfaction of long stifled wants, and catch-up on the part of Europe’s capitalist economies and Japan to the technological frontier would have probably curbed economic growth in any case. The problem of integrating baby boomers into a workforce, which was already beginning to shed manufacturing jobs, further stressed the Fordist system of accumulation, leading to wholesale changes in its characteristic modes of regulation: fiscal policy was subordinated to monetary policy or, perhaps more accurately full employment subordinated to price stability, inheritance and income tax rates slashed, capital controls eliminated, and exchange rates floated.
Arguably, the demise of the Fordist accumulation regime followed, in part, from its success. Increasing mechanization and computerized production hollowed out the blue-collar workforce in the industrialized West and led, thereby, to the marasmus of labor movements. Mass production shifted to the developing world where wages are low and environmental quality standards lax. Both developments reduced political support for policies aimed at broad-based gain sharing. Moreover, activist investors, especially in the English speaking world, increasingly found ways to use the market for corporate control to discipline hired managers and stock options and bonuses to align managerial interests more closely with theirs – away from growth and toward maximization of shareholder wealth. As Solow put it, in his respectful review of Piketty’s book: “It is pretty clear that the class of super-managers belongs socially and politically with the rentiers, not with the larger body of salaried and independent professionals and middle managers.”