Final notes on Piketty's Capital in the 21st Century

Chapter 12 sees Piketty going global. Having thus far kept a mostly national perspective, he now looks at capital at a wordwide level. That makes sense: colonies aside (and even they fell far short of today’s cross-positions), major international investments is a relatively new phenomenon, as is the difficulty of associating a capital to a country.

This is another reason why the elevated levels of r (return on capital) could go on a bit longer: whereas developed countries are awash in capital, in fact probably have too much for their own good, this is not the case of the world as a whole –though the gap is less than one may have thought.

There, Piketty has an extremely interesting line of study. Having shown that the richest people saw their wealth grow faster than everyone else, he examined what caused this divergence (it is true both of highly concentrated and highly diversified massive fortunes, surprisingly) looking at the returns obtained by the dotations of various US universities. The picture is crystal clear: the bigger the amount to invest, the higher the returns it gets.

As in other cases, I am not entirely convinced by the transmission mechanism that he suggests as an explanation of the fact. He suggests that this is because bigger fortunes can employ more talent to scout for investment opportunities. But since investments must remain highly diversified (they are usually in small capitalisation and a big investment would quickly swamp the market) there should be a rather quickly reached limit to this kind of economies of scale. Also, pension funds, which can be even bigger, should thus generate higher returns, yet everything I’ve seen would seem to indicate that this is not the case. I would hazard a guess (for which I have no actual data other than anecdotal) that some actors are offered opportunities that simply will not be open to other institutions even if one of their scouts were to detect it. There can be a variety of reasons. For instance, being able to say that Warren Buffett took a large share in your capital is likely to help convince others to buy at a probably much higher price. Being partly funded by Harvard could make a technological start-up look better. Many companies try to have some of their capital held by actors that they believe (sometimes naïvely) will help them win business through their connections.

Again, my data is purely anecdotal, although anecdotally I have seen it in spades. Major actors will directly be contacted, which saves on scouting, and offered sweeteners, sometimes huge ones. Including this effect could help explain some of the gaps in return. Then there is another one: unbelievably wealthy people and organisations tend to have a lot of political influence. It is not entirely surprising that they will sometimes use it to further their economic interests, and that would include helping the return on their capital.

Whatever the breakdown in causes, the effect seems pretty well established, and incredibly worrying. Until then, Piketty’s central thesis was that r would not move much whereas he would expect g (growth rate) to drop, and r was usually taken as a fixed value. As I’ve mentioned earlier, for r to hold will probably require direct political action (and we may have just uncovered a sign of the ability of capital owners to get the desired result). I should also say a few words of the rather strange way Piketty looks at g, especially in the context of a book that oozes concerns about inequality.

Essentially, while Piketty reckons productivity growth will probably drop a little (he does not talk about environmental constraints and resource scarcity to anywhere near the extent of the impact I believe they will have, although he mentions that even to maintain productivity growth at a passable level would require finding new sources of energy), the drop in g will mostly come from the population growth component. And then he proceeds with his analysis, just using the global g.

However, the impact on inequality is totally different whether g is driven by productivity or population. To show why, let’s totally simplify and have two situations. In one, there is no population growth, only productivity. If indeed we have the net r>g, capital will grow in importance, but at least that is the whole of the divergence (and of course some of the returns on capital would be spent, so actually the divergence would be slightly less). Now if we have no productivity growth, only population, then even with r=g, it would mean that big capital owners would massively pull away. Yes, there would be ever fewer of them, so they would be a very small subset of the population, but they would still essentially hold all capital and increasing returns from it, whereas everybody else would totally fail to improve their situation.

The rate of capital to revenue and the breakdown going to each may be the same in both situations, but for inequality I would say that they are very different. I reckon that we should mostly look at the gap between return on capital and productivity growth, but the drop in population growth should be much less troublesome and indeed should not favour capital holders. 

However, that will be of very limited comfort if wealthy capital holders completely diverge from modest capital holders. It could mean the modest ones would not be able to ever manage profitable savings (since secular stagnation should be a dampener on the returns they can get) whereas the wealthy ones could siphon any gains in productivity and then some. Worryingly, this narrative seems to fit very well with observations over the past few years or decades. Piketty’s data clearly shows that, the higher you go, the faster you break away. The proportion of capital held by the top one in twenty million people has trebled (!) over 25 years, the proportion by the top one in a hundred million almost quadrupled, even before you take into account what is hidden in fiscal paradise, which is most probably disproportionately held by very wealthy people. Even higher, Bill Gates and Lilian Bettencourt alike saw their (disclosed) net worth multiplied by 13 over 20 years, for a 15% nominal or 10-11% real annual return.

Having spent a considerable amount of work to describe our current predicament, Piketty moves towards proposing solutions in the Fourth and last part, beginning with chapter 13. He shows how the social state is a creation of the 20^th century, that he very clearly states his intention of preserving. Not a lot for me to learn there, but it is probably a useful chapter for many over-enthusiasts of purely mathematical micro-economics. In this chapter, he explicitly mentions John Rawls, confirming my impression that he was referring to A Theory of Justice in his introduction.

Still, one line of study that we may too easily forget rather naturally follows from the previous chapter, that extended his study to emerging countries: a major challenge throughout the century will be to help the formation of stronger, more stable states (and with it the possibility of a social state) in emerging countries. Since the regulation of capital (and very high incomes) will necessarily be in a significant part through taxation, it will require some level of homogeneity, which is also desirable in pure fairness terms. Also, the legitimacy of significant taxation in countries that have no social state would appear problematic. However, formation of such states in countries that have an unfortunate history (often because of what the West did during and just after colonisation) will not be straightforward and, you feel, ought to be to a large extent a duty of the countries that helped create the mess. Yet there appears little sign of this at the moment.

Chapter 14 looks at revenue and inheritance taxation. Simply describing their histories is quite fascinating. In particular, it is a welcome reminder of how things that are described as impossible, unconstitutional, destructive and so on would in fact look quite mild in comparison to what things actually were not that long ago. This is somewhat less true of France, that has kept quite a steady top marginal taxation rate since 1936 (although the inheritance rate has gone up significantly in the mid-80s, as often going completely against the worldwide trend at the time), but Germany to some extent (but of course for a few years their policies were dictated by Washington), and above all the UK and USA have been all over the place, with changes that can be described as abrupt rather than gradual.

It is also clear that Germany likes its rentiers. Except for the mid-70s to mid-80s, when France had the lowest top marginal succession taxation rate (it now has the lowest) in the comparison of France, Germany, USA and UK, it has been the lowest of the bunch whenever its tax laws were not set by the Allied countries at the end of WW2. We have also seen earlier that it has a much more concentrated capital than any other continental Europe country. It also consistently taxes revenue less than France (but consumption more), and of course fights tooth and nail against inflation.

Piketty makes an interesting point (something he had already mentioned and often repeats in interviews) about the difficulty of setting appropriate policies in a context where rather weird lessons were retained from the 60s-70s period. English-speaking countries, seeing the world catch up with them in productivity, blamed their welfare state and high top tax rates (helped in that by a lot of propaganda of course). Since they slashed those right as continental Europe pretty much finished catching up –and thus ceased to have a much higher productivity growth- they tend to know, just know, that high top tax rates are self-defeating and kill the economy. Of course, the fact that this “lesson” serves the interest of very powerful people only makes it more likely to stick.

Of course, I must mention something that has already been discussed by several reviewers, and that, while not new, is made crystal clear by such a historical review: the fact that confiscatory taxation (that is, taxation set with the main target of reducing inequalities, rather than to collect revenue) is an English speaking world invention. By the way, although the book does not mention it, other work by Piketty and Saez shows that what tends to be called confiscatory is not that far from what a tax aiming for revenue would be: the optimum top revenue tax rate is something like 72%.

Chapter 15 is dedicated to what Piketty calls a useful utopia, describing an international tax on capital. It is unlikely to happen in the short term, and because of that he has been criticised for writing a chapter on it, considering it a waste of the reader’s time. I find that rather silly. Ever heard of the Overton window? People promoting the wealthy’s interests never seem shy of promoting totally outrageous ideas in order to shift it rightwards. And now we should castigate an academic for describing what he reckons is the optimal policy (while himself acknowledging it as a utopia, though a useful one), simply because it’s unlikely to be implemented soon in its most complete form?  Actually, in terms of Overton window, we’d need someone to argue for something much more ambitious, so that this policy would not look like being at the fringe. Also, one should note that his suggestion that it would be the best policy is very deeply thought through and explained. It can be argued, but certainly not dismissed out of hand.

So, let’s instead look at the substance of it. His proposed tax is highly progressive, which is good, but even states how to set the progressivity –mostly, the point would be to counter the divergence effect. This could be combined with one-off taxes at a much steeper rate to bring down the level of inequality, and the complete domination of private over public capital. Indeed, it is clear that over the past few decades, states not only decided not to monetise their debts, they also chose to borrow from the rich rather than tax them (Piketty has demonstrated in other work, and briefly shows again here, how total tax rates tend to quickly become regressive at the very top, propaganda notwithstanding).

So Piketty would not suggest, at least as a central scenario, anything that would restrict the ability to save and generate returns from it –his solution would, however, make sure that starting from an advantaged base would not increase the rate of return, that while you would enjoy a higher revenue from the high nominal, there would not be an accelerating divergence. He does mention that states could decide to set the rate higher in order to reduce inequality –as before, he asserts what can hardly be honestly disputed, while mentioning that one could go further- and that the whole exercise would require international collaboration and systematic exchange of data (which is an added reason for having a non-zero rate even at low levels of capital –everyone would report capital). In order to make it simple enough and to fight the tendencies to under-declare, it would be based on a pre-filled declaration.

I have mentioned that I felt Piketty may have overstated the inevitability of a high return on capital, and suggested addressing all the artificial components and policies boosting this return. So, where do I sit on his suggestion? As far as I can see, it is totally independent, and complementary. There is no way that policies can target exactly the socially optimal return on capital (and there is no natural one, since markets are social constructs, as is the right to property). So there will always be a need to avoid a systematic divergence. And it could never be overkill: in the absence of high, diverging levels of wealth, nobody would be taxed at a significant level. Since whatever would be collected would reduce the needs to tax elsewhere, such a tax (which would hit idle capital the hardest) would increase economic efficiency. It would also have a positive impact on inequality, and Piketty quite convincingly argues that the other possible options would do that less efficiently. So it seems that it is something that Rawlsian people over the world should push for, and an interesting yardstick for other policies (the close you get to that, the better).

It should also be noted that Piketty concerns himself with capital and inequalities of capital (also revenue, although that is not as central). The tax system would of course need to take other objectives into account, such as addressing externalities, helping growth or, more pertinent, employment… It is clear that Piketty sees them as desirable objectives, but they are not the topic of this book. In particular, Piketty addresses the consequences of inflation from that angle alone, not from the perspective of its impact on growth, investment, employment… With this in mind, his argument at this point is quite persuasive.

An interesting aside is that it seems that poor African countries would be among the main beneficiaries of such an internationally organised tax –as hidden capital outflows greatly exceed international help. They would of course be much more easily recouped in an international system.

Among those who criticised Piketty for writing a whole chapter about a wealth tax, there was sometimes the argument that he should not give up on taxing inheritance. But I don’t see that he does at all. Surely, indeed, inheritance should be taxed –merely correcting the divergence of returns on capital would do nothing to prevent dynasties, for a start. But it seems to me that it is insufficient. If wealth is never taxed, that means that, for the length of a person’s life at the very least (it’s unlikely that nothing at all would be transmitted, any massive windfall gains would be untouchable. Say someone exploits a loophole in a law, or well-targeted lobbying towards a sympathetic government, to make a billion dollars in a totally socially unproductive way –he would then remain immensely rich for the rest of his life, with nothing reverting to society until his death. This feels to me like socially problematic. Also, from the distant (and fictional) point when inheritance would be taxed at 100%, it would take around 20 years (15 is the long-term average, but finance on steroids has made wealth a bit younger) to correct half of the inequalities. Do we have that long?

Chapter 16 deals with the issue of public debt (particularly in the Eurozone). In case anyone had any such expectation, let’s be clear: he does not write within an MMT framework. It is probably just as well –his work cannot be dismissed as fringe economics (well, it is, though. He has been dubbed a “French revolutionary” by the New Statesman, despite at every turn refraining from taking a stronger stance that the data would absolutely command), and of course an MMT perspective would not weaken his conclusions about very high and concentrated private capital.

To summarise his conclusions, he first very quickly dismisses the idea of reducing public debt through privatisation of most everything. He thus sees three options (he does not advocate default, which would at the macro level be equivalent to a one-off tax, but less well targeted and with more unwanted consequences): an exceptional tax on capital (pretty much countering the result of states having borrowed from wealth rather than taxing it) which he sees as much the better choice; as a distant second, inflating the debt away; and, much the worst, austerity, which he notes is the chosen path at the moment.

The problem with inflation is that it’s much too poorly targeted and not always progressive –indeed certainly regressive between middle classes and the very wealthy (who are hardly affected at all). Also, in case of an overshoot, going back is always somewhat painful, which would not be the case with a one-off mitigation of the unbelievably high current rate of private capital. It’s hard not to think of Keynes, who expressed that helping the endless accumulation of claims to enjoyment which are not intended to be exercised at any definite time was not a sensible way to run an economy.

Piketty slams austerity, and yet he is too generous to it –possibly because the book was actually published (rather than translated) in 2013. He mentions the clearest, prolonged case of austerity, that of the UK in the 19^th century, and admits that it should not be quite as bad this time around, first because debt is closer to 100% of GDP than 200%, but also because there was essentially no inflation whereas now “pretty much everyone accepts a target of 2%”. Admittedly, we are still above the almost 0 of the 19^th century, but admitting to a target (and count me among those who don’t admit 2%, which was pulled out of a hat, as a target. The West needs more than that) is not the same thing as having it. Currently, inflation in the Eurozone is below 1% and going south. Austerity is even worse than you think, even accounting for the fact that austerity is even worse than you think.

The Eurozone current predicament may be why he takes the time to describe the peculiarities of that first ever instance, on such a large scale, of a currency without a State (or, as I was describing it in conversations lately, the disappearance of a State in the Eurozone, if one considers that among the State attributes is the control of the currency). This just adds another layer to the problems linked to the democratic controls and transparency (which he briefly talks about separately as well). This should be a rich field of study. 

He also in this chapter briefly touches upon topics such as public capital and global warming (or rather a general loss in natural capital). This topic would require a whole book and in this respect it becomes clear that, while it can temporarily disappear in the “market value” aggregate of capital, various forms are not all that substitutable.

Finally, we reach the conclusion. Piketty is clear that his work is not the final word and will be proven to contain weaknesses (several of which he has admitted in interviews). No surprise in those last few pages, which sum up the underlying points of the previous 900 or so, depending in which language you read it. He calls r>g the inherent contradiction of Capitalism, which is probably fair –whether it is an inherent, quasi-mechanical outcome or, as I reckon, an empirical observation of something that is in large part due to the ability of wealthy people and groups to get the social order that suits them, it is clear that it is and has been a major source of instability.

Finally, a very relevant observation with the very last sentence: after having expressed his wish to see more economists (and other social science experts) make the effort to gather time series on which to back their studies (a call to empiricism which is long overdue), he notes that citizens should pay interest to questions of money and wealth, that those who hold a lot never forget to defend their interest and notes that “Refusal to count rarely helps the poorest”.

All in all, the book is very readable, and what took me long was reading it critically at every stage –however, one surely gets more from reading that way. By all mean don’t content yourself with those notes and read the whole thing. Many a fascinating insight is mentioned almost in passing, and will not be found in a summary. If those notes have a strong proportion of apparent criticism, it is because none of the possible mistakes are trivial, and faced with such an impressive work, any disagreement needs to be well qualified. While Piketty is of course human and fallible, this is nothing like a facile, superfluous book. It is an extremely well argued and coherent body of thought, displaying a very high awareness of existing studies (while not accepting them at face value when their points are too unpersuasive). Like another book it evokes, Rawls’ Theory of Justice, I believe it will prove enlightening to the reader but, even better, will make the active reader ask more questions and think by himself.