An Introduction to Thomas Piketty's Capital in the 21st Century- A Macat Economics Analysis
Does the structure of capitalism eliminate
inequality or reinforce it? That is the question at the heart of Capital
in the Twenty-First Century, by the French economist, Thomas Piketty. One
of the most discussed academic books published since the turn of the century, it analyses
the role that capitalism plays in global inequality. For years most economists have believed that
capitalism reduces inequality between the richest and poorest in the long run. For
example, the Kuznets Curve hypothesis suggested that inequality rises when countries industrialise
but then falls.
Piketty disagrees. He claims that capitalism creates greater
economic inequality. The Kuznets Curve was constructed using data
relating to wealth and income collected from the late 19th to the early 20th century. But
Piketty benefitted from a whole century of extra data right into the early 21st century.
Using this wider pool of figures, Piketty does two things.
He argues that Kuznetss
data is misleading, because it was drawn from what turns out to be a very unusual period
of history. And he creates a theory he calls the central contradiction of capitalism. So what is this central contradiction of
capitalism? Throughout history, the annual rate of return
on capital which means the profits or the interest you earn from investing your
money usually exceeds the annual growth rate of the overall economy. Return on capital
(or r) has remained relatively constant at around 5% - despite radical changes
in who controls the capital its generally the rich and individuals who inherit it and
whether its held as gold, bonds, land or in an investment portfolio.
In contrast to this, the annual growth of
an economy (or g) has almost always remained close to zero (it has only, in the
last two centuries, reached a level of 1-2%). Theres not much short of revolution
that those individuals who rely solely on labour to earn a living can do to change
it. Let me introduce Jane and Joe. They both earn $100,000 a year.
But Jane also
has a $10million inheritance which she invests annually in the stock market, earning a yearly
return of 5%. Joe has no savings. Lets see how their incomes evolve. Both Jane and Joe spend all of their annual
salaries.
After a year, Joe will have nothing left over whereas Jane will have made $500,000
from her investments, which she reinvests. Fast forward ten years Joes total wealth has grown very little
it depends on whether he is able to negotiate a raise but raise or no raise Janes
$10million has now grown to be worth more than $16million demonstrating Pikettys
argument that the difference in interest between r and g can lead to widening inequality
over time. To avoid this, he proposes a global tax on wealth that would effectively lower
the rate of return on capital. A more detailed examination can be found in
the MACAT analysis..
inequality or reinforce it? That is the question at the heart of Capital
in the Twenty-First Century, by the French economist, Thomas Piketty. One
of the most discussed academic books published since the turn of the century, it analyses
the role that capitalism plays in global inequality. For years most economists have believed that
capitalism reduces inequality between the richest and poorest in the long run. For
example, the Kuznets Curve hypothesis suggested that inequality rises when countries industrialise
but then falls.
Piketty disagrees. He claims that capitalism creates greater
economic inequality. The Kuznets Curve was constructed using data
relating to wealth and income collected from the late 19th to the early 20th century. But
Piketty benefitted from a whole century of extra data right into the early 21st century.
Using this wider pool of figures, Piketty does two things.
He argues that Kuznetss
data is misleading, because it was drawn from what turns out to be a very unusual period
of history. And he creates a theory he calls the central contradiction of capitalism. So what is this central contradiction of
capitalism? Throughout history, the annual rate of return
on capital which means the profits or the interest you earn from investing your
money usually exceeds the annual growth rate of the overall economy. Return on capital
(or r) has remained relatively constant at around 5% - despite radical changes
in who controls the capital its generally the rich and individuals who inherit it and
whether its held as gold, bonds, land or in an investment portfolio.
In contrast to this, the annual growth of
an economy (or g) has almost always remained close to zero (it has only, in the
last two centuries, reached a level of 1-2%). Theres not much short of revolution
that those individuals who rely solely on labour to earn a living can do to change
it. Let me introduce Jane and Joe. They both earn $100,000 a year.
But Jane also
has a $10million inheritance which she invests annually in the stock market, earning a yearly
return of 5%. Joe has no savings. Lets see how their incomes evolve. Both Jane and Joe spend all of their annual
salaries.
After a year, Joe will have nothing left over whereas Jane will have made $500,000
from her investments, which she reinvests. Fast forward ten years Joes total wealth has grown very little
it depends on whether he is able to negotiate a raise but raise or no raise Janes
$10million has now grown to be worth more than $16million demonstrating Pikettys
argument that the difference in interest between r and g can lead to widening inequality
over time. To avoid this, he proposes a global tax on wealth that would effectively lower
the rate of return on capital. A more detailed examination can be found in
the MACAT analysis..
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