When The Rate Of Return And The Rate Of Growth Do Not Matter Much For Piketty

So, I have finally gotten around to reading Piketty's monumental book.  Something struck me right away that I think many ignore, at least I have seen no one comment on it.  His emphasis on the importance of r > g, (rate of return on capital as he defines it greater than GDP growth rate) seems overblown.  Now I must admit that he repeatedly warns that the path of the distribution of income and wealth is hard to predict and that many factors are involved.  But it is also the case that he makes little of how often the direction of change does not correspond with the direction of change in this simple equation, that its effect is overwhelmed by other factors.

This can be seen by considering the first two figures in the entire book, which appear in his Introduction and that he declares are the most important in the book, what he is trying to explain ultimately.  The first shows the share of the top decile  of the US income distribution from 1910-2010 and the second shows the ratio of capital to income for Britain, France, and Germany from 1870-2010.  What is striking is how often changes in these have little to do with changes in r-g.  As it is, he argues in the book for the near constancy of r in all these nations over a long period of time, which means effectively that it is changes in g that largely drive this gap.

So, what do we see?  For the US the top decile starts out well off in 1910, reaching a peak just before the Great Crash, then it falls to the 1970s after which it rises again, reaching nearly its 1920s level by 2010.  However, what is not discussed much is that nearly all of the decline in inequality occurs in one tiny period: World War II.  He spends almost no time in this large book focusing on that peculiarity.  It is true that g was high in this period, but not that much higher than during the 1960s or for that matter the 1920s.  In the 1960s there was little change in this top decile share, which essentially got as low as it was going to go by 1945 and basically bounced around after that not moving much until it took off after 1980 or so.  And  in the 1920s rather than falling, the top decile share actually rose rather then fell.  It fell initially at the beginning of the Great Depression when g fell hard.

He does provide an explanation of the 1920s and early 30s, but it goes against his basic story about g.  What led to the peak at the end of the 20s?  A sharp rise in capital gains income.  And the following decline was the reversal of this with the stock market crash.  OK, that is almost certainly correct, but it goes against the story about g.  And how is it that essentially all of the decline in income inequality from 1931 to the 1970s occurred in the early 1940s?  He really does not focus on this, but he does indicate what is up, and it is important for his policy discussion at the end of the book.  That is when the US federal tax code went into its most progressive state, with the top marginal income tax rate moving up to the 90+% level in 1940, just in time for the war, where it would stay until the mid-1960s tax cut.  Of course there was a surge of g, and we know that increased employment of women and minorities helped lower inequality, but it is striking how much change in inequality was in these five years alone.

The story in Europe is slightly different, and, of course, it focuses on wealth rather than income.  There, with some minor differences between the three countries, wealth compared to output starts out very high in 1870 and stays there until  World War I, then only to massively collapse in all three countries, although not quite as much in the UK as in Germany and France.  Capital makes a slight recovery during the 1920s, when g was up compared to the previous decade (ooops, going the wrong way), only to decline after 1930 steadily, reaching a minimum in 1950 for all three.  For France and Germany it starts rising again, steadily in the case of Germany and continuing until now.  With Britain it sits at the same level 1950-1970, and then starts rising. 

But here is the catch.  During the 50s and 60s, economic growth was much higher in both France and Germany than in the previous two decades, and also it was higher than in Great Britain, which put in a sclerotic performance during those decades.  But if a higher g is supposed to be associated with less wealth inequality, that is the exact opposite of what we see here.  Wealth inequality declines during the troubled 30s and 40s, only to reappear in the high growth 50s and 60s in France and Germany, while failing to do so in the more stagnant UK. 

Now he does provide quite detailed stories of what was going on in these nations, although his focus is most detailed for France.  War, inflation, and bankruptcy destroy fortunes, although the direct damage of war is not really all that important.  The end of all this allows for capital to reaccumulate, at least in France and Germany, if not Britain.  But this simply emphasizes how these other factors can easily overwhelm what is going on with g.

Indeed, the vast majority of the decline is not in the Depression or the much more physically destructive World War II, but in the decade of World War I.  Here is where capital simply plunges, falling by more than half in both France and Germany, and by about a third in Britain.  What is curious is that the largest part of this decline is in foreign holdings, which simply collapse.  His discussion of the increase in foreign assets in the nineteenth century involved the colonial empires of these nations, although this was not so important for Germany, which he really does not discuss.  But, while Germany lost its foreign empire, if anything those of Britain and France increased due to  WW I, reaching their peaks in the 1920s as they picked up former colonies of Germany, as well as ones in parts of the former Ottoman Empire.  Piketty simply never acknowledges this.

What else happened?  Oh, the Bolshevik Revolution, which led to the repudiation of tsarist Russian debts, many of whose bonds were owned in these countries, and also the expropriation of foreign company holdings in Russia.  Needless to say this has nothing to do with g.

So, a number of critics have argued that policy really drives all this more than his grand dynamics of r and g.  Offhand looking at his own numbers, this would appear to be the case.  In many decades what is happening to distribution is going in quite the opposite direction from what should be the case if one just looks at r and g (mostly just g).  If it is not policy that is causing this, it is some exogenous shock.

Of course for his current policy discussion, he argues that everything is now working to increase inequality.   The growth rate has fallen and policy has moved to favor the wealthy and those who inherit (particularly in the US on the latter).  So, policy must be changed if we are not to end up a patrimonial capitalism.  On that he probably is correct, but he may well have overstated the role of his grand dynamics and understated the role of everything else in his discussion, even as he provides many caveats on this point.

Barkley Rosser