Pikettymania

By Megan McArdle,

Why America has a wealth inequality fever.

A specter is haunting Europe and the U.S.—the specter of plutocracy. In Britain, Deputy Prime Minister Nick Clegg has suggested the moment has arrived to consider a wealth tax. In France, which already has one, plans to ease its bite were recently canceled. Even in the more timid precincts of Washington, you cannot swing a V for Vendetta mask without hitting a think tank panel on inequality. Everyone, it seems, is worried we are shortly headed for a world in which a handful of rich people will own everything, and the rest are forced to rent their air and water from Mark Zuckerberg.

Small wonder, then, that French economist Thomas Piketty’s Capital in the Twenty-First Century has ignited an ideological fervor reminiscent of a Paris mob at the gates of the Bastille. The title seems to be a puckish homage to Karl Marx’s Capital. Although Piketty disdains Marx’s unsystematic thinking, they share a core concern about wealth run amok or rather too much concentrated in one place. Piketty speaks for a lot of people when he voices a dark half-prophecy that the forces of capital accumulation will leave us with a society radically less equal, less mobile, perhaps even less democratic. As he puts it, “The past devours the future.”

Booksellers have been unable to keep Capital on their shelves. This runaway success may not seem too surprising in an era when President Obama has called inequality “the defining challenge of our time.” However timely the argument, the book itself is not what one thinks of as popular reading. “When the book came out,” says economics professor Brad DeLong, of the University of California at Berkeley, “I thought it had an audience of three people in Berkeley”—himself, economic historian Barry Eichengreen, and Christina Romer, former head of the president’s Council of Economic Advisers.

How did this book work its way to the top of Amazon.com’s (AMZN) ranks, right up there with The Conscious Parent and Frozen Little Golden Book?

Part of the answer is controversy. Liberals love its affirmation of their sense that the rich have never been richer, while conservatives worry it is an attempt to steal a base in the ongoing battle to tax private wealth. Capital in the Twenty-First Century is a perfect stand-in for collective anxiety about the fate of the middle class, from Occupy Wall Street’s concern that the 1 Percent are leaving the rest of us to an increasingly impoverished future, to the growing worry on the right that inequality springs from and is creating a vicious cycle of economic instability and cultural breakdown among the two-thirds of the American population who lack a college diploma. The book doesn’t speak to our current situation nearly as much as many buyers probably think. But the conversation it has provoked very much does.

Piketty’s book is an expansion of his earlier work but also a significant departure: For the first time he is attacking the problem of wealth inequality, as well as income inequality. People frequently speak as if the two are interchangeable. They are in fact quite distinct—one does not imply the other—and part of what makes Capital in the Twenty-First Century so important is that it provides a comprehensive account of the coevolution of income and capital.

The first thing to understand about Capital is that it is not really one book. There’s a data book, an analysis book, a book of projections about the future, and a book of policy recommendations based on those projections. All four are packaged within its 700 pages and frequently interleaved. Each has different strengths and weaknesses, a different style of argument, and a different audience—and when you see commentators yelling at each other about the contents, it’s probably because they’re talking about different books.

Over the last few weeks, however, Piketty has taken some knocks. Four French economists published an article arguing that his results on rising wealth are largely driven by the Europe-U.S. housing bubble, which has pushed up home prices but not necessarily rents. This could seriously undercut Piketty’s thesis in one of two ways: Home prices could fall back toward previous levels as central banks begin raising interest rates, or they could keep rising much faster than rents—in which case, the return on large amounts of our capital stock would fall.

Chris Giles, economics editor of the Financial Times, alleged serious errors in Piketty’s work. Giles went through the data, which Piketty makes available to all on the Web. He claimed to have found flaws ranging from minor transcription errors to an inexplicable divergence between Piketty’s data on British wealth inequality and the data sets the professor cites.

n an e-mail to Bloomberg News, Piketty rejects these arguments, saying “there’s no mistake or error” in his work. This might be a bit strong—what superman has published 700 pages without so much as a misplaced decimal point? And even many of his critics seem to agree the supposed errors aren’t fatal.

r > g has become a somewhat unlikely catchphrase among many left-leaning commentators. In English, what this means is that the rate of return on capital, r, is higher than the growth rate of the economy as a whole, g. In even plainer English, this means income from investments will grow faster than wages.

Piketty dubs this the central contradiction of capitalism and spends much of Capital teasing out its implications. He concludes that, if left unchecked, capital tends to grow faster than the economy; so over time, the ratio of wealth to income soars. He details a dire possible future that looks a lot like the past—which is to say, a world in which inheritance trumps almost every other possible way of making money.

The idea that r is greater than g itself is not so disputed. “Of course r is greater than g,” says Rogoff. Winship says it’s “basically noncontroversial, because you have to have some compensation for risk.” People who save and invest their money are choosing to trade away today’s income in exchange for income tomorrow. Investments have to pay a premium to get people to park their money—and since the future is uncertain, that premium has to be pretty large.

The biggest complaint is that his results depend heavily on his assumptions—and his assumptions are not necessarily good. “Even if one grants r > g, capital may grow more rapidly than output, less rapidly, or at the same pace,” says a critique by Stefan Homburg of Germany’s Institute of Public Finance. In other words, even if the return on capital is higher than the growth rate of the economy, that doesn’t mean capital will accumulate and concentrate itself indefinitely; the capitalists might spend it, give it away, or divide it among heirs faster than it accumulates. Even Piketty acknowledges that capital will not accumulate forever, as Marx predicted.

Whether he’s right depends on a number of things. For example, as the stock of capital gets larger, the return on each additional dollar invested into capital is likely to fall. If you’re the first person to open a fast-food restaurant in your town, the return on your investment is probably pretty high. If you’re the 80th, you should have more modest expectations. Piketty assumes that the return on capital will stay high enough to keep capital incomes rising for a good long while, even as growth in the rest of the economy slows because of a variety of technological and demographic factors.

Why the assumption? For one thing, his data show that return on capital was high before the Industrial Revolution, when rates of growth were very low. There’s a problem with this: Piketty doesn’t really have good data for the period before the Industrial Revolution. So he just infers a rate based on what information we have about land rents and interest rates. While that’s perfectly fair, it gives credence to the critique that he’s bolstering an assumption about the future with yet another assumption about the past.

… if it’s relatively easy to substitute capital for labor—imagine staffing your fast-food restaurants with hamburger-cooking machines and order-taking computers that never take a break and don’t demand raises or health insurance—then additional investments may be made at a high rate of return. Berkeley’s DeLong explains Piketty’s future in a single word: “Robots!”

OK, but how many of them will we buy? How fast capital accumulates also depends on the behavior of the capitalists. Do they take their extra income and reinvest it in more income-producing capital? Or do they invest it in extravagant vacations, designer clothes, and rapidly depreciating yachts? Piketty assumes that the savings rate will stay steady; this is not necessarily the most obvious assumption. … Over time, each additional machine is apt to create less and less value relative to its cost. So maybe you put the money into a nicer vacation instead or give it away.

This might not hold for the giant fortunes that Piketty worries are accumulating …[like] … Bill Gates … [and] … Warren Buffett.

The taxes, dislocation, and sheer physical destruction involved in fighting large-scale wars appear to be devastating to wealth. Piketty’s analysis shows a U-shaped curve for European capital in the 20th century: It starts at a peak on the eve of World War I, then quickly declines, bottoming out from 1950 to 1970 before beginning to rise sharply again. Piketty’s work suggests that this era was an historical anomaly, and he predicts that capital will dominate the future as it did before the wars.

But predicting the future can be hard work. Imagine an ancestral Thomas Piketty sitting down in 1913 to write Capital in the Twentieth Century. Such a book would probably have shown a continuation of long-term trends, with a tiny European elite deriving most of their outsize income from investments or land. He would probably predict that capital income, which had recently been rising in Britain and France after a 30-year decline, would continue to soar. In other words, his major prediction would have likely been totally wrong.

By extension, any policy changes he suggested would also be wrong. This section of the book, and especially Piketty’s proposal of a global tax on wealth to prevent the accumulation of massive fortunes, is almost universally viewed as the weakest. “I suspect he doesn’t take that seriously himself,” Rogoff says of the wealth tax. “First of all, it’s next to impossible to implement. … “Does he mean to have a wealth tax on the French middle class and send the money to Africa?” asks Rogoff. … Wealth taxes were adopted by a lot of countries in the 20th century; most abandoned them, because the rich people kept moving abroad and taking their capital with them. That’s why Piketty has proposed making his wealth tax global. As Rogoff points out, however, this substitutes one political economy problem for the even larger difficulty of getting every last nation on the earth to agree to impose it.

Even if we assume Piketty’s prediction is correct, that economic forces favoring capital will cause it to accumulate and concentrate in the hands of a hereditary superelite, and even if we assume his remedies would work, that leaves one big question to debate: Is this really the most important issue facing the world, “the defining challenge of our time”?

The most remarkable thing about Piketty’s book is that it owes its popularity to U.S. audiences. When Capital in the Twenty-First Century was published in France last year, it sat quietly on the shelves.

… as the book shows, wealth inequality is far less pronounced in the U.S. than in Europe. The dramatic U curve in European wealth is practically flat in America, where the capital-to-income ratio in 2010 was lower than it had been in 1870—or 2000.

They’re not wrong that something is happening in the U.S. While people do hate the idea of a landed gentry with huge trust funds—think of the 1 Percent owning more than a third of all wealth—that’s not actually what’s driving the troubling trends. A society that used to offer broad security, stability, and opportunity to the top 75 percent of households is now increasingly divided into an educated elite and a low-skilled workforce for whom work is uncertain and not very well paying. This doesn’t just make it harder to sustain the iconic single-family home on a nice lot; it makes it harder to form stable families and communities. Among people without a college diploma, life looks more and more like it did for the welfare-dependent underclass in the 1980s: exploding levels of single parenthood with multiple partners and low levels of participation in civic groups such as churches and bowling leagues. People living in this environment are more financially and emotionally vulnerable; children are more likely to drop out of school and the labor force.

Among the educated, marriage is great, healthier than ever. But looking at the chaos at the bottom, and forced to compete with the superrich for college slots and houses in good school districts, many, even among the well educated, are terrified they won’t be able to assure their children a place in the middle class—especially since their own jobs, while more secure than the loading dock work at Walmart (WMT), are more vulnerable to layoffs than they used to be. All this is made scarier still by the rising cost of health care and college tuition.

Of course, this is partially a story about capital: Robots actually have replaced a lot of jobs and will replace more in the future. … capital is becoming a better substitute for many forms of labor—and the people who did that labor are having trouble finding replacement jobs that will pay them as well as their old ones did.

This is also a story about globalization. The rise of China has added a billion people to the global workforce, most of them willing to work for much less than an American autoworker. Immigration has brought low-wage competition for construction workers and landscapers. The Internet and the emergence of robust global markets have increased the returns available to people at the very top. Everything from consumer electronics to movies are sold in a single world market, which means the winners get paid more than ever. The losers can no longer survive by finding a smaller pond, as the global marketplace has blown away local niches.

While global markets make capital more valuable, they also destroy a lot of capital; just ask the people who owned the factories now rusting along half the highways in the Midwest. … “If you took the whole world as a country, you’d be pretty excited about what has happened over the last 30 years,” says Rogoff. Of course, if you’re a steelworker in Ohio, that’s cold comfort.

Piketty’s proposal for higher taxes, including a wealth tax, might stop wealth from accumulating in quite such dramatic piles. What it can’t do is roll back the automation and globalization processes that have so many people so terrified; at best, it would slow the pace. We could use the proceeds of a wealth tax to ease some of the pain, but even in countries with a generous social safety net, long-term unemployment is miserable.

Judging from the reviews and the reaction and commentary, most readers are probably not looking to tease out these sorts of complications. They are interested in the book’s broad sweep

Piketty has touched off the most vigorous public conversation about inequality since Occupy Wall Street—only this time it’s a conversation about data and economics, rather than the wealth of certain bankers and the propriety of camping in the streets. That’s a lot of progress to come from one man.

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