Home' Trinidad and Tobago Guardian : April 27th 2014 Contents income from 1700 to 1910, then fell sharply from 1910 to
1950, presumably as a result of wars and depression, reaching
a low of 2.5 in Britain and a bit less than three in France. The
capital-income ratio then began to climb in both countries,
and reached slightly more than five in Britain and slightly less
than six in France by 2010.
The trajectory in the United States was slightly different:
it started at just above three in 1770, climbed to five in 1910,
fell slightly in 1920, recovered to a high between five and 5.5
in 1930, fell to below four in 1950, and was back to 4.5 in
The wealth-income ratio in the United States has always
been lower than in Europe. The main reason in the early years
was that land values bulked less in the wide open spaces of
North America. There was of course much more land, but it
was very cheap. Into the twentieth century and onward, how-
ever, the lower capital-income ratio in the United States
probably reflects the higher level of productivity: a given
amount of capital could support a larger production of output
than in Europe.
It is no surprise that the two world wars caused much less
destruction and dissipation of capital in the United States
than in Britain and France. The important observation for
Piketty s argument is that, in all three countries, and elsewhere
as well, the wealth-income ratio has been increasing since
1950, and is almost back to nineteenth-century levels. He
projects this increase to continue into the current century,
with weighty consequences that will be discussed as we go
on.In fact he predicts, without much confidence and without
kidding himself, that the world capital-income ratio will rise
from just under 4.5 in 2010 to just over 6.5 by the end of this
century. That would bring the whole world back to where a
few rich countries of Europe were in the nineteenth century.
Where does this guess come from? Or, more generally, what
determines an economy s long-run capital-income ratio any-
way? This is a question that has been studied by economists
for some 75 years. They have converged on a standard answer
that Piketty adopts as a long-run economic "law." In rough
outline it goes like this.
Imagine an economy with a national income of 100, growing
at 2.0 per cent a year (perhaps with occasional hiccups, to
be ignored). Suppose it regularly saves and invests (that is,
adds to its capital) 10 per cent of national income. So, in the
year in which its income reaches 100 it adds 10 to its stock
of capital. We want to know if the capital-income ratio can
stay unchanged for next year, that is to say, can stabilise for
the long run.
For that to happen, the numerator of the capital-income
ratio must grow at the same 2.0 per cent rate as the denom-
inator. We have already said that it grows by 10; for that to
be 2.0 per cent of capital, capital must have been 500, no
more, no less. We have found a consistent story: this year
national income is 100, capital is 500, and the ratio is 5. Next
year national income is 102, capital is 510, the ratio is still
5, and this process can repeat itself automatically as long as
the growth rate stays at 2.0 per cent a year and the saving
/ investment rate is 10 per cent of national income.
Something more dramatic is true: if capital and labour
combine to produce national output according to the good
old law of diminishing returns, then wherever this economy
starts, it will be driven by its own internal logic to this unique
self-reproducing capital-income ratio.
Careful attention to this example will show that it amounts
to a general statement: if the economy is growing at g percent
per year, and if it saves s percent of its national income each
year, the self-reproducing capital-income ratio is s / g (10 /
2 in the example).
Piketty suggests that global growth of output will slow in
the coming century from 3 per cent to 1.5 per cent annually.
(This is the sum of the growth rates of population and pro-
ductivity, both of which he expects to diminish.) He puts the
world saving / investment rate at about 10 per cent. So he
expects the capital-income ratio to climb eventually to some-
thing near 7 (or 10 / 1.5). This is a big deal, as will emerge.
He is quite aware that the underlying assumptions could turn
out to be wrong; no one can see a century ahead. But it could
plausibly go this way.
Positive net return
The key thing about wealth in a capitalist economy is that
it reproduces itself and usually earns a positive net return. That
is the next thing to be investigated. Piketty develops estimates
of the "pure" rate of return (after minor adjustments) in Britain
going back to 1770 and in France going back to 1820, but not
for the United States. He concludes: "(T)he pure return on
capital has oscillated around a central value of 4.0--5.0 per
cent a year, or more generally in an interval from 3.0--6.0 per
cent a year. There has been no pronounced long-term trend
either upward or downward.... It is possible, however, that the
pure return on capital has decreased slightly over the very long
run." It would be interesting to have comparable figures for
the United States.
Now if you multiply the rate of return on capital by the cap-
ital-income ratio, you get the share of capital in the national
income. For example, if the rate of return is 5.0 per cent a year
and the stock of capital is six years worth of national income,
income from capital will be 30 per cent of national income,
and so income from work will be the remaining 70 per cent.
At last, after all this preparation, we are beginning to talk
about inequality, and in two distinct senses. First, we have
arrived at the functional distribution of income---the split
between income from work and income from wealth.
Second, it is always the case that wealth is more highly con-
centrated among the rich than income from labor (although
recent American history looks rather odd in this respect); and
this being so, the larger the share of income from wealth, the
more unequal the distribution of income among persons is
likely to be. It is this inequality across persons that matters
most for good or ill in a society.
This is often not well understood, and may be worth a brief
digression. The labor share of national income is arithmetically
the same thing as the real wage divided by the productivity
Would you rather live in a society in which the real wage
was rising rapidly but the labour share was falling (because
productivity was increasing even faster), or one in which the
real wage was stagnating, along with productivity, so the labour
share was unchanging? The first is surely better on narrowly
economic grounds: you eat your wage, not your share of national
income. But there could be political and social advantages to
the second option. If a small class of owners of wealth---and
it is small---comes to collect a growing share of the national
income, it is likely to dominate the society in other ways as
well. This dichotomy need not arise, but it is good to be clear.
Suppose we accept Piketty s educated guess that the cap-
ital-income ratio will increase over the next century before
stabilising at a high value somewhere around 7.0. Does it follow
that the capital share of income will also get bigger? Not nec-
essarily: remember that we have to multiply the capital-income
ratio by the rate of return, and that same law of diminishing
returns suggests that the rate of return on capital will fall. As
production becomes more and more capital-intensive, it gets
harder and harder to find profitable uses for additional capital,
or easy ways to substitute capital for labor. Whether the capital
share falls or rises depends on whether the rate of return has
to fall proportionally more or less than the capital-income ratio
There has been a lot of research around this question within
economics, but no definitely conclusive answer has emerged.
This suggests that the ultimate effect on the capital share,
whichever way it goes, will be small. Piketty opts for an increase
in the capital share, and I am inclined to agree with him. Pro-
ductivity growth has been running ahead of real wage growth
in the American economy for the last few decades, with no
sign of a reversal, so the capital share has risen and the labor
share fallen. Perhaps the capital share will go from about 30
per cent to about 35 per cent, with whatever challenge to dem-
ocratic culture and politics that entails.
There is a stronger implication of this line of argument, and
with it we come to the heart of Piketty s case. So far as I know,
no one before him has made this connection. Remember what
has been established so far. Both history and theory suggest
that there is a slow tendency in an industrial capitalist economy
for the capital-income ratio to stabilise, and with it the rate
of return on capital. This tendency can be disturbed by severe
depressions, wars, and social and technological disruptions,
but it reasserts itself in tranquil conditions.
Over the long span of history surveyed by Piketty, the rate
of return on capital is usually larger than the underlying rate
of growth. The only substantial exceptional sub-period is
between 1910 and 1950. Piketty ascribes this rarity to the dis-
ruption and high taxation caused by the two great wars and
the depression that came between them.
There is no logical necessity for the rate of return to exceed
the growth rate: a society or the individuals in it can decide
to save and to invest so much that they (and the law of dimin-
ishing returns) drive the rate of return below the long-term
growth rate, whatever that happens to be.
It is known that this possible state of affairs is socially perverse
in the sense that letting the stock of capital diminish until the
rate of return falls back to equality with the growth rate would
allow for a permanently higher level of consumption per person,
and thus for a better social state. But there is no invisible hand
to steer a market economy away from this perversity.
Yet it has been avoided, probably because historical growth
rates have been low and capital has been scarce. We can take
it as normal that the rate of return on capital exceeds the
underlying growth rate.
But now we can turn our attention to what is happening
within the economy. Suppose it has reached a "steady state"
when the capital-income ratio has stabilised. Those whose
income comes entirely from work can expect their wages and
incomes to be rising about as fast as productivity is increasing
through technological progress. That is a little less than the
overall growth rate, which also includes the rate of population
Now imagine someone whose income comes entirely from
accumulated wealth. (I am ignoring taxes, but not for long.)
If she is very wealthy, she is likely to consume only a small
fraction of her income. The rest is saved and accumulated,
and her wealth will increase. If you leave $100 in a bank
account paying 3.0 per cent interest, your balance will increase
by 3.0 per cent each year.
This is Piketty s main point, and his new and powerful con-
tribution 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. (There seems
to be no offsetting tendency for the aggregate share of capital
to shrink; the tendency may be slightly in the opposite direction.)
This interpretation of the observed trend toward increasing
inequality, and especially the phenomenon of the 1.0 per cent,
is not rooted in any failure of economic institutions; it rests
primarily on the ability of the economy to absorb increasing
amounts of capital without a substantial fall in the rate of
return. This may be good news for the economy, as a whole,
but it is not good news for equity within the economy.
Robert M Solow, New Republic
APRIL 27 • 2014 www.guardian.co.tt SUNDAY BUSINESS GUARDIAN
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Accumulating equity and wealth
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