In “Capital in the 21st Century,” Thomas Piketty of the Paris School of Economics proposes an economic theory of rising inequality over time thanks to the growing prevalence of capital over labor. That theory’s analysis of recent trends and its prediction about future inequality—and the capital-centered channel that he specifies for it to play out—have been subjected to criticism from economists, most pointedly from some who conduct research in macroeconomic theory. There are substantial differences between the theory Piketty uses and some of the economics profession’s received wisdom. This short paper examines how his theory relates to key ideas in macroeconomics, and, where they are not consistent with Piketty’s empirically-based analysis and conclusions, why Piketty’s assumptions, reasoning, and predictions are more likely to be correct than those of his critics.
Piketty argues that there are two mechanisms by which capital is and will continue to be the reason for rising wealth and income inequality. Both mechanisms are premised on the long-run empirical relation r > g, meaning that the rate of return to owning capital is higher than the economy-wide growth rate (which determines the growth rate of wages). Both mechanisms are also based on the empirical fact that the distribution of capital is highly skewed: the top 10 percent of the wealth distribution has always owned more than 50 percent of total wealth, and has historically owned 90 percent or more of total wealth.
The two mechanisms that determine rising wealth and income inequality are:
• The wealthy are likely to accumulate more and more wealth (as a percentage of the economy’s annual output) because the return they get from existing wealth net of consumption and of wealth taxes is higher than the growth rate of output. As they do, the share of annual output that accrues to the owners of capital will increase. That growing capital share increases the incomes of the already-wealthy owners of capital relative to the much larger portion of the population who earn income mostly or solely from their labor.
• Even stipulating that capital’s share of income remains constant, the wealth and income distributions can still become more and more skewed thanks to capital accumulation if the rate of return earned by the wealthy is an increasing function of initial wealth, or if the saving rate is an increasing function of initial wealth, or both.
Each of the three challenges considered in this white paper casts doubt on one or both elements of Piketty’s capital channel. (Please click here to read the full white paper and citations)