(Heather Boushey, executive director and senior economist for the Washington Center for Equitable Growth, appeared on the PBS News Hour on May 13 alongside Kevin Hassett of the American Enterprise Institute and moderator Gwen Ifill of PBS to debate the importance of Thomas Piketty’s new best-selling book “Capital in the 21st Century.” Her column below encapsulates her views on the book as discussed on the show. You can find her review of the book here.)
People continue to ask me what they need to know about economist Thomas Piketty’s 700-page tome, “Capital in the 21st Century.” I read the book, which is genuinely engaging, and I recommend you do the same. But I get that it’s a big, academic book with quite a few economic equations, so let me give you a simple answer for what you need to know.
What I learned from reading Piketty is that he has an impressive treasure trove of data (much of it compiled with his co-authors) and the data show that today’s income inequality is calcifying into tomorrow’s wealth inequality, which has serious implications for economic growth, the possibility of the everyday Americans moving up the income ladder, and our democracy.
The importance of Piketty’s perspective comes from his attention to two often-overlooked ways of understanding modern economies. The first is his focus on understanding how income flows become capital stocks. The second is his focus on the trends at the tippity-top of the economic distribution—the top 1 percent—where the biggest accumulations of capital have occurred. Both developments point to the growing economic inequality of the past 40 years devouring our future. This dynamic is troubling indeed for the promise of the American Dream. So let’s look at each of these insights in turn.
Income and capital
When Forbes puts out its new list of the top-earning chief executives, Piketty’s data push us to look not only at their current income, but also how that income will accumulate over time. As an economist, I get that inequality can create an incentive to work harder. Increasing pay for workers with greater skills, talent or effort is good, for a more skilled workforce results in a more productive economy.
But we don’t talk much about how today’s high earners become tomorrow’s propertied elite. Piketty brings back the idea of the “rentier,” the person (or, more likely, the family) whose income comes from their stock of accumulated wealth, through property rents or income from investments. Today’s flow of income becomes tomorrow’s stock of capital in a variety of ways. First, many senior corporate executives and other professionals are paid millions of dollars in salary—much of which they invest—alongside millions more worth of stock options that convert into capital. Second, larger investments tend to earn a higher return because they can accommodate greater risk. If you have more capital, it’s easier to make even more. And finally, large amounts of accumulated capital cannot easily be spent by these investors within in their lifetime, leaving it to their heirs.
Leaving an inheritance isn’t necessarily a bad thing for the children of the very wealthy, but it does mean that a nation’s wealth grows increasingly concentrated among those born into very affluent families. A vibrant economy requires a living workforce with incentives to be the best and create the next big thing—be it the iPhone, the electric car, or the know-how to cure cancer through new genomic discoveries. The opportunity to be the best may well be limited by the concentration of wealth at the very top of society because future inventors will not have the wherewithal to learn and study, invent and start a company. Many Americans boast ancestors who left the Old World because they wanted their chance to make it big; they didn’t want to live in a society dominated by families with “old money.”
Piketty illustrates what happens in a society where capital overwhelmingly trumps labor by pointing to several European novels of the 18th century, where the characters focus on marrying well rather than improving their productive endeavors. Piketty’s data show this is where we’re headed in the United States today. That’s not a recipe for a vibrant economy.
The growing wealth of the wealthiest
Piketty then explores where this wealth is really concentrated. He wants us to recognize that today’s rising inequality isn’t about too many falling behind; it’s about only a few pulling very far ahead—a dynamic that runs counter to how Americans think about inequality. Americans often discuss inequality in terms of “fairness,” which in turn leads policymakers to frame their efforts to foster a more equal society in terms of creating “equality of opportunity.” The American Dream is premised on the idea that anyone can make it to the top of the economic ladder, and much of our political and policy rhetoric is organized around the idea that being born into a low-income family should not prohibit individuals from reaching their highest potential.
What’s more, the idea that there may be something wrong with a few individuals taking in so much of our nation’s income isn’t even on the table because of the belief that “they earned it.” Americans tend to embrace a form of capitalism that is all about risk-taking and the subsequent big pay-off—the reward that incentivizes taking those risks in the first place. Yet Piketty spells out several important reasons to look at the very top and question whether this is the kind of capitalism our economy is fostering today and into the future. He concludes that the vast majority of us are getting a raw deal because the rewards going to the top one percent are not justified by their risk-taking. Paying top dollar is supposed to bring top talent and top productivity, yet Piketty shows that we cannot look to productivity to explain the exceedingly high wages accruing to the top one percent. In fact, he calls doing so “illusory.”
The rise in U.S. inequality stems from increased pay specifically to the top one percent of income earners. As a test, Piketty compares the skills of the top one percent with the next nine percent, who are doing very well relative to the remaining 90 percent of income earners but not so much compared to the top one percent, to see if they differ. They don’t. So skills cannot explain the rise in incomes in the top one percent relative to the next nine percent. There is something else is going on that is not benefiting our economy.
Furthermore, Piketty warns that growing wealth at the very top has nothing to do with skills. It is important to ensure that the children of all Americans have a fair shot at opportunity But given the growing importance of inherited wealth—and the increasingly well-documented importance of both financial capital and human capital that wealthier parents are able to pass on in the form of much better early childhood education, attendance at better primary and secondary schools, important connections when applying to college and those first jobs—what is equality of opportunity?
The Piketty moment
In the two months since Piketty’s book was published in English, economists have been arguing over his central economic premise—the idea that so long as the rate of return to capital, r, is greater than the rate of economic growth, g, then economic inequality will continue to rise. In a recent speech, Jason Furman, the Chair of the White House Council of Economic Advisers, succinctly summarized the nut of the issue: “Intuitively, wealth grows with r while wages grow with g.” Thus, as long as the rate of return on capital exceeds the rate of economic growth, income from wealth is greater than that from wages.
That’s the past devouring the future—and it happens because income flows become capital stocks. The central take-away here is that in order to create a vibrant economy and a strong middle class we need to pay attention not only to wages, but also capital. This is being done by Piketty and his colleagues through the sheer breadth and quality of Piketty’s (and his colleagues’) impressive data. Indeed, already Piketty had a ready-made audience for his new book, because it was Piketty’s 2003 paper in the Quarterly Journal of Economics (with Emmanuel Saez) that first made it possible for us to see what was happening in the “top 1 percent.”
Now, “Capital in the 21st Century” expands our knowledge about global inequality. The data alone are a seminal contribution to economics that is a good thing no matter what you think of how he interprets the data.