A Review of Capital in the 21st Century by Thomas Piketty

05 August 2014

In drawing attention to income and wealth inequalities across the globe – based on
an impressive array of historical data – Thomas Piketty has provided a considerable
service to an economics profession obsessed, as he argues, with spurious
mathematical modelling. However, what is far less certain is whether he delivers
what his book “Capital in the 21st Century” appears to promise, i.e. a modern,
comprehensive analysis of the dynamics of capitalism and comprehensive manifesto
for change. The aim of this critical review – there have been any number of flattering
reviews – is to provide a centre-left critique of Piketty’s book, while being very
supportive of his general approach and his conclusions about the dangers of not
attempting to redress the economically dysfunctional – as well as socially unjustified)
global maldistribution of income and wealth.
Refreshingly Piketty approaches the subject from a ‘classical economics’ viewpoint,
concerned as it was with economics as a study of the distribution of income
and wealth. He attempts to provide a historical analysis of capitalism tracing income
and wealth distribution through many centuries, pre-dating modern industrial and
financial capitalism. He does this by deriving his theory of capitalist development
from long-run longitudinal and cross-country data sets. No-one is better qualified,
given Piketty’s previous collaborative work with Saez and Atkinson on US income
and wealth inequality, using tax record data. The coverage in Piketty’s new book is
staggering: it covers two to three centuries of empirical data on capital and output,
national income distributions, the rate of return on capital, inflation, inheritance flows
and more data, for the most important rich economies (France, UK, United
States, and somewhat less Germany, Japan, Sweden, and Canada). From this data
he derives the theory that he advances to explain the likely failure of capitalism in the
21st century; namely that that the underlying dynamics of capitalism lead to an
increasing tendency for wealth to accumulate in the hands of a relative small group
of ‘patrimonial’ and rentier capitalists. Piketty’s theory is essentially derived from his
data, rather than being an analytical growth theory which is then tested on the data.
However, the theory, nonetheless, must stand on its own feet, and be capable of
extrapolation over a future period. We should start, therefore, with the theory.
The Theory
His theory is contained, essentially, in two equations
β = s/g
α = r*β
β is the capital/income ratio of a nation’s economy
s is the savings ratio
g is the growth rate
α is capital’s share of the national income
r* is the real rate of return on capital
The first equation does not tell us very much as it represents an accounting
relationship (an identity). It simply defines the share of capital in national income (α)
as the rate of return on capital (r) times the ratio of the capital stock to income (β).
The second equation purports to indicate the essential dynamics of capitalism.
It represents a long-run, steady state condition. The ratio of capital stock to
income equals the savings ratio (s) divided by the growth rate (g).
Piketty’s argument – derived from analysis of his long-term data sets – is that the
capital’s share will tend to rise if the rate of return on capital is greater than
the growth rate, assuming no change in the savings ratio. Piketty goes on to
argue that a r*>g is, historically, the norm. However, this relationship did not hold (i.e.
(g) was higher than (r*)) from 1910 to 1980) during most of the 20th century. This
‘gap’ he attributes to the advent of two world wars (which he argues destroyed
capital) and the 1930s depression in between, both factors leveraging growth
upwards over this period and, at the same time, depressing the capital share. This
unique period has ended and capitalism in the 21st century is reverting to its
underlying historical position.
Supporting Evidence
Piketty’s empirical argument rests on his perception that his data sets permit
an interpretation of industrial and pre-industrial capitalist history from 1700 to 1910
(though one of his graphs goes back to pre-Roman times), which shows (r*) greater
than (g) and, hence. high capital shares, until interrupted by the period from 1910 to
This later period saw – following the two world wars and the depression between
them – a strong growth recovery during the post-second world war period, plus a
mixture of high income and wealth taxation and inflation. These factors combined to
ensure a lower (r*) and a higher economic growth rate (g), and hence to constrain
the capital share (α).
From 1980 the wealth concentration of the very rich started to increase. Piketty
suggests that in the 21st century the ‘historically normal’ r*>g relationship will obtain
and that, hence, capital’s share will rise inexorably, in line with the “fundamental
law” represented by Piketty’s second equation. This is supported, he argues, by his
(albeit historically contingent) view that a) there is slowing population growth
constraining the labour supply and hence growth, and b) technology will not lift the
productivity of capital (he is a technology pessimist), and hence capital deepening
will not stimulate growth. Finally, the savings ratio will also not adjust to compensate
for the capital share growth, His view is, therefore, that capitalism will fail in this
century. Unless, that is, one accepts Piketty’s prescription of a global wealth tax,
which even he regards as “utopian”. (This pessimism makes Marx look positively
optimistic; at least he postulated a working class revolution to stop the ‘inevitable’!)
A slightly different pattern from that of wealth emerges in relation to income shares of
the rich. These fell during the three decades following the Second World War, but
have increased again for the rich and particularly for the very rich from 1980. This
income is increasingly being converted into wealth by the latter. Hence, Piketty’s
references to “patrimonial capitalism” and the growth of the rentier class (here
he was anticipated by Keynes and by Schumpeter). But Piketty does not distinguish
between entrepreneurs and rentiers, arguing that entrepreneurs inevitably also
become rentiers, often concurrently. Hence, the increasing distortion of income,
since 1980, provides the extreme growth of wealth so far in this century.
Some Concerns
There are a number of concerns about Piketty’s approach and conclusions,
particularly in relation to his definition of capital and his explanation of the dynamics
of capitalism and the determinants of economic growth, as indeed there are about
some of his discussion of policy issues in Part 4 of his book.
First, as James Galbraith, and others, has observed, Piketty’s definition of capital
raises some definitional and theoretical problems. He conflates physical capital and
financial capital. His ‘capital’ is actually wealth so long as it produces any
income/rent, notional or otherwise. But he, nonetheless, uses his definition of capital
as if it is coterminous with physical capital, used as a determinant of economic
growth. This is to say the least, unusual, if not improper.
Piketty includes housing and land, even when they are not in productive use.
However, he apparently excludes other aspects of infrastructure, e.g. bridges.
Importantly, the substantial fluctuations in the capital share which he observes are
often due to financial fluctuations in market value and not the growth and decline of
physical capital. Piketty, on the other hand, argues that during the period 1910 to
1950 it was precisely the destruction of physical capital, attributable to the advent of
two world wars, which led to its reconstruction and stimulation of economic growth.
Though plausible, it is also convenient for Piketty’s argument and may not historically
be entirely correct, particularly in respect of the first world war.
Moreover, for someone who advocates political and social analysis of economic
events, Piketty ignores the economic impact of the social movements which arose
during this period, such as the development of trade unions, socialist and communist
political parties, the relative emancipation of women, etc, (this social dimension is
well-covered in a another recent book, ‘People; The Rise and Fall of the Working
Class, 1910 to 2010’ by Dr Selina Todd ).
Piketty, in fact, adopts a neo-classical view of capital and growth, commenting
favourably on long-run, Solow-type growth models. In so doing he misrepresents the
(Cambridge, UK versus Cambridge, Mass.) controversy and its resolution in favour
of Cambridge, UK. The controversy resulted in a general acceptance (e.g. notably by
Paul Samuelson) that capital is incommensurable with land and labour, and also that
there is no linear, monotonic relationship between the rate of profit/interest and
physical capital intensity (and hence no aggregate production function). These
conclusion hold for all neo-classical models, including general equilibrium models;
notwithstanding their current employment in economics and the collective amnesia
about the actual resolution of the Cambridge controversy (see also Luigi Pasinetti).
Piketty seems ignorant of this rather crucial debate or its resolution, even though it
would actually support his views on much of mainstream economics teaching.
For a modern book, the changing nature of national income in developed countries –
with services dominating (e.g. manufacturing in the UK is now just under 10% of
GDP) – is ignored, In services, productivity is not dependent of the input of
physical capital and mainly not on capital deepening. Rather is total factor
productivity more important, including so-called ‘human capital’. Because there is no
market exchange of human capital then this is excluded from Piketty’s classification
of capital.
Hence, feeding Piketty’s rather loosely defined marketable capital – driven by
fluctuating financial asset values – into a long-run balanced growth model is
inappropriate. Yet this is what Piketty effectively does. Moreover, he tends to
assume historical long-run values, e.g. for the rate of return on capital, without any
analysis of why the value(s) are what they are. There is, therefore, inter alia,
confusion between a rate of return derived from profit on productive capital
employed and the financial rate of return linked the, institutionally fixed, rate of
Second, despite Piketty’s scathing remarks about Marx he, himself, may be accused
of a) ‘nicking’ his explanatory equation from Marx and b) suggesting a similar
historical inevitability about his prediction (save for his impractical, by his own
admission, global wealth tax idea). This combination seems to undermine his
outright rejection of Marx. Piketty will, presumably, argue that, unlike Marx, his
theoretical position is derived from an empirical statistical data set, and is, therefore,
inherently more likely to be correct. In fact, as pointed out earlier, this is not, in
principle, the case. The other problem is that the data sets are neither long enough
(or sometimes they are too long, e.g. back to antiquity) nor consistent enough (the
cross-country comparisons and time series do not always work, see Branko
Milanovic) as a basis on which to erect a theory which has so little analytical and
institutional content. To be fair to Piketty he does frequently counsel against placing
too much credence on his own data.
Third, despite this apparent quasi-Marxist approach, Piketty seems to oscillate
between: 1) a neo-classical growth model approach (he regards the Solow-type
models as valid); 2) a somewhat simplistic Marxist view of the evolution of rate of
return on capital, but ignoring Marx’s view of capital as the surrogate for power, and
3) an apparently anti-neo-liberal position, but without any challenge to the increasing
marketisation of society or the validity of the market as a process construction as
used by mainstream economists.
Fourth, Piketty’s obsession with pre-tax incomes and taxation means that he fails to
consider a possibly easier method of reducing the flow of rentier income from
monopoly rents and excessive profits by increasing substantially the minimum wage
and by freeing up collective bargaining. Expanding rather than contracting the
state provision of public goods – which Piketty mentions in relation to the ‘social
state’ (see below), but is pessimistic about expanding their provision – would also
assist in redressing the balance between lower and middle income earners and the
rich. Of course, all of these remedies, together with Piketty’s own, will be rejected by
the neo-liberal consensus which is currently the political economic orthodoxy.
Piketty’s relative neglect of social and institutional factors; regulatory action by the
state, and political cultural factors means that he rarely engages with the neo-liberal
positions which require to be challenged if his prescriptions are to be accepted.
Piketty’s Policy Discussion and Recommendations
Part 4 of Piketty’s book is devoted to a discussion of policy issues and options.
Again, though he makes some strong and valid observations on the issues on
income and wealth disparities and the available remedies (essentially taxation), there
are some weaker sections.
First, his discussion of pensions is useful, but not comprehensive, and is based very
much on the French and other European country (excluding the UK) models. He is
also pessimistic about the affordability of state-provided ‘pay as you go’ pensions. In
fact, a reasonable level of state pensions is affordable, despite increasing longevity.
It is a matter of political will. The bigger problem, given increasing longevity, is the
cost requirements for social and nursing care in the developed countries. However,
improving life styles (e.g. better diet, more exercise) should reduce morbidity in the
elderly, and technology (about which Piketty is generally pessimistic) should reduce
the costs of health care delivery, except of course for personally delivered social
Second, he ignores the historical (statistical) evidence for periods of economic
growth, as well as inflation, reducing debt/gdp ratios. Still, importantly and
refreshingly, he appreciates that public debt is actually private wealth, and hence his,
correct, support for a net wealth tax to reduce debts and deficits. But, of course, as
remarked earlier, he is pessimistic about economic growth, assuming that the weak
population growth and reduced capital-deepening via technology will inexorably lead
to lower growth. Incidentally, he fails to mention the real debt problem, particularly in
the UK and the US, of the mountainous private debt, which will slow economic
growth. Higher wage growth, via increasing the minimum wage and strengthening
trade union wage-bargaining, will both increase growth and reduce dependency on
consumer credit/private debt.
Third, aside from his sensible espousal of a regional EU wealth tax, his discussion
of the Eurozone problems and the ECB is not very illuminating, e.g. his suggestion
that the ECB operates to buy sovereign bonds only in the secondary market ignores
(since 2010) the fact that this is true of both the Fed and the BoE. Interestingly,
though he rightly rejects the baseless Maastricht debt/gdp and deficit/gdp ratios
(however ignoring the rather more important Maastricht common inflation target of
2%), his suggestion is to allow national parliaments to set such ratios, and not the
European parliament. This seems slightly at odds with his view that there should be
an EU-wide net wealth tax.
Fourth, he correctly, indicates the need for fiscal support of the “social state”, and
distinguishes, as is sometimes not done, between the state provision of services and
the redistributive transfer payments, e.g. pensions, made by the state. He observes
that this division is broadly 50:50. However, he is pessimistic that either of these
levels could be raised. This is partly because he has traditionally classic liberal views
on the efficacy of private markets and individual rights. This is indicative of Piketty’s
reluctance to radically challenge the current neo-liberal consensus on the issue of
the role of the state.
The above criticisms may seem rather harsh. I am certainly supportive of Piketty’s
strictures about the sterile mathematical nature of modern general equilibrium
modelling and its focus on micro-economics, and of his view that economics should
be more concerned about the political and social dimensions of society.
But I am disappointed that the welcome given to Piketty’s book, accompanied by his
recent high profile in both the mainstream economic commentariat and the media,
has not led, so far, to a more proportionate response to the lacunae in his analysis.
We still require a more adequate political economic analysis of modern financial
capitalism to accompany Piketty’s comprehensive presentation of the outcome of
21st century capitalism in terms of the distorted distribution of global income and
wealth and its persistence, unless radical measures are taken to address the
problem. But to suggest, as have both supporters and opponents, that Piketty is a
‘Marx for the 21st century’ appears somewhat premature
However, Piketty’s unchallengeable demonstration of the substantial and growing
concentrations of global wealth and income, and of the necessity of redressing them,
is an important contribution to a much-needed intellectual debate on political
economy. The maldistribution of global income, wealth, and resources is the most
important global problem we face in this century, contributing as it does to both
global warming and ethnic conflicts. This for me is Piketty’s real and lasting
Michael Lloyd, May 2014

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