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Over 1,000

people lie
down on a San
Francisco
beach to spell
out “TAX THE
1%” in October
2011
© 2011 JOHN
MONTGOMERY

Super-rich century
Why is inequality rising—and will it now fall?
ROBERT SKIDELSKY

Capital in the 21st Century classes of producer, landlords, capitalists and


by Thomas Piketty (Harvard, £29.95) workers. Each of these classes owned a factor

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of production—land, capital and labour. With
he early 19th-century founders of land and capital scarce relative to labour, land-
the classical school of economics lords and capitalists could claim a dispropor-
reasoned that the distribution of tionate share of the produce that they and the
a society’s income depended cru- workers jointly produced. Workers’ pay would
cially on who owned its produc- be forced to subsistence. Classical socialism, as
tive resources. David Ricardo identified three Karl Marx conceived it, was a branch of this

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tree. Abolish private ownership of land and School of Economics, revives the economics
capital (and the power which this gave) and of David Ricardo and Karl Marx. His thesis is
one would abolish the “rents” to their owners, simple. The growing concentration of capital
enabling workers to receive their proper share in fewer hands has enabled its owners to keep
of production. it relatively scarce and thus valuable. Agricul-
tural land has dropped out as a factor of pro-
“It is only reasonable to duction, but urban real estate has taken its
place. Capitalist societies therefore have a nat-
assume that people in a ural tendency to generate a highly unequal
position to set their own distribution of wealth and income.
This natural tendency to inequality was
salaries will treat suppressed in the period between 1910
themselves generously” and 1960, as the two world wars and the
Great Depression destroyed a mass of
But towards the end of the 19th century, dis- inherited capital, while trade union pres-
cussion of the class inequality of rewards faded sure, progressive taxation and welfare
away. The marginalist revolution—direct pre- prevented its reconstitution. But from the late
cursor of the mathematical economics of 1970s, with the decay of these countervailing
today—dropped the attempt at social real- forces, the natural inequality of the system
ism, by positing a perfectly competitive mar- has reasserted itself, so that today it is almost
ket economy with numerous “agents,” each as great as it was before 1914. Piketty’s point
of whom would receive the value of his “mar- here is that while the divergence of wealth and
ginal product”—the exact amount he added income under capitalism is natural, its “com-
to economic value. The existence of power in pression” is contingent on singular events plus
the market was recognised only in the form of policy reactions, which contrasts with the pre-
“monopoly”—a single firm in an industry being diction of the American statistician Simon
able to set the price of its product, a problem Kuznets, whose data—dating from 1955—
to be tackled by regulation or trust-busting showed inequality naturally diminishing over
laws. This new, marginal analysis was intended time.
to bypass the unsettling distributional issues Though Piketty’s study focuses mainly on the
raised by the classical economists. The claim USA, Britain, and France, the same U-shaped
that the market paid every producer what he trajectory of inequality can be observed in
was worth undercut the socialist argument for most rich countries. Continuing high inequal-
redistribution. ity is socially and economically destabilising,
In his massive book, Capital in the 21st Cen- though it need not lead to Marx’s apocalypse.
tury, Thomas Piketty, a professor at the Paris So what we need is another bout of social

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© XTYRTRYRTR RTYRTRYT
Unemployed men outside a soup kitchen in Chicago, 1931: the Great Depression “destroyed inherited
capital,” reducing inequality as a result

democracy especially in the form of progres- his main ideas do tend to be drowned by the
sive taxation. data. Readability is sometimes sacrificed to
You may think that it doesn’t require 600 authority.

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pages to get this message across. This would
be wrong. The strength of Piketty’s book is his here are three components of ine-
close attention to the different sources of ine- quality: capital ownership, the
quality, the massive documentation under- income to which it gives rise, and
pinning his history and conclusions, and his income from labour. Piketty defines
impressive culls from sociology and literature, capital as any non-human asset that can be
which exhibit the richness of “political econ- borrowed or exchanged on some market,
omy” compared to its thin mathematical suc- which is different from the textbook defini-
cessor that has attained such prominence. But tion, where capital is just the tools used for

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production. So capital, or wealth, can include that enabled a middle class to emerge. Before
residential property and financial assets. the wars, the middle 40 per cent and bottom
Income from capital is not simply profit, but 50 per cent were indistinguishable in terms of
also rent, dividends and so forth. Income from capital ownership—each owned approximately
labour is the usual: wages and bonuses. 5 per cent of total wealth. But as a result of
A big change from earlier times is that today, the wars the middle 40 per cent accrued more
high income earners also tend to have a lot of wealth, and the income to which it gave rise.
capital. People earning high wages invest their Piketty describes the growth of a “patrimonial
money in property, stocks, and other assets, (or propertied) middle class” as “the princi-
which yield a return. So high incomes from pal structural transformation of the distribu-
work are a means to capital accumulation. tion of wealth in the developed countries [of
Before the First World War, this was not so true: the USA and Europe] in the 20th century.’’
people did not accumulate capital through Turning to income, we find 30 per cent
work; they mainly inherited it. This was the of national income going to capital, with
rentier economy of the late Victorians so elo- the remaining 70 per cent going to labour.
quently depicted by John Maynard Keynes, in Extreme income inequality can arise in two
which income came from rents and dividends. ways. It can come from a “hyperpatrimonial”
The job was then to preserve the family fortune society of rentiers. In this type of society inher-
by marrying well; real work was for the poor. ited wealth, accumulated over several genera-
Piketty points out that capital ownership has tions, attains extreme levels. Total income is
always been quite concentrated. A century ago, then dominated by a small number of people
the richest 10 per cent in Europe owned about getting very high incomes from capital. This
90 per cent of the wealth. In the early 2010s, was the pattern before the First World War.
they owned about 60 per cent of wealth in But excessive income inequality can also
Europe, and 70 per cent in the US. Despite the arise from a “hypermeritocratic society,”
media hype surrounding the super-rich, this is which is more characteristic of today, espe-
considerably less than before, but it remains cially in the US. This society is characterised by
very significant. Inequality of capital owner- extra large incomes earned by a small subset of
ship is even more striking at the level of cen- labour, which is why it is also called a society of
tiles: today, the richest 1 per cent own about 25 “superstars,” or more appropriately, a society
per cent of wealth, which corresponds to €5m of “supermanagers.” In the US, income ine-
per person, as opposed to 50 per cent in 1900. quality in 2000-10 regained the record levels
It was the decrease in capital ownership for observed between 1910 and 1920, with Britain
the richest 10 per cent, and especially for the trending the same way.
top 1 per cent in the era of the two world wars, What has happened over the course of the
during which time much capital was destroyed, industrial age is that we have moved from a

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“hyperpatrimonial” to a “hypermeritocratic” US and UK have allowed senior managers


society, with a phase between when inequality to set their own pay. “It is only reasonable to
was compressed. Between 1914 and 1945, the assume,” he remarks drily, “that people in a
income share of the top 1 per cent fell from 20 position to set their own salaries have a natu-
per cent to just 7 per cent, which accounted ral incentive to treat themselves generously or
for “roughly three-quarters of the decrease in at the least to be rather optimistic in gauging
inequality.” This made way for the new mid- their marginal productivity.” The business cul-
dle class. ture in Japan and Europe evolved in the same
However, from the 1970s, the very rich direction, but later and not to the same extent.
started to race away not just from the middle At the same time, taxes on top incomes have
but from the rich. “In all the English-speak- been reduced supposedly to “incentivise” their
ing countries,” writes Piketty, “the primary
reason for increased income inequality in “Only the wealthiest can
recent decades is the rise of the superman-
ager in both the financial and non-finan-
afford to hire the best
cial sectors.” These are members of the chief portfolio managers. Past a
executive class, who run global manufactur-
ing businesses, investment banks, technology
certain threshold, money
companies and so on. tends to reproduce itself”
The super rewards to these supermanag-
ers can’t be explained by their higher mar- earners to work harder. Piketty conjectures
ginal productivity—that is, by the extra output that “meritocratic extremism” or the “winners
that they produce. As Piketty says, “one would take all” culture of the US may be behind the
expect a theory based on ‘objective’ measures shift to greater inequality. And one may add
of skill and productivity to show relatively uni- that where social superiority is conferred by
form pay increases within the top decile.” That birth, as it was in the past, one has less need
is, the income of the top 1 per cent should not to affirm it by conspicuous earnings and con-
be rising faster than that of the next 9 per cent sumption. However, all of this is just a way of
because members of the top 1 per cent are saying that distribution is increasingly fixed by
unlikely to be significantly more skilled and power, not by the market.
productive than the next 9 per cent. But the Although inequality has returned, the struc-
income of the top 1 per cent has risen substan- ture of contemporary inequality is different—
tially faster than that of the rest. hard work finally pays more than inheritance.
So what does explain the extravagant rewards Piketty explains how before the First World
of the very rich? The short answer, says Piketty, War “work and study alone were not enough
is that, since the 1970s, “social norms” in the to achieve the same level of comfort afforded

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The question we can then ask is whether the


recent financial crisis is likely to decrease ine-
qualities in the same way as the Great Depres-
sion did. Piketty concludes that it will not,
because the stock market euphoria prior to the
crash was not the structural cause of increased
inequality. To be sure, in the short run, the
crash may have a “compressing” effect, but the
short-term collapse in financial assets did “not
alter the long-run trend.” This seems reasona-
ble: the destruction of the wealth and prestige
of the ruling class was much greater in the era
of the two world wars and the Great Depression
than anything we have recently experienced.
Inequality will continue to increase, because
inheritance will become increasingly impor-
tant. “There is nothing to prevent the children
of supermanagers from becoming rentiers,”
and while the baby boom generation grew
up with the idea that the age of inheritance
was over, those born in the 1970s and 80s have
already experienced the revival of inheritance
and gifts.
Piketty uses Balzac’s novel of 1834, Le Père
Demography plays an important role here.
Goriot, to illustrate the difference between
Piketty writes that, “Other things being equal,
inequality in the 19th century and today
strong demographic growth tends to play an
by inherited wealth and the income derived equalising role because it decreases the impor-
from it.” This is why in Balzac’s novel of 1834, tance of inherited wealth: every generation
Le Père Goriot, Vautrin demonstrates to Ras- must in some sense construct itself.” The prob-
tignac that he is better off marrying Mad- lem is that we are now experiencing a return to
emoiselle Victorine than becoming a royal a “low growth regime.”
prosecutor. There was a dramatic change In the 21st century the distribution of income
after the Second World War—the people at from capital will become even more unequal
the top of the income distribution were no than capital ownership per se because there
longer aristocrats, but lawyers, doctors, and are economies of scale: people with larger port-
“supermanagers.” folios achieve larger returns. One explanation

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Bill and Melinda Gates in June 2009: Bill’s fortune increased from $4bn to $50bn between 1990
and 2010

is that certain investments, such as expensive than output and income, meaning that ine-
property, are accessible only to the super-rich. quality increases. So if the return on capital is
Another is that only the wealthiest can afford high for rich people, inequality will have a ten-
to hire the best portfolio managers. Either dency to rise explosively. And the return to low
way, past a certain threshold, “money tends growth, including low demographic growth,
to reproduce itself.” Piketty takes the example means that inequality will rise even more.
of Bill Gates and Liliane Bettencourt, whose Piketty predicts that growth will not exceed
fortunes increased at the same pace—$4bn to 1-1.5 per cent in the long run, whereas the aver-
$50bn and $2bn to $25bn respectively between age return on capital will be 4-5 per cent.
1990 and 2010—despite the fact that Liliane Even if the total volume of inheritance
Bettencourt never worked a day in her life. regains past levels, it will not necessarily play
The historical record so painstakingly dis- the same social role as before. There are fewer
sected can be summarised by what Piketty very large estates of £30m, or even £5-10m
calls the “fundamental force for divergence.” and many more of £200,000- 500,000 or even
When the return on capital exceeds the growth £1-2m—not sufficient for heirs to give up work
of the economy, inherited wealth grows faster and live on interest.

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The only way of limiting the acceleration of Whether it’s power or talent which makes
inequality, while preserving entrepreneurial the super-rich rich, the key point is that they
spirit and economic growth, is, Piketty con- can perpetuate their position by leveraging
cludes, to impose a progressive wealth tax on super-salaries into capital and living off the
the largest fortunes. returns, as they did in the 19th century. How-

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ever, this may be a transient opportunity, for
eeply impressive in its style and one would expect that their supercharged sala-
learning, Piketty’s argument is nev- ries will eventually be competed away. In other
ertheless incomplete. His story is words, it’s an open question whether present
about the super-rich racing ahead levels of inequality can perpetuate themselves.
of the rich (and everyone else) since the 1980s. Piketty’s book is a timely intervention in the
He explains this by the power of the rich to set current debate about inequality and its causes.
their own pay and the ease with which they Everyone agrees that inequality has been grow-
can transform their super-salaries into capital. ing. But does the growth of inequality matter?
But there may be another explanation, which The quick answer is that it is bad economically
is that digital technology actually increases and socially. It is bad economically because it
the marginal product of the top performers in narrows the consumption base on which invest-
all fields of endeavour, creating a global elite ment depends; and it bad socially because,
of superstars who are distinguished from the as Piketty says, it “undermines the merito-
rest by their exceptional talents. This is the cratic values on which democratic societies
view of Erik Brynjolfsson and Andrew McA- are based.” But few politicians have a clue
fee in their new book The Second Machine Age. what to do about it.
To the extent that “technology increases the
reach, scale, or monitoring capacity of a deci-
sion-maker,” it makes managers more “valu-
able.” This implies that supermanagers get
higher pay because they are more productive,
not just because they can set their own salaries.
Digital technology can also boost rewards to
superstar writers and performers. For exam-
ple, digitisation and globalisation have “super-
charged the ability of authors like JK Rowling
to leverage their talents… Rowling’s stories
can be captured in movies and video games as
well as text, and each of those formats... can be
transmitted globally at a trivial cost.” “Oh no, I lost two followers”

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