See discussions, stats, and author profiles for this publication at: https://www.researchgate.

net/publication/276126063

Thomas Piketty, Capital in the 21st Century

Article  in  Journal of Comparative Policy Analysis · April 2015

DOI: 10.1080/13876988.2014.987971

CITATION READS

1 14,393

1 author:

Fred Thompson
Willamette University
154 PUBLICATIONS   989 CITATIONS   

SEE PROFILE

Some of the authors of this publication are also working on these related projects:

Property Tax Administration in Oregon View project

Measuring revenue diversification and volatility View project

All content following this page was uploaded by Fred Thompson on 26 October 2015.

The user has requested enhancement of the downloaded file.

Capital In The 21st Century.
Thomas Piketty. Paris School of Economics. Campus Paris-Jourdan, 48, boulevard Jourdan .
75014 Paris . France; E-Mail : piketty@psemail.eu
Cambridge, MA. 2014. Harvard University Press. ISBN 9780674430006. 696 pp.
Translated by Arthur Goldhammer.
 
 
st
Thomas Piketty’s Capital in the 21 Century is a wonder almost without precedent: a serious
work of comparative policy analysis that is also a runaway best seller. Further, Capital in the 21st
Century is great read. It is entertaining, informative, and challenging.

The book is divided into three parts. The first outlines the basic dynamics of the distribution of
income and wealth and shows how these dynamics have played out in Western Europe, North
America, Japan, and Australia since the 18th Century. Piketty’s basic conclusion from this
analysis is that capitalism is biased in favor of capitalists – in the long run the economic
inequality that matters isn't the gap between people who earn high salaries and those who earn
low ones, it is the gap between people who inherit great wealth and those who don't. The second
part describes the ebb and flow of inequality in the 20th Century and tries to explain its decline in
the period between 1910 and 1970, the so-called great compression, and its subsequent recovery.
The third lays out an assortment of policy prescriptions intended to reduce or forestall increased
inequality.

In this review I will focus on the second part of the book. Most reviewers have attended to the
first; I have nothing to add to what they have said. As for the third part, it is just not as profound
as the rest of the book. In contrast, part 2 is both intriguing and challenging and hasn’t really
gotten the attention it deserves.

Let’s start with some definitions. Income is a flow. It is usually defined as consumption plus the
change in wealth, over some finite period. Wealth is the present value of the future income
streams associated with the bundle of property rights comprising one's endowment, which is a
stock. We can’t measure these things directly, but instead infer their values from data acquired
for other purposes: collecting taxes (income and inheritance taxes primarily) and measuring
aggregate output and consumption. Piketty’s main contribution lies in the detective work that he
and his many collaborators have done to piece together estimates of income and wealth and their
distribution across time and space from diverse imperfect and incomplete sources. In his analysis
of income distributions, Piketty focuses primarily on two measures: the ratio of the 90th income
centile to the 10th and the proportion of total income received by the top 1 or top 0.1 percent of
households. Where wealth is concerned, his favorite measures are the wealth share held by the
top 10, 1, and 0.1 percent of the population.

The central mystery of the book, given capitalism’s bias, is the fall in inequality in midcentury.
Piketty’s most intriguing argument is that this phenomenon resulted from the destruction and
high taxation caused by the two world wars and the Great Depression and was sustained by the
rapid demographic and economic growth that followed World War II. This argument can be read
as a direct challenge to what might be called the standard story, although they are not necessarily
incompatible.

1
The standard story of the great compression assigns a key role to organized labor, which was at
the apex of its power in the postwar era, not only in the social-democratic states of Northern
Europe, but throughout the industrialized world, owing to the vast expansion of mass production.
According to this story, organized labor was politically decisive in its support of the welfare
state, Keynesian full-employment policies, high inheritance and income tax rates, heavy reliance
on payroll taxes, capital and foreign exchange controls, and universal secondary education. The
upshot of these policies was greatly increased consumption, widely shared wage gains, and
“profitless growth” – what Michel Aglietta calls the Fordist regime of capitalist accumulation in
A Theory of Capitalist Regulation (2000).

Then, declining population growth, satisfaction of long stifled wants, and catch-up on the part of
Europe’s capitalist economies and Japan to the technological frontier slowed economic growth.
The problem of integrating baby boomers into a workforce, which was already beginning to shed
manufacturing jobs, further stressed the Fordist system of accumulation, leading to wholesale
changes in its characteristic modes of regulation: fiscal policy was subordinated to monetary
policy or, perhaps more accurately, full employment subordinated to price stability, inheritance
and income tax rates slashed, capital controls eliminated, and exchange rates floated.

According to this perspective, the demise of the Fordist accumulation regime followed, in part,
from its success. Increasing mechanization and computerized production hollowed out the blue-
collar workforce and led, thereby, to the marasmus of labor movements in the industrialized
West. Mass production shifted to the developing world where wages are low and environmental
quality standards lax. Both developments reduced political support for policies aimed at broad-
based gain sharing.

Picketty is dismissive of this perspective: “Neither the economic liberalization that began around
1980 nor the state intervention that began in 1945 deserves much praise or blame. The best one
can say is that they did no harm.” Consequently, he is indifferent to most of the literature on the
political economy of this era, with its attention to regimes of accumulation and modes of
regulation (the institutions, policies, and practices governing the operation of accumulation
regimes). Instead, he focuses on the timing of the onset the great compression: World War I in
France, England, and Germany, reinforced in each case by World War II and its aftermath, the
Great Depression in the United States, Canada, Sweden, and Australia, and World War II in
Japan. The mechanisms he stresses include wealth destruction through physical destruction,
confiscatory income and inheritance taxes, inflation, the nationalization of industry, and wartime
restraints on high-end wages.

Here, I think Piketty misses an opportunity. His use of literature to illustrate key points is one of
the delights of this book; the references to Jane Austen and Honoré de Balzac are especially
noteworthy. Inflation played a big role in the destruction of wealth because of massive
government borrowing in wartime, which crowded out other investment, rationing, and the
forced liquidation of other assets. This is one of the commonplace tropes of the interwar
European literature contrasting the Belle Époque with a meaner present, poignantly in Joseph
Roth’s description of the von Trotta’s loss in The Emperor’s Tomb and ironically in John
Galsworthy’s Forsythe Saga.

2
The second factor Piketty stresses is the burst of rapid economic growth following World War II,
due to recovery from war and depression, as well as demographic and technological change,
which for a period overwhelmed the effects of inheritance. The French case matches up with his
formulation particularly well. Capital-income ratios held steady at about seven from 1700 to
1910, fell sharply from 1910 to 1950, reaching a low of a bit less than 3, then began to climb, by
2010 to about 6. Furthermore, Piketty provides pretty compelling evidence that in France
increased wealth has driven increased income inequality. Wealth distributions apparently
followed similar trajectories in Germany, the United Kingdom, Sweden, and Japan, although he
argues that the timing of the climacteric varied from country to country and that the force of
inheritance was moderated by higher income and inheritance tax rates.

In Piketty’s saga, the United States is exceptional. Rapid growth in production and population
meant that inherited wealth always played a smaller role in North America than in Europe. It
evidently still does, although that could change with slower population and economic growth.
Nevertheless, income is now more unequal in the United States than in Western Europe. Indeed,
income concentrations in the United States currently exceed the peaks of the 1910s and 1920s.
According to Piketty, the surprising thing about this phenomenon is that these top-end incomes
come from labor, not capital. Piketty associates this unprecedented explosion of labor-income
inequality with the rise of ‘supermanagers,’ which he attributes to dramatic reductions in
marginal income tax rates. He also notes that things have moved in similar directions in Britain,
Canada, and Australia, but not in Western Europe and Japan, where marginal tax rates and the
distribution of income from labor have not changed much since the 1940s.

Piketty’s basic explanation for the recovery of inequality in America, tax policies, works for me,
both as a matter of timing and motivation,1 but his identification of the perpetrator seems a bit
off. The supermanagers he limns are powerful CEOs of publicly-held corporations who bully or
seduce boards into letting them set their own salaries and perquisites and who, owing to
decreases in top-end marginal income tax rates, now have much stronger incentives than ever
before to grant themselves big pay boosts.

In contrast, others stress the role played by shareholder activism in this process. Robin Marris,
for example, in The Economic Theory of Managerial Capitalism (1964) and Managerial
Capitalism in Retrospect (1998), outlines an alternative explanation of the evolution of American
and British capitalism, although taxes play an equally prominent role in his account. Marris
reminds us that in the immediate postwar era, most output was supplied by large publicly held
corporations, where managerial control was separate from ownership, and argues that the
managers of these enterprises used their considerable discretion to grow organizations rather than
to maximize shareholder wealth, since they generally got higher salaries and greater status from
running bigger businesses. The result was profitless growth, which wealthy shareholders
tolerated because they were more concerned with managing confiscatory tax liabilities than with
maximizing returns on investment. Marris also argued that the focus on growth was socially
desirable – growth-seeking firms make countries grow faster.

1
I  am  actually  somewhat  uneasy  about  this.  As  a  general  rule,  changes  in  tax  policies  have  bigger  effects  on  the  
timing  and  reporting  of  income,  on  tax  avoidance  and  evasion,  than  on  underlying  realities    

3
Like Piketty, Marris argues that things started to change with the so-called Kennedy tax cut in
the United States, which motivated shareholders to pay greater attention to bottom lines, and
accelerated with subsequent reductions in marginal tax rates. Consequently, activist investors
increasingly sought to exploit corporate governance mechanisms and the market for corporate
control to discipline hired managers to maximize share price, at the expense of growth. After
1993, the tax laws were rewritten to accommodate the use of stock options and bonuses to align
managerial interests even more closely with investors.’ According to Marris, Anglo-American
shareholder activism and the subsequent large and sustained increase in the value of publicly
traded shares had the effect of enriching shareholders, financial professionals (the 25 highest-
earning hedge fund managers in the United States took home $21 billion in compensation in
2013, according to Alpha magazine), and a handful of CEOs, whose pay soared, but, by tying
their interests more narrowly to those of shareholders, also reduced CEO discretion.

Given Piketty’s narration of the German case, it’s mildly surprising that he doesn’t give greater
attention to Anglo-American shareholder activism. As he notes, his overarching theory fails in
the German case when he uses stock market valuations instead of book value, because, under the
German ‘stakeholder model’ of corporate governance, shareholder rights to cash flows are
relatively weak. Consequently, he notes that German managers/directors have broader
obligations than their American counterparts and greater discretion to pursue growth and stability
at the expense of profitability and that German managers/directors throw off far less of the
economic value their businesses generate to shareholders; instead, they retain more of it,
presumably in the best interests of other stakeholders and almost certainly the society at large.

There’s another reason to question the importance of Piketty’s supermanagers in this process.
Indeed, Piketty acknowledges that his supermanager story appears belied by a salient fact: he
wants to explain the relative increase in the earned incomes of 160,000 households (the top .1
percent), but there are only 500 CEOs of Fortune 500 publicly traded companies – in fact there
are only about 3,500 large publicly traded companies in the U.S., down from more than 5,000 in
the mid-80s (altogether the census now reports fewer than 10,000 C corporations with 500 or
more employees). But, he then cites Bakija, Cole, and Heim (2012) to the effect that “that
executives, managers, supervisors, and financial professionals account for about 60 percent of
the top 0.1 percent of income earners in recent years, and can account for 70 percent of the
increase in the share of national income going to the top 0.1 percent of the income distribution
between 1979 and 2005.” And he blithely proceeds with his supermanager story. A closer look at
this paper suggests a somewhat different interpretation, however. Bakija, Cole, and Heim report
that the share of national income going to the top 0.1 percent of households (Table 7a) increased
from 3.3 percent of the total in 1979 to 10.3 percent in 2005. Top executives, managers, and
supervisors working for publicly held, non-financial corporations did quite well during this
period, increasing their share from 1.2 percent to 2.2 percent of the total, but their domination of
the top 0.1 percent declined almost by half. In 1979 they took home 37 percent of the income
earned by the top 0.1 percent of households; by 2005 their share had dropped to 21 percent. In
contrast, financial professionals and managers made out like bandits, increasing their share of the
total from 0.4 percent to 2.1 percent, while their share of the income of the top 0.1 percent of
households nearly doubled.

However, the really big winners were executives, managers, and supervisors working for

4
 privately held, non-financial enterprises. Their share of total income increased from 0.3 percent
to 2.5 percent; they now take home nearly one dollar in every four earned by the top 0.1 percent
of households. A privately held business in the U.S. is one where five or fewer individuals own
more than half of the stock. Most are ‘pass-through’ enterprises: their income passes directly to
their owners’ personal income tax returns. In contrast the income of C corporations is taxed
twice, through corporate income taxes and then again through personal income taxes on
dividends and capital gains. Individually, family or employee owned businesses are all eligible
for pass-through status, as are most partnerships. That doesn’t necessarily mean that they are
small; nearly 60,000 of them have 100 or more employees. But it does imply that most of their
high-income employees are also owners.

Just as tax policies may account for an upsurge in shareholder activism, they can also help to
make sense of the rise of privately held businesses, which now account for more than 50 percent
of all business income in the U.S., triple what it was when the pass-through provision was
enacted 1986. But neither the upsurge in shareholder activism nor the rise of privately held
businesses is consistent with Piketty’s supermanger story. Rather, they both assign the lead role
to owners, not their corporate minions. Perhaps, Piketty ought to be reminded of his own lesson
number 1 – the bias of capitalism.
 
Bibliograpy
Jon Bakija, Adam Cole, and Bradley T. Heim. Jobs and Income Growth of Top Earners and the
Causes of Changing Income Inequality: Evidence from U.S. Tax Return Data. Williams College,
working paper, April 2012 version.
http://web.williams.edu/Economics/wp/BakijaColeHeimJobsIncomeGrowthTopEarners.pdf
Reviewer:
Fred Thompson
Director, Center for Governance and Public Policy Research
Grace and Elmer Goudy Professor of Public Management and Policy
Atkinson Graduate School of Management
Willamette University
900 State Street, Salem OR 97301 USA
E-mail: fthompso@willamette.edu

View publication stats