Talk about a bizarre context. Reading Thomas Piketty’s Capital in the 21st Century while exploring the remote islands of Vanuatu is a bit like an appendage falling asleep. You know it’s there in the same way that you know that the world’s motor runs on wealth and trade, but it seems distant, foreign, and not quite attached. Piketty, an economist at the Paris School of Economics, statistically maps a developed world in which capital wealth is skyrocketing into multiples of income, while ashore on the sandy island of Rowa the local fisherman disdain our offer of Vatu (the local currency) for the mullet they caught last night, but are excited to trade for fresh water, fishing line, and an underwater flashlight. Capital redefined.

Cover of Thomas Piketty's Capital in the 21st Century

Capital in the 21st Century

It takes a while to plow through Piketty’s book, which is perhaps more famous for being talked about than read. This is in part because the first two sections (300 pages) walk through an amazingly comprehensive data set of wealth and income records dating back to the 18th century in three key economies—Britain, France, and the U.S.. There’s a lot of detail here, but the main focus is on the ratio of capital wealth to annual income. That is, between how much real estate, stock, and other assets a country and its citizens own relative to how much citizens earn as income each year, which is a kind of variant on how much they produce, or GDP. During the 18th and 19th century, in Britain and France, this ratio was pretty stable, and pretty high, at about 6 times annual income. In the U.S., which was a much less developed country in the 19th century with vast tracts of very cheap land, the ratio was much lower. But, in the 1880s-1910s the U.S. finally shed its agrarian past, and jumped into the game. By the time of the Great Gatsby and the Newport Mansions wealth in the U.S. was 4 times income and the country was beginning to look a lot more European terms of inequality.

Interestingly, the ratio dropped precipitously in both Europe and the U.S. during the 20th century when the upheavals of two world wars and a depression pulled the rug out from under capital while economies (and incomes) thrived.

R > G

The other big problem that Piketty spills a lot of ink on is how the rate of return on capital has historically exceeded the growth rate of the economy, which he symbolizes in the formula r > g. You can think of it this way. The growth rate of a country directly fuels income. If a country grows 3% then you can assume that salaries grow an average of 3% and income rises by this amount. If this rate is lower than the rate of return on capital then capital (wealth) grows faster and the gap widens.

During the 19th century r was greater than g, but not by much. Wealth grew quicker than income, but it took two centuries to reach six times income by the eve of World War I. In the 20th century these countries took on tons of debt, which they canceled through inflation, driving the rate of return on capital into the ground. Meanwhile, starting in the 1940s, their economies boomed. So, suddenly, g is greater than r. There’s a lot more going on, of course, including the introduction of income tax, etc., that overall drives inequality to its lowest levels. But, in the end, by the 1960s wealth is around 2 times income. It’s interesting to note in this time of nostalgia for when America was great that it was made so by such decidedly anticapitalist processes that resulted in a much more even playing field.
Since 1980, though, things have changed. Some of this has been political.

First France, then England and the U.S., experienced a shift to the right and a series of policies that helped wealth accumulate. But, the main dynamic, according to Piketty, is that the rate of return on capital is outstripping—in some cases by a lot—the rate of growth. Currently, the rate of return on capital is around 5%, although there’s a big range here with small savers earning less than this and huge funds like the university endowments that can tower in the 10s of billions earning a upwards of 10% and 13%. (Yowza!) At the same time, growth is pretty low—around 3%. Leave this ratio alone for long enough and 19th century-style inequality comes roaring back, which is exactly what happens. The European capital-income ratio is currently around 5 times income, and U.S. is about 4. 

The big difference is that the rate of return on capital is inching higher today than in the past, for certain segments of society, and growth is losing steam. Piketty estimates that about half of growth is demographic—growing populations through births and immigration. But, in Europe and the U.S. birth rates are leveling off or declining, and immigration is nowhere near where it was 100 years ago. It doesn’t take an economist to see what happens as r slouches toward 6% o5 7% and g retreats to 1.5%, ushering in the greatest inequality spread modern societies have ever seen.
What is to be done?

Global Tax on Capital

Pinketty’s big proposal is the creation of a global tax on capital, which requires a transparent sharing of all private financial assets (bank deposits, stocks, real estate, etc.) between governments and banks around the world. Separating the tax from the transparent sharing of information for a moment, he describes a whole lot of benefits from just the latter. For one, this kind of financial cadaster (a French concept of a centralized roll of assets) would allow centralized banks and other international monetary organizations like the IMF to move more quickly and effectively to staunch big crises like the Cypriot crisis of 2013 or the Greek financial crisis. As well, it would eliminate the serious issue of tax havens, which economist Gabriel Zucman estimates currently houses 10% of global GDP (ouch!) and which, in turn, causes the world’s balance sheet to tip out of balance. (In fact, as Pinkety remarks, the disappearance of wealth into these tax havens looks as though Mars is lending to Earth from a global balance sheet perspective.)
As great as this ideal of transparent financial information would be, it’s hard to imagine something like this happening, especially as the world is getting so prickly about privacy. On some level, with the recent GDPRS legislation in Europe and lots of well-intentioned privacy fights in the U.S., we’re moving very much in the opposite direction—towards a place where there’s more opacity not less, which gives freer reign to wealthy tax avoiders.

Beyond this, it’s also hard to imagine asset holders agreeing to tax themselves in the public interest. Perhaps that’s a very cynical, American view; but I think it applies not only to large but also small asset holders. Although, in truth, your average 401k holder who earns 4% over the long run has very little in common with Harvard, which is minting about 13%, I don’t think that the average asset holder would want to cap that return at all. She’s bought into the game, lined by the hope of bigger returns. Perhaps it’s cynical, but it seems like once one figures out and buys into the game in which wealth begets wealth regardless of salary, one is loathe to change the rules.

Despite this, Piketty’s book contains a bucketload of data about the flow of money around the world today and the amazing processes at work underpinning it all. To my daughters’ great annoyance I constantly reference it during dinner conversations. Just wait until I make it required reading for them as we sail through Southeast Asia this year!