Why We’re in a New Gilded Age
Emmanuelle Marchadour
Thomas Piketty in his office at the Paris School
of Economics, 2013
Paul Krugman
MAY 8, 2014 ISSUE
Capital in the Twenty-First Century
by Thomas Piketty, translated from the French by Arthur Goldhammer
Belknap Press/Harvard University Press, 685 pp., $39.95
Thomas Piketty, professor at the Paris School of
Economics, isn’t a household name, although that may
change with the English-language publication of his
magnificent, sweeping meditation on inequality,
Capital in the Twenty-First Century. Yet his influence
runs deep. It has become a commonplace to say that we
are living in a second Gilded Age—or, as Piketty likes
to put it, a second Belle Époque—defined by the
incredible rise of the “one percent.” But it has only
become a commonplace thanks to Piketty’s work. In
particular, he and a few colleagues (notably Anthony
Atkinson at Oxford and Emmanuel Saez at Berkeley)
have pioneered statistical techniques that make it
possible to track the concentration of income and
wealth deep into the past—back to the early twentieth
century for America and Britain, and all the way to the
late eighteenth century for France.
The result has been a revolution in our understanding
of long-term trends in inequality. Before this
revolution, most discussions of economic disparity more or less ignored the very rich.
Some economists (not to mention politicians) tried to shout down any mention of
inequality at all: “Of the tendencies that are harmful to sound economics, the most
seductive, and in my opinion the most poisonous, is to focus on questions of distribution,”
declared Robert Lucas Jr. of the University of Chicago, the most influential
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macroeconomist of his generation, in 2004. But even those willing to discuss inequality
generally focused on the gap between the poor or the working class and the merely welloff,
not the truly rich—on college graduates whose wage gains outpaced those of lesseducated
workers, or on the comparative good fortune of the top fifth of the population
compared with the bottom four fifths, not on the rapidly rising incomes of executives and
bankers.
It therefore came as a revelation when Piketty and his colleagues showed that incomes of
the now famous “one percent,” and of even narrower groups, are actually the big story in
rising inequality. And this discovery came with a second revelation: talk of a second
Gilded Age, which might have seemed like hyperbole, was nothing of the kind. In
America in particular the share of national income going to the top one percent has
followed a great U-shaped arc. Before World War I the one percent received around a fifth
of total income in both Britain and the United States. By 1950 that share had been cut by
more than half. But since 1980 the one percent has seen its income share surge again—and
in the United States it’s back to what it was a century ago.
Still, today’s economic elite is very different from that of the nineteenth century, isn’t it?
Back then, great wealth tended to be inherited; aren’t today’s economic elite people who
earned their position? Well, Piketty tells us that this isn’t as true as you think, and that in
any case this state of affairs may prove no more durable than the middle-class society that
flourished for a generation after World War II. The big idea of Capital in the Twenty-First
Century is that we haven’t just gone back to nineteenth-century levels of income
inequality, we’re also on a path back to “patrimonial capitalism,” in which the
commanding heights of the economy are controlled not by talented individuals but by
family dynasties.
It’s a remarkable claim—and precisely because it’s so remarkable, it needs to be examined
carefully and critically. Before I get into that, however, let me say right away that Piketty
has written a truly superb book. It’s a work that melds grand historical sweep—when was
the last time you heard an economist invoke Jane Austen and Balzac?—with painstaking
data analysis. And even though Piketty mocks the economics profession for its “childish
passion for mathematics,” underlying his discussion is a tour de force of economic
modeling, an approach that integrates the analysis of economic growth with that of the
distribution of income and wealth. This is a book that will change both the way we think
about society and the way we do economics.
1.
What do we know about economic inequality, and about when do we know it? Until the
Piketty revolution swept through the field, most of what we knew about income and
wealth inequality came from surveys, in which randomly chosen households are asked to
fill in a questionnaire, and their answers are tallied up to produce a statistical portrait of the
whole. The international gold standard for such surveys is the annual survey conducted
once a year by the Census Bureau. The Federal Reserve also conducts a triennial survey of
the distribution of wealth.
These two surveys are an essential guide to the changing shape of American society.
Among other things, they have long pointed to a dramatic shift in the process of US
economic growth, one that started around 1980. Before then, families at all levels saw
their incomes grow more or less in tandem with the growth of the economy as a whole.
After 1980, however, the lion’s share of gains went to the top end of the income
distribution, with families in the bottom half lagging far behind.
Historically, other countries haven’t been equally good at keeping track of who gets what;
but this situation has improved over time, in large part thanks to the efforts of the
Luxembourg Income Study (with which I will soon be affiliated). And the growing
availability of survey data that can be compared across nations has led to further important
insights. In particular, we now know both that the United States has a much more unequal
distribution of income than other advanced countries and that much of this difference in
outcomes can be attributed directly to government action. European nations in general
have highly unequal incomes from market activity, just like the United States, although
possibly not to the same extent. But they do far more redistribution through taxes and
transfers than America does, leading to much less inequality in disposable incomes.
Yet for all their usefulness, survey data have important limitations. They tend to
undercount or miss entirely the income that accrues to the handful of individuals at the
very top of the income scale. They also have limited historical depth. Even US survey data
only take us to 1947.
Enter Piketty and his colleagues, who have turned to an entirely different source of
information: tax records. This isn’t a new idea. Indeed, early analyses of income
distribution relied on tax data because they had little else to go on. Piketty et al. have,
however, found ways to merge tax data with other sources to produce information that
crucially complements survey evidence. In particular, tax data tell us a great deal about the
elite. And tax-based estimates can reach much further into the past: the United States has
had an income tax since 1913, Britain since 1909. France, thanks to elaborate estate tax
collection and record-keeping, has wealth data reaching back to the late eighteenth
century.
Exploiting these data isn’t simple. But by using all the tricks of the trade, plus some
educated guesswork, Piketty is able to produce a summary of the fall and rise of extreme
inequality over the course of the past century. It looks like Table 1 on this page.
As I said, describing our current era as a new Gilded Age or Belle Époque isn’t hyperbole;
it’s the simple truth. But how did this happen?
2.
Piketty throws down the intellectual
gauntlet right away, with his book’s very
title: Capital in the Twenty-First Century.
Are economists still allowed to talk like
that?
It’s not just the obvious allusion to Marx that makes this title so startling. By invoking
capital right from the beginning, Piketty breaks ranks with most modern discussions of
inequality, and hearkens back to an older tradition.
The general presumption of most inequality researchers has been that earned income,
usually salaries, is where all the action is, and that income from capital is neither important
nor interesting. Piketty shows, however, that even today income from capital, not earnings,
predominates at the top of the income distribution. He also shows that in the past—during
Europe’s Belle Époque and, to a lesser extent, America’s Gilded Age—unequal ownership
of assets, not unequal pay, was the prime driver of income disparities. And he argues that
we’re on our way back to that kind of society. Nor is this casual speculation on his part.
For all that Capital in the Twenty-First Century is a work of principled empiricism, it is
very much driven by a theoretical frame that attempts to unify discussion of economic
growth and the distribution of both income and wealth. Basically, Piketty sees economic
history as the story of a race between capital accumulation and other factors driving
growth, mainly population growth and technological progress.
To be sure, this is a race that can have no permanent victor: over the very long run, the
stock of capital and total income must grow at roughly the same rate. But one side or the
other can pull ahead for decades at a time. On the eve of World War I, Europe had
accumulated capital worth six or seven times national income. Over the next four decades,
however, a combination of physical destruction and the diversion of savings into war
efforts cut that ratio in half. Capital accumulation resumed after World War II, but this was
a period of spectacular economic growth—the Trente Glorieuses, or “Glorious Thirty”
years; so the ratio of capital to income remained low. Since the 1970s, however, slowing
growth has meant a rising capital ratio, so capital and wealth have been trending steadily
back toward Belle Époque levels. And this accumulation of capital, says Piketty, will
eventually recreate Belle Époque–style inequality unless opposed by progressive taxation.
Why? It’s all about r versus g—the rate of return on capital versus the rate of economic
growth.
C
Just about all economic models tell us that if g falls—which it has since 1970, a decline
that is likely to continue due to slower growth in the working-age population and slower
technological progress—r will fall too. But Piketty asserts that r will fall less than g. This
doesn’t have to be true. However, if it’s sufficiently easy to replace workers with machines
—if, to use the technical jargon, the elasticity of substitution between capital and labor is
greater than one—slow growth, and the resulting rise in the ratio of capital to income, will
indeed widen the gap between r and g. And Piketty argues that this is what the historical
record shows will happen.
If he’s right, one immediate consequence will be a redistribution of income away from
labor and toward holders of capital. The conventional wisdom has long been that we
needn’t worry about that happening, that the shares of capital and labor respectively in
total income are highly stable over time. Over the very long run, however, this hasn’t been
true. In Britain, for example, capital’s share of income—whether in the form of corporate
profits, dividends, rents, or sales of property, for example—fell from around 40 percent
before World War I to barely 20 percent circa 1970, and has since bounced roughly
halfway back. The historical arc is less clear-cut in the United States, but here, too, there is
a redistribution in favor of capital underway. Notably, corporate profits have soared since
the financial crisis began, while wages—including the wages of the highly educated—
have stagnated.
A rising share of capital, in turn, directly increases inequality, because ownership of
capital is always much more unequally distributed than labor income. But the effects don’t
stop there, because when the rate of return on capital greatly exceeds the rate of economic
growth, “the past tends to devour the future”: society inexorably tends toward dominance
by inherited wealth.
onsider how this worked in Belle Époque Europe. At the time, owners of capital could
expect to earn 4–5 percent on their investments, with minimal taxation; meanwhile
economic growth was only around one percent. So wealthy individuals could easily
reinvest enough of their income to ensure that their wealth and hence their incomes were
growing faster than the economy, reinforcing their economic dominance, even while
skimming enough off to live lives of great luxury.
And what happened when these wealthy individuals died? They passed their wealth on—
again, with minimal taxation—to their heirs. Money passed on to the next generation
accounted for 20 to 25 percent of annual income; the great bulk of wealth, around 90
percent, was inherited rather than saved out of earned income. And this inherited wealth
was concentrated in the hands of a very small minority: in 1910 the richest one percent
controlled 60 percent of the wealth in France; in Britain, 70 percent.
No wonder, then, that nineteenth-century novelists were obsessed with inheritance. Piketty
discusses at length the lecture that the scoundrel Vautrin gives to Rastignac in Balzac’s
Père Goriot, whose gist is that a most successful career could not possibly deliver more
than a fraction of the wealth Rastignac could acquire at a stroke by marrying a rich man’s
daughter. And it turns out that Vautrin was right: being in the top one percent of
nineteenth-century heirs and simply living off your inherited wealth gave you around two
and a half times the standard of living you could achieve by clawing your way into the top
one percent of paid workers.
You might be tempted to say that modern society is nothing like that. In fact, however,
both capital income and inherited wealth, though less important than they were in the
Belle Époque, are still powerful drivers of inequality—and their importance is growing. In
France, Piketty shows, the inherited share of total wealth dropped sharply during the era of
wars and postwar fast growth; circa 1970 it was less than 50 percent. But it’s now back up
to 70 percent, and rising. Correspondingly, there has been a fall and then a rise in the
importance of inheritance in conferring elite status: the living standard of the top one
percent of heirs fell below that of the top one percent of earners between 1910 and 1950,
but began rising again after 1970. It’s not all the way back to Rasti-gnac levels, but once
again it’s generally more valuable to have the right parents (or to marry into having the
right in-laws) than to have the right job.
And this may only be the beginning. Figure 1 on this page shows Piketty’s estimates of
global r and g over the long haul, suggesting that the era of equalization now lies behind
us, and that the conditions are now ripe for the reestablishment of patrimonial capitalism.
Given this picture, why does inherited
wealth play as small a part in today’s
public discourse as it does? Piketty
suggests that the very size of inherited
fortunes in a way makes them invisible:
“Wealth is so concentrated that a large
segment of society is virtually unaware of
its existence, so that some people imagine
that it belongs to surreal or mysterious
entities.” This is a very good point. But
it’s surely not the whole explanation. For
the fact is that the most conspicuous
example of soaring inequality in today’s
world—the rise of the very rich one percent in the Anglo-Saxon world, especially the
United States—doesn’t have all that much to do with capital accumulation, at least so far.
It has more to do with remarkably high compensation and incomes.
3.
Capital in the Twenty-First Century is, as I hope I’ve made clear, an awesome work. At a
time when the concentration of wealth and income in the hands of a few has resurfaced as
a central political issue, Piketty doesn’t just offer invaluable documentation of what is
happening, with unmatched historical depth. He also offers what amounts to a unified field
theory of inequality, one that integrates economic growth, the distribution of income
between capital and labor, and the distribution of wealth and income among individuals
into a single frame.
And yet there is one thing that slightly detracts from the achievement—a sort of
intellectual sleight of hand, albeit one that doesn’t actually involve any deception or
malfeasance on Piketty’s part. Still, here it is: the main reason there has been a hankering
for a book like this is the rise, not just of the one percent, but specifically of the American
one percent. Yet that rise, it turns out, has happened for reasons that lie beyond the scope
of Piketty’s grand thesis.
Piketty is, of course, too good and too honest an economist to try to gloss over
inconvenient facts. “US inequality in 2010,” he declares, “is quantitatively as extreme as
in old Europe in the first decade of the twentieth century, but the structure of that
inequality is rather clearly different.” Indeed, what we have seen in America and are
starting to see elsewhere is something “radically new”—the rise of “supersalaries.”
Capital still matters; at the very highest reaches of society, income from capital still
exceeds income from wages, salaries, and bonuses. Piketty estimates that the increased
inequality of capital income accounts for about a third of the overall rise in US inequality.
But wage income at the top has also surged. Real wages for most US workers have
increased little if at all since the early 1970s, but wages for the top one percent of earners
have risen 165 percent, and wages for the top 0.1 percent have risen 362 percent. If
Rastignac were alive today, Vautrin might concede that he could in fact do as well by
becoming a hedge fund manager as he could by marrying wealth.
What explains this dramatic rise in earnings inequality, with the lion’s share of the gains
going to people at the very top? Some US economists suggest that it’s driven by changes
in technology. In a famous 1981 paper titled “The Economics of Superstars,” the Chicago
economist Sherwin Rosen argued that modern communications technology, by extending
the reach of talented individuals, was creating winner-take-all markets in which a handful
of exceptional individuals reap huge rewards, even if they’re only modestly better at what
they do than far less well paid rivals.
Piketty is unconvinced. As he notes, conservative economists love to talk about the high
pay of performers of one kind or another, such as movie and sports stars, as a way of
suggesting that high incomes really are deserved. But such people actually make up only a
tiny fraction of the earnings elite. What one finds instead is mainly executives of one sort
or another—people whose performance is, in fact, quite hard to assess or give a monetary
value to.
Who determines what a corporate CEO is worth? Well, there’s normally a compensation
committee, appointed by the CEO himself. In effect, Piketty argues, high-level executives
set their own pay, constrained by social norms rather than any sort of market discipline.
And he attributes skyrocketing pay at the top to an erosion of these norms. In effect, he
attributes soaring wage incomes at the top to social and political rather than strictly
economic forces.
Now, to be fair, he then advances a possible economic analysis of changing norms, arguing
that falling tax rates for the rich have in effect emboldened the earnings elite. When a top
manager could expect to keep only a small fraction of the income he might get by flouting
social norms and extracting a very large salary, he might have decided that the opprobrium
wasn’t worth it. Cut his marginal tax rate drastically, and he may behave differently. And
as more and more of the supersalaried flout the norms, the norms themselves will change.
There’s a lot to be said for this diagnosis, but it clearly lacks the rigor and universality of
Piketty’s analysis of the distribution of and returns to wealth. Also, I don’t think Capital in
the Twenty-First Century adequately answers the most telling criticism of the executive
power hypothesis: the concentration of very high incomes in finance, where performance
actually can, after a fashion, be evaluated. I didn’t mention hedge fund managers idly:
such people are paid based on their ability to attract clients and achieve investment returns.
You can question the social value of modern finance, but the Gordon Gekkos out there are
clearly good at something, and their rise can’t be attributed solely to power relations,
although I guess you could argue that willingness to engage in morally dubious wheeling
and dealing, like willingness to flout pay norms, is encouraged by low marginal tax rates.
Overall, I’m more or less persuaded by Piketty’s explanation of the surge in wage
inequality, though his failure to include deregulation is a significant disappointment. But
as I said, his analysis here lacks the rigor of his capital analysis, not to mention its sheer,
exhilarating intellectual elegance.
Yet we shouldn’t overreact to this. Even if the surge in US inequality to date has been
driven mainly by wage income, capital has nonetheless been significant too. And in any
case, the story looking forward is likely to be quite different. The current generation of the
very rich in America may consist largely of executives rather than rentiers, people who
live off accumulated capital, but these executives have heirs. And America two decades
from now could be a rentier-dominated society even more unequal than Belle Époque
Europe.
But this doesn’t have to happen.
4.
At times, Piketty almost seems to offer a deterministic view of history, in which
everything flows from the rates of population growth and technological progress. In
reality, however, Capital in the Twenty-First Century makes it clear that public policy can
make an enormous difference, that even if the underlying economic conditions point
toward extreme inequality, what Piketty calls “a drift toward oligarchy” can be halted and
even reversed if the body politic so chooses.
The key point is that when we make the crucial comparison between the rate of return on
wealth and the rate of economic growth, what matters is the after-tax return on wealth. So
progressive taxation—in particular taxation of wealth and inheritance—can be a powerful
force limiting inequality. Indeed, Piketty concludes his masterwork with a plea for just
such a form of taxation. Unfortunately, the history covered in his own book does not
encourage optimism.
It’s true that during much of the twentieth century strongly progressive taxation did indeed
help reduce the concentration of income and wealth, and you might imagine that high
taxation at the top is the natural political outcome when democracy confronts high
inequality. Piketty, however, rejects this conclusion; the triumph of progressive taxation
during the twentieth century, he contends, was “an ephemeral product of chaos.” Absent
the wars and upheavals of Europe’s modern Thirty Years’ War, he suggests, nothing of the
kind would have happened.
As evidence, he offers the example of France’s Third Republic. The Republic’s official
ideology was highly egalitarian. Yet wealth and income were nearly as concentrated,
economic privilege almost as dominated by inheritance, as they were in the aristocratic
constitutional monarchy across the English Channel. And public policy did almost nothing
to oppose the economic domination by rentiers: estate taxes, in particular, were almost
laughably low.
Why didn’t the universally enfranchised citizens of France vote in politicians who would
take on the rentier class? Well, then as now great wealth purchased great influence—not
just over policies, but over public discourse. Upton Sinclair famously declared that “it is
difficult to get a man to understand something when his salary depends on his not
understanding it.” Piketty, looking at his own nation’s history, arrives at a similar
observation: “The experience of France in the Belle Époque proves, if proof were needed,
that no hypocrisy is too great when economic and financial elites are obliged to defend
their interest.”
The same phenomenon is visible today. In fact, a curious aspect of the American scene is
that the politics of inequality seem if anything to be running ahead of the reality. As we’ve
seen, at this point the US economic elite owes its status mainly to wages rather than capital
income. Nonetheless, conservative economic rhetoric already emphasizes and celebrates
capital rather than labor—“job creators,” not workers.
In 2012 Eric Cantor, the House majority leader, chose to mark Labor Day—Labor Day!—
with a tweet honoring business owners:
Today, we celebrate those who have taken a risk, worked hard, built a business and
earned their own success.
Perhaps chastened by the reaction, he reportedly felt the need to remind his colleagues at a
subsequent GOP retreat that most people don’t own their own businesses—but this in itself
shows how thoroughly the party identifies itself with capital to the virtual exclusion of
labor.
Nor is this orientation toward capital just rhetorical. Tax burdens on high-income
Americans have fallen across the board since the 1970s, but the biggest reductions have
come on capital income—including a sharp fall in corporate taxes, which indirectly
benefits stockholders—and inheritance. Sometimes it seems as if a substantial part of our
political class is actively working to restore Piketty’s patrimonial capitalism. And if you
look at the sources of political donations, many of which come from wealthy families, this
possibility is a lot less outlandish than it might seem.
Piketty ends Capital in the Twenty-First Century with a call to arms—a call, in particular,
for wealth taxes, global if possible, to restrain the growing power of inherited wealth. It’s
easy to be cynical about the prospects for anything of the kind. But surely Piketty’s
masterly diagnosis of where we are and where we’re heading makes such a thing
considerably more likely. So Capital in the Twenty-First Century is an extremely
important book on all fronts. Piketty has transformed our economic discourse; we’ll never
talk about wealth and inequality the same way we used to.
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