Distribution in XXI century according to Piketty

The French economist is not the twenty-first century Karl Marx, rather he is a new Simon Kuznets, but a leftist Kuznets.

1. "The capital of the XXI Century" is a successful book; like other popular books on economics, will be cited by many but read by few. It is worth to read it, because it provides a mass of data and considerations on the wealth and income distribution, one of the central themes of the economics as political science. It should be said right away what there isn’t in Piketty’s work. There isn’t a theory of value, a theory of capitalist development and its underlying trends, or of the economic cycle. The French economist is not the twenty-first century Karl Marx, rather he is a new Simon Kuznets, but a leftist Kuznets. The latter, fourth Nobel Prize for Economics in 1971, was the one who defined the concepts of gross domestic product and its components.

Looking at the series, Kuznets has formulated a hypothesis about the evolution of inequality in income distribution, known as the Kuznets curve, whose shape resembles an inverted U-shaped, or a bell shape. When the curve ascends the inequality (measured by the Gini index) increases. The bell shape indicates that the distribution of income tends to worsen in the first phase of development, improving instead in a constant manner with the transition to the industrial economy. This is because in a first stage, the richest segment of the population invests its capital, further increasing their wealth; but later with the development of industry and services, and the decline of agriculture, the wealth is spread among the population; it creates a strong middle class, and the concentration of personal income decreases, while competition reduces firms' profits .

Piketty shows that the period covered by Kuznets is very specific; it is true that from the first to the second world war there was a sharp decline in the capital-income ratio, and that in the thirty years following the Second World War, the ratio did not grow, or grew slightly. But those were two particular periods: in the first the destructions of capital were large, while in the second there was a strong income growth, especially in European continental countries and Japan; but the secular trend reappears, when we extend the view on the data that from the nineteenth arrive until the first decade of the millennium.

2. As far as the performance of the capital-income is concerned, the magic formula is s/g. The capital includes all forms of capital, real and financial, movable and immovable. The income is net of depreciation. The formula tells us that if we consider that over time, with constant rate of saving (net) and growth of income, then the capital-income ratio will tend towards s/g; if s is equal to 10%, and g to 1.5%, the ratio will be close to 6.7, i.e. total assets of private sector will be 6.7 times income. Obviously any long period of time neither s nor g are constant, but vary, whereby also the capital-income, in short periods (for example, five years), will have oscillations. But just consider the average propensity and the average growth over the period to figure out where you will be placed at the end of the period.

From the capital-income you may shift immediately to the share of capital income in national income: you have just to multiply the stock of capital for its average return (r) in order to get the  factor distribution, rs/g. A yield of 5% leads to a 33% share, a yield of 4% to 27%. For example, the graphs 6.1 to 6.4 of Piketty’text show, in France and in the UK, that the share of capital income fluctuate below 30% for most of the last century and are situated, around 2010, right around the 27%.

Since the capital is much more concentrated than income, it is clear that incomes from capital are much more concentrated than those from work, despite the explosion of "workers" multi-millionaires. In fact, there are professionals, artists and athletes who earn hundreds of times the average income, but the bulk of these are the ones that Piketty calls the super-cadres, namely the CEOs of banks and large companies, or those immediately below them. In reality it is people who steal a share of the profits of the companies, for reasons that have been thoroughly explained. In the functional division their income gains (at least in large part) should be placed among the returns on capital, and not on labour, even if they spend a lot of time in their offices.

Piketty dwells at length on the relationship between r and g. It is in fact clear that if s remains constant, a fall of g with respect to r leads to an increase of the ratio, and this in turn determines a worsening of the personal distribution of income. A ratio of 4/1.5 applied at a rate of 10% savings determines a market share of 26.7%, but if g falls slightly to 1.4, the percentage rises to 28.6%, almost two points higher. However, the three variables are not independent. A positive relationship between growth rate and savings emerges in the long run; the case of China is perhaps one of the most spectacular. Piketty doesn’t believe to the Modigliani’s explanation with its life cycle saving theory, but there are also alternative explanations, which show a positive relationship between the two variables. On the other hand in the last seven years, with the onset of the crisis, we have seen very large falls in GDP growth  and in  investment returns, both real and financial.

3. The reading of the first three parts of the book produces a sense of ineluctable determinism; sixty years of the last century, beginning with the First World War, were a special time, which is over. The tendency will be to return to the levels of inequality of the belle époque, beautiful, of course, for owners of opulent wealth. However, the graphic 10:10 seems to offer some hope. It shows the difference between the net return of capital (after tax and losses) in the last two thousand years, with a projection up to 2100 until the nineteenth century. Obviously the estimates are necessarily to be taken with great caution, but the difference between r and g is very large. But throughout the twentieth century and beyond (the aggregation of the data is from 1913 to 1950 and from 1950 to 2012), the ratio is reversed, and the growth rate exceeds the net return on capital. It is Piketti’s projection towards the end of the twenty-first century that shows again a gap between a growing r and falling g.

It is possible to have some doubts on the evaluation of the different components of capital. Piketty shows that the share of the land fells in the two centuries that have elapsed since Ricardo’s time; while buildings went up, representing now the largest component of private wealth, higher than the value of productive enterprises. Now the bulk of the buildings is made up of residential houses; the price of housing is given by the ratio of rents and interest rate in the long term. Periods of strong growth of these prices depend on both the numerator increases due to an imbalance between supply and demand, and to a decrease in long-term rates. But during periods when real estate bubbles have deflated rents have fallen, and with it the price of housing, despite the decrease of long-term rates.

A similar argument can be repeated for the buildings to productive use. Then the forecast of an increase in the value of real estate, in relation to GDP, is quite uncertain. With regard to the productive capital, Bob Rowthorn (Insight  Piketty's Capital in the Twenty-First Century - A Critique) has a good criticism directed at the hypothesis under the dynamics of factor shares adopted by Piketty. The bleak forecast of the French author may perhaps be questioned without having to rely on the hopes of the progressive tax on capital; that may play a role in mitigating the degree of concentration in the top 1% of the wealthy, but  cannot be able to correct the underlying trend, if this is what Piketty has in mind.

An important role will be played in the coming decades by economic policy guidelines that governments will take. If in Europe the road will continue to be that indicated by the Germany, it is clear that the functional distribution, and therefore also the personal one, tend to worsen. An export-led economy is necessarily an economy in which the private and public consumption must leave a suitable place to exports, or rather to an adequate surplus in the trade balance. So the share of wages in GDP has to be contained. It seems that Spain is referred to as the model for other European countries in difficulty, including France. Over the past six years, the Spanish wage share has fallen by 3.7 percentage points. Six years is a short period from the point of view of the forces described by Piketty; the improvement in the share of profits depends on precise policy choices.

Ruggero Paladini

Economist - Professor of "Scienza delle Finanze" at University "La Sapienza" Roma; Member of the Economic Board of Insight - ruggero.paladini@uniroma1.it