A Summary of the Important Points in Capital in the Twenty-First Century
by Malte Skarupke
Capital in the Twenty First Century by Thomas Piketty was widely recognized as a very important book when it came out in 2013. Yet somehow now, in 2018, I rarely encounter people who have learned the lessons from the book. Of course I don’t expect most people to read the book, but since the lessons are so important for development of society, I would expect them to be spread by other means. In order to help that, I decided to write this blog post which summarizes the most important points. So here is the first point:
1. The more money you have, the more money you make
This seems to be a fundamental law of economics. It’s not something we have constructed. It’s even true in primitive societies: If there are two families, one family owns two cows, and one family owns ten cows, the family with ten cows doesn’t make five times as much money as the family with two cows, it makes more than that. That’s because it can more easily survive bad times (like if a cow gets sick) or it can invest in better tools to take care of cows, and those tools pay off more (like fences or a cow shed).
The book traces that out with lots of numbers: Bill Gates keeps on getting richer even though he hasn’t worked in years. It was very hard for anyone else to overtake him as the richest person in the world. Also the richest universities make more interest on their endowments than less rich universities. Why? Because they can pay better people to manage those endowments.
2. Return on capital is higher than economic growth
This is usually put as the most important lesson of the book (the famous r > g inequality) but this one is only important if you also state that people who have more money make more money.
What does it mean if return on capital is higher than economic growth? It means if you rent out a house, you will probably make a higher percentage return on that (say 5%) than the economy grows (say 2%). This is not just true for houses, but for many forms of capital: Factories, bonds, stocks, farms, you name it. The return on all of those is different, but it’s usually bigger than the growth of the economy. And once again this seems to be a fundamental law. It’s always been true throughout human history (with very brief exceptions).
So if the economy only grows by 2% a year and people who own capital make 5% (or more) a year, what does that result in? Well let’s say the whole economy has a value of 10000. And after one year it has grown to a value of 10200 (2% growth). And let’s say the owner of your apartment has a total wealth of 100, and after one year his wealth has grown to 105 (5% growth) then he now has a bigger part of the total wealth than he had the year before. He started off with 1% of the total economic pie, and after one year he had 1.03% of the total economic pie. What does that do in the long term?
3. The only long-term stable distribution is extreme inequality
We live in a very unusual time in history, because inequality isn’t that high right now. Inequality is getting bigger, but it’s still not where it has been historically.
Historically what happened is that you had a few very rich people (kings, nobles) but 90% of the population was living in complete poverty. They owned basically nothing and barely survived. The middle class was tiny (lesser nobles, merchants).
This third point follows directly from the first two points. Since those two points seem to be fundamental (they’ve always been true, through all of human history) this third point is also a fundamental thing.
So if you’re ever wondering how much worse inequality can get: It is going to get a whole lot worse. Right now we don’t have anyone who is as important as kings used to be. Until that happens, inequality is not as bad as it usually is.
4. We got to this unusual time through destruction and high taxes
I said that we live in an unusual time in that inequality is fairly low. How did we get here? Four things: The great depression, the two world wars, and the new deal. The great depression and the two world wars destroyed a lot of wealth. The high taxes of the new deal prevented the rich people from taking off again.
Since then we have reduced taxes on the rich and had a long period of peace and stability. So inequality is going up again.
5. Life used to be a lot more expensive
It’s hard for us to imagine what life was like before modern technology. For example when David Foster Wallace talked about Dostoyevsky novels, he complains about how the novels are made harder to understand because the society was so different, and among other things he says this:
Obscure military ranks and bureaucratic hierarchies abound; plus there are rigid and totally weird class distinctions that are hard to keep straight and understand the implications of, especially because the economic realities of old Russian society are so strange (as in, e.g., the way even a destitute “former student” like Raskolnikov or an unemployed bureaucrat like the Underground Man can somehow afford to have servants)
(quote from David Foster Wallace’s “Consider the Lobster” page 263)
Capital in the Twenty-First Century was the first book I read that gave an explanation for this weirdness. The book explains how in former times, you were considered a poor person if you made five times the average income. To be considered middle class you had to make 20 to 30 times the average income. Why? Because to do anything you needed servants. Everything was hand-made and everything had to be done by hand. Piketty uses nineteenth century novelists to illustrate this point:
one can read between the lines an argument that without such inequality it would have been impossible for a very small elite to concern themselves with something other than subsistence: extreme inequality is almost a condition of civilization.
In particular, Jane Austen minutely describes daily life in the early nineteenth century: she tells us what it cost to eat, to buy furniture and clothing, and to travel about. And indeed, in the absence of modern technology, everything is very costly and takes time and above all staff. Servants are needed to gather and prepare food (which cannot easily be preserved). Clothing costs money: even the most minimal fancy dress might cost several months’ or even years’ income. Travel was also expensive. It required horses, carriages, servants to take care of them, feed for the animals, and so on. The reader is made to see that life would have been objectively quite difficult for a person with only 3-5 times the average income, because it would then have been necessary to spend most of one’s time attending to the needs of daily life. If you wanted books or musical instruments or jewelry or ball gowns, then there was no choice but to have an income 20-30 times the average of the day.
(quote from page 415 of Capital in the Twenty-First Century)
So you were considered poor if you had 3 to 5 times the average income. And the 90% of the population that didn’t have that kind of money weren’t really part of society. So the poor student from David Foster Wallace’s quote probably still had an income of several times the average income of the time (maybe from his family, but I haven’t read the book).
So what’s going to happen?
The above points are what I consider to be the most important points. So what’s going to happen? This part will be my own theories. First of all inequality is going to get a lot worse again. Rich people will always make more money, and their income will always grow faster than the economy, so their share of the pie will get larger and larger. In theory we can control that through higher taxes, but in the US rich people seem to be really good at influencing politics to their advantage. They now pay lower taxes than the average American, and they can now donate unlimited money for political causes and thus further change rules in their favor.
How far will that go? Much further than most people imagine. There will be people as powerful as kings used to be. Of course we won’t call them kings (maybe we’ll call them “oligarchs” or “trillionaires”). But how did you get to be a king in the old days? You got to be king by having enough money to hire the largest army. It was more complicated than that, but that’s the basic idea. Hiring a big army probably won’t work in modern times but they will find other ways to be influential. Rules and laws will be changed to allow for more influence of rich people. There will be a new aristocracy where people live in a parallel world of inherited wealth with its own social norms, fashions, manners etc.
Is there any way that that won’t happen? Hard to say. We live in a very unusual time where inequality isn’t that big, so for us it just seems unimaginable, but extreme inequality was the norm for all of human history so why wouldn’t we be moving back to that?
We got to this low inequality through destruction and high taxes. We probably don’t want another world war, so high taxes would be a way to keep high inequality in check. And it could happen. Bernie Sanders was surprisingly popular in the last election, so it’s not inconceivable that we’ll get somebody like that to be president at some point. But those things can only ever delay the rise of the rich people. There are fundamental laws at work here. You’d have to either change it so that the people who have more money don’t make more money (change lesson 1 above) or so that return on capital is not greater than the growth of the economy (change lesson 2 above). If you attempt to change either of those, you will have very, very strong opponents fighting against you.
Despite all that I’m also optimistic, because I think it’ll never be as bad again as it was before modernity. Thanks to modern technology, even poor people are actually living fairly good lives. This is not to say that there aren’t people out there who work very hard and still barely make enough to get by, but those are no longer the norm. And those people don’t die at the same rate as people did in the middle ages. Now as a counter point, I do think that there are plausible scenarios where we are back to crazy unequal societies. For example the back story of Horizon: Zero Dawn has a fairly consistent view of this with rich people who never work, and poor workers who don’t even make enough money to pay for their rent, so they just fall further and further into debt. But scenarios like that just seem unlikely. Why wouldn’t somebody come along in that situation and build cheap housing? (on the other hand we already prevent construction of cheap housing…)
In any case we are currently watching the conflict between people who like things to be as equal as they have been recently, and rich people who like to be richer and more influential. Rich people seem to be winning, and Capital in the Twenty-First Century helped to illustrate that one of the reasons for that is that rich people have fundamental laws of economics on their side. And it helped to illustrate that we are currently living in abnormal times, and having crazy rich people around (like kings and queens) is much more normal, and we’ll probably move back to that. It takes work to keep inequality low. By default it will always rise.
Another book that touches on all of this, and provides possible solutions is Inequality, by Anthony B. Atkinson.
He basically advocates for a 65% upper tax bracket as a mathematical counterforce of rising inequality due to capital.
I’m planning to read The Great Leveler next. From my vague understanding, it offers a counter to what’s suggested by Atkinson.
The main failure of Piketty’s book is that it entirely fails to discuss the one major unspoken assumption the entire book rests on, namely that a society with an extremely biased distribution of wealth is “bad”.
I’ve seen nowhere in the book a rationale that participant in a society that has reach the equilibrium distribution he describes are necessarily miserable. Without tackling that, what is the point of the book?
Interesting! Thanks for sharing. You may also be interested:
View at Medium.com
Most of anything based on Piketty is wrong. Why? Well, this assumes that markets don’t evolve and in fact, there’s no evolution in the system.
The simple example of this being not the case is the fall of Tzars in Russia or the French Revolution. Distribution became so extreme that the system failed (bloodshed, war etc.) – this, in fact, seems to relate to basics of game theory.
Another example is how invention introduces changes in inequality – though 1st Industrial Revolution maybe wasn’t all sugar and cherries but the simple reason why people preferred working in the city was that it was way better (profitable) to live there.
It’s actually pretty basic argument in modern economics and Piketty was not only widely criticized for most of his theory at the release of the book but also, later on, found empirically wrong (e.g. inheritance tax).
There’s need for an allowance for some inequality as this allows for things like entrepreneurship which in turns allows for movement between social strata (between working classes) but too much inequality will, always, make the system fail.
So that’s in regard to saying inequality is only stable solution.
What about other points? The more money you have the more money you have – no. It’s obviously wrong in the current times. This seems to be the foundation of Piketty’s view on inheritance, but inheritance actually was proved to increase wealth distribution (there’s an empirical study on this problem exactly).
So, destruction and taxation – again, this is based on Piketty’s view that since inheritance increases inequality than to decrease inequality we need ways to take away from the rich, through taxes. This again was proved to be wrong. Rich are very good at avoiding taxes and they get better as they get richer. The studies on inheritance tax proved that when inheritance is taxed the wealthy look and find ways to preserve it, thus inheritance tax actually affecting the poor more.
Next wrong (totally) point: return on capital is always greater than economic growth … dot-com bubble? Any other market crash related to luxury capital like tulip craze? I mean, even the example you gave is obviously wrong, because after enough iterations personal capital is greater than the whole market which is possible or stable how? Return on capital is not only related to economic growth but it’s also a bit of a gamble.
1. The more money you have, the more money you make – this doesn’t seem correct on the whole and is just a refresh on Marx’s class warfare and LTV interpretation. There are studies proving this wrong.
2. Destruction and high taxes – totally wrong, stemming from the fact that Piketty entirely skipped over entrepreneurship as something affecting wealth distribution. Totally wrong, a simplest explanation why is an observation of how innovation and entrepreneurship created wealth.
3. Inequality being long-term stable – totally wrong, to the point of being pretty obvious looking at any natural process or last 500 years of history.
4. Return on capital being greater than economic growth – uhhh, no. Doesn’t work mathematically and really is just a version of 1.
Essentially, Piketty’s book is really, really poor resource to get an idea about how economy works.
“This is not to say that there aren’t people out there who work very hard and still barely make enough to get by, but those are no longer the norm.” I would guess at least three billion people live like this. Assuming those number are correct, that -is- the norm. This article seems written from the perspective of the bubble where even the poorest person has almost enough to eat.
What’s going to happen all depends on politics. As the great depression, politics of the 1930s, and subsequent world wars showed, it’s perfectly possible for the power or the rich to be broken by political means. The trouble is that under plurality voting (and the other almost-as-bad systems in use then and now), doing so necessarily entails horribly dangerous extremism. Mathematical properties of current voting systems essentially guarantee this, and the early signs of the process are already observable. It turns out that there is a single very hopeful idea about how things might be done differently: http://rangevoting.org