CAPITAL CHARGE
It is rare that an economic historian makes it on to late-night chat shows, but Thomas Piketty has been hailed by the American media as a ‘rock-star economist’. In his native Paris — a city from which, he admits, he has rarely ventured — he is better known as an adviser to the Socialist Party.
His new book, Capital in the Twenty-First Century, is a doorstep of a volume, its title deliberately apeing Marx’s Das Kapital with similar prescriptions, including an 80 per cent global wealth tax. So why is anyone taking him seriously?
The answer is that Piketty claims to have discovered the historical fact that the rich really do get richer. He has analysis, and plenty of anecdotes, to back up the claim, plus a neat, scientific-looking way of expressing it, suggesting that redistribution is not just fair, but a technical necessity for economic survival. No wonder the left is fawning over him.
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Piketty’s simple claim is that the rate of return on capital always exceeds the overall rate of economic growth — or in his quasi-scientific version, r > g. Capital owners, in other words, grow wealthier faster than workers and entrepreneurs. Over the years, that leaves us with an aristocracy of rentiers with an increasing share of society’s wealth.
After 300 years of Western capitalism, you may ask, where exactly are all these rentier wealth-hoggers? Well, says Piketty, every so often the wealth of the capital owners is dissipated by war. But then the cycle starts over and the rich keep on getting richer once again, until the next war intervenes. That is a nice try at explaining why his theory, despite all his history and anecdotes, does not actually fit the observed facts.
But there is a very much simpler and more systematic explanation — market forces and competition. (As people consistently underestimate this, I have just written The Economics of Success.)
Piketty’s rentier aristocracy view of wealth accumulation presumes that capital is a sort of utility, like a tree that regularly drops fruit into the owner’s lap. But capital is actually very diverse. Different capital produces different returns and is exposed to different degrees of risk. But ‘risk’ is a word that hardly features in Piketty’s analysis. (Too many years spent in cushy, subsidised Paris, perhaps.)
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Capital can be destroyed at any time, and not just by war. If capital is to produce any return at all, it has to be created, accumulated, targeted, serviced, managed and maintained. Its owners can fail at any of those stages, and often do. Losing wealth is much easier than holding on to it.
Utility-type capital may produce a pretty certain return, but precisely its returns tend to be low, as holders of T-bills and gilts will testify. Equally, entrepreneurs would not risk their money in a venture with a high risk of failure unless the potential rewards were high. And the existence of even a small risk makes a mockery of Piketty’s view that the returns on capital will keep on rising faster than overall growth from now until doomsday (or at least, until the next war). It is hard enough to predict what profits a company might make next year, never mind in ten years or a hundred.
Wealth of experience
If you believe that the rich keep getting richer, then the Canarsie people who, legend has it, traded Manhattan Island to the Dutch for $24-worth of beads were pretty shrewd. If they had invested the $24 at 6 per cent compound interest, today they would have enough to buy the whole place twice over, skyscrapers and all, and still with $1 billion in change.
But no wealth accumulation is that consistent. Even without wars, somewhere between 1626 and today their fortune would have been dissipated through folly, misfortune, greed or miscalculation.
When you introduce risk into Piketty’s analysis, things look entirely different from his image of capital owners getting richer and richer. Adjusted for risk, the return on capital is modest — and has been falling for decades. Rates naturally tail off as the best opportunities are exploited and only the thinner ones are left. Sure, some people earn good returns from investing in, say, emerging markets. But the risks are high. And in fact, most capital remains at home, where its returns do not even beat the stock market.
Capital, though, is only one factor of production. You need land, labour and brains too. If capital really did take a larger share, wages would soon be bid up. That is exactly what happened in the 19th century — a period of huge capital accumulation that also saw huge rises in the living standards of ordinary workers. (By making the entire economy more efficient, capital benefits everyone.)
Nor are capitalists and workers separate groups nowadays. Workers invest in pension and savings plans, giving them enormous capital holdings of their own. (When people talk about the evil City, this fact is often conveniently forgotten.)
But maybe the biggest kind of capital in today’s services-led economy is another that Piketty overlooks: human capital. There is nothing aristocratic about that, as it is a form of capital that we all have. And indeed we invest in our human capital — learning skills, going to college, moving to better jobs and suchlike. In payback terms, it is about the best investment you can make. That’s a return on capital that benefits everyone, not just a few already wealthy people.
The success of poor immigrant groups — the huddled masses turning up at Ellis Island, or the more recent East European arrivals in Britain — shows that people without financial or physical capital can and do prosper. You do not need to be rich to get rich. Piketty sees only inequality because he looks only at raw earnings.
That ignores the fact that we pay taxes on those earnings in order to support health, education, welfare and other redistributive programmes. Post-tax, wealthy countries are the most equal; it is the poor ones that are unequal. And it is better to be poor in a rich capitalist society than in a poor non-capitalist one.
A problem shared
If you want to make a country poor, Piketty’s redistributionist policies are a good start. Countries that penalise capital owners make it less worthwhile for people to create and preserve capital. They have less domestic and foreign investment, fewer savers to fund projects and a focus on distribution rather than growth. Impose a big capital tax and you end up with Cyprus-style instability or Zaire-style ruin. High taxes also lower people’s investment in their own human capital.
The result is lower growth, productivity and wealth, which hurts the poor much harder than it hurts the rich and well-connected. And do we really expect any government to administer an 80 per cent wealth tax without corruption?
For a really radical policy to help the poorest among us, why not try open immigration? Today, how wealthy you are is mostly down to where you live. That is because some countries have built up productive capital and have a rule of law to protect it, while others do not. Far from wanting to tax capital, we need to let everyone enjoy its enormous benefits.
Eamonn Butler is the author of The Economics of Success: 12 Things Politicians Don’t Want You to Know (Gibson Square Books)
