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By Kenneth Thomas

Thomas Piketty's (CV) Capital in the Twenty-First Century is the most important book on economics published in this century. The book has made a huge splash and drawn the ire of conservatives for its straightforward argument that recent increases in inequality in numerous countries are likely to rise to unprecedented heights unless governments can reach democratically based solutions to this problem.

As I mentioned previously, the book's success is built on a mountain of data that a multinational team of researchers has been compiling for 10 years, the World Top Incomes Database, as well as long-term wealth records dating back to 1790 in the case of France. Piketty, in fact, has been working on inequality issues for 20 years. As he remarks in the book, until the creation of these datasets, debate on inequality was a "dialogue of the deaf" with precious few facts to back up anyone's arguments. A lot of this work has been taking place out of sight of most pundits, as Piketty's early books and papers are published in French, with the exception of the reasonably well-known papers he co-authored with Emmanuel Saez on U.S. inequality.

Most notably, there has been only one significant challenge to Piketty's data, and it was easily swatted down. Chris Giles of the Financial Times claimed that wealth inequality in the United Kingdom had declined since 1980, not risen as given in Piketty's book. But Giles made the error of taking survey-based wealth data (which sharply underestimates the wealth of the rich) and splicing it on to much more accurate estate tax-based data, to get a declining share of wealth for the top 10% and the top 1%. As Piketty says in his response:

Also note that a 44% wealth share for the top 10% (and a 12.5% wealth share for the top 1%, according to the FT) would mean that Britain is currently one the most egalitarian countries in history in terms of wealth distribution; in particular this would mean that Britain is a lot more equal that Sweden, and in fact a lot more equal than what Sweden has ever been (including in the 1980s). This does not look particularly plausible.

Obviously I agree with Piketty, but don't take my word for it. According to Eurostat, the Gini index for income inequality (which runs from 0 to 1, but is often multiplied by 100, as here; higher is more unequal) in 2012 was 32.8 for the United Kingdom versus 24.8 for Sweden. (For comparison, the United States was at 45.0 in 2007, according to the CIA World Factbook.) Combine that with the fact that wealth is more unevenly distributed than income in every country, and it is impossible for U.K. wealth to be more equally distributed than Sweden's is today, let alone at its most equal point in the 1980s. Moreover, according to Piketty's data on Sweden, which Giles does not dispute, the top 10% there owned just a tad under 60% of wealth, and the top 1% fully 20% of wealth, in 2010 (Figure 10.4, p. 345).

So what does all this new data show? First of all, the data show that the optimistic post-war notion that inequality had been solved for good was an illusion. As Piketty points out, economist Simon Kuznets had posited that as countries developed from very poor to very rich, as their GDP per capita increased, countries became more unequal at low levels of income (think China today). However, after a certain tipping point was reached, as countries raised their per capita GDP, their income distribution would become more equal. This was based on what Kuznets saw in the 1950s, a situation where income inequality was indeed declining in the industrialized countries. Many people expected that as more countries developed, they would pass the tipping point, and income inequality would decline in more and more countries. Alas, since 1980, we have seen a resurgence of inequality in the wealthy countries, turning the second half of Kuznets' story into a "fairy tale."

According to Piketty, the reasons we saw a sharp decline in wealth inequality in the wealthy countries from 1910 to 1980 are that there were substantial destructions of capital in the two World Wars, plus high taxes levied on the wealthy to finance the wars, which could not be paid for otherwise. Then, after World War II, there were very rapid growth rates possible as the various countries played catch-up to get back to their pre-war growth trends.

This brings us to a second major point of Piketty's book. He argues that the relationship between the rate of return on investments (r) and the country's growth rate (g) is a critical determinant of how concentrated wealth becomes in a society. If r exceeds g, over time capital ownership becomes more concentrated and society less equal. In all probability, developed countries can only expect to see growth, after inflation, of 1% to 1.5% per year. Of course, China and some other developing countries are growing more rapidly, but as they reach the technological frontier, their growth will slow. Meanwhile, the return on investment is more on the order of 4-5% annually. Thus, for industrialized countries, there is considerable danger that the wealth will become significantly more concentrated, and Piketty considers it obvious that high inequality is dangerous to democracy.

Alas, it's late; I have to stop for the night (but not at Hotel California). I'll have more to say very soon.

Source: Understanding Piketty, Part 1