Radical Critique of Piketty: A Primer

Nicholas Partyka I Social Economics I Analysis I June 11th, 2014

The following analysis is a primer for a two-part book talk on Piketty's "Capital in the Twenty-First Century," co-sponsored by the Hampton Institute and Capital District OFS (Organization for a Free Society). The talks are scheduled for Monday, June 23 and Monday, June 30, 2014 at 6:00 PM at the Social Justice Center in Albany, NY. For the first talk (6/23), Colin Donnaruma and Nicholas Partyka will review Piketty's central thesis about inequality, provide an overview of his data, and analyze his approach and methods. For the second talk (6/30), they will review Piketty's positive solution to the problem of inequality, including a critique of its adequacy and potential short-comings.

Over the past couple of months the dominant media in the US and the English-speaking world generally has given a lot of attention to one book in particular. This is interesting because the attention given this particular book is entirely out of keeping with so-called normal expectations. This sense of surprise can be detected in numerous credulous headlines from most if not all the major publications and media outlets regarding the popularity and fiscal success of a six hundred page book by a French economist on income inequality.[1] The book we are talking about here is of course the now well known Capital in the Twenty-First Century by Thomas Piketty. This sense of surprise exists for many reasons. A couple obvious ones are that books this long are not typically popular among the general reading public, nor are books on or by economists, and especially economics books on an arcane subject like historical trends in income inequality. Not that no one reads these books, far from it, but that the top of the list of New York Times or Amazon.com best sellers is not a place one is accustomed to seeing a tome of this kind.

Not only is it surprising that this book has received so much critical acclaim, and commercial success, but it is also surprising that the coverage of the book's ideas has been so widespread in the dominant media. Not only is the media telling the story of the books success, and merely reporting that people are buying the book, but a great many in the media have engage with the ideas presented in Piketty's book. It would be one story to report an odd story about how a book on economics is actually selling a lot of copies; so many that another printing is underway. [2] It is another thing to discuss and analyze the ideas presented in that book. That this has been done at all in the dominant media is somewhat surprising, but that that it has been done by almost every major newspaper, political magazine, and cable TV news outlet is quite surprising.

Everyone from Mother Jones and The Nation on the left, to National Review and New Statesman on the right have given coverage to Piketty. The New York Times, Washington Post, The Guardian, Wall Street Journal, Businessweek, The Financial Times, Forbes, The Atlantic, New Republic, The Economist have all run several stories relating to Piketty's Capital.[3] Most if not all major television news programs have also devoted plenty of time to discussion of Piketty, including the PBS Newshour.[4] Pundits, commentators, and analysts from across the spectrum of acceptable political positions have seemed to have put their two cents in on Piketty.

Challenging Neoliberal Orthodoxy with a Simple Claim

Why this is so surprising to many, myself included, is that Piketty's book is on income inequality, and presents data and ideas that challenge the now dominant 'conventional wisdom' in economic theory, i.e. the neo-liberal consensus. This rather jaundiced view of economic theory emerged as the dominant, even orthodox, position in the late 1970s and early 1980s. This view held that supply-side stimulus was the way to boost overall economic growth. They also advocated for deregulation of many markets and industries, as well as the privatization of increasingly many functions once belonging to the public sector. One of the biggest causes championed by this conservative coup in conventional economic thought was tax reform. The idea was to reform the tax code in a way that would enable the now infamous "trickle down" process to lift overall economic growth. Low taxes on high income earners have been and remain a cornerstone of this view of economic theory. According to this theory, low taxes on high income earners allows these hard working people to keep more of their income, and as a result to invest more, and thus create jobs and opportunities for others in society. The problems with this theory are well-known, but also beyond the scope of this essay.

At a moment in time in our society where income inequality and the host of related problems is once again being seen as a real economic and political problem, one at least worthy enough to be on the table for discussion, perhaps we should not be in the least surprised by the success of this book. Indeed, in the wake of a severe financial crisis in 2007-2008 and prolonged recession, now called the Great Recession, as well as a weak recovery and the dramatic economic and social effects of this economic shock interest in income inequality seems rational. So much so that it formed one crucial source of the discontent that spawned the Occupy Wall-Street movement in 2011.

And yet, the media elites - if one judges from their headlines anyway- seen quite shocked by the immense interest in Piketty's work. Much of this shock comes from the fact that the orthodoxy of economic theory of the last three decades claims inequality is not an issue, not one worth discussing anyway. Growth is the answer to all social ills on this view. Perhaps another part of the shock being expressed in the capitalist media is explained by the fact that on Piketty's analysis growth simply cannot be answer to our social ills.

Of course one must mention that the reactions to Piketty's book have been mixed. Many on the right are now obsessed with this idea that Piketty's book is fundamentally flawed because he got the math wrong due to an article in Financial Times.[5] Many on the left, on the other hand, are triumphant because they see Piketty's work as vindication of what they have been saying at least since the beginning of the most recent US financial crisis.[6] Many in the center, or even center-left see in Piketty a rationale for the slightly higher taxes they would like to see adopted. Many on the right see Piketty as a dangerous rouge, someone making too much out of nothing and instigating people to advocate for unsound policies.

Piketty's Approach and Data

So, the question at this point becomes, what exactly is Piketty saying that has everyone seemingly so riled up? At the risk of spoiling the ending, the truth is that Piketty's claims are not too terribly radical. Piketty presents a very thorough and detailed account of the evolution of income inequality from 1700 to 2013. He investigates changes in the composition of capital, in the composition of income in various income classes, and much more. He makes use of a very large body of evidence from diverse sources. His data is largely composed of tax records from many countries. In the main he makes use of data on income, estate, and inheritance tax records to show how inequality in income and wealth has changed over time in scope as well as in structure. Setting out clearly and thoroughly the dominant trends in the changes in income and wealth inequality in many countries is the most important practical contribution of Piketty's work.

The main theoretical contribution that Piketty's book makes is his short and elegant, but powerful equation (r > g). In this equation (r) stands for the rate of return on capital, and (g) stands for the rate of growth of income. What this equation says is that as long as r is greater than g inequality in wealth and income will increase. For Piketty this equation constitutes a basic law of capitalism, and represents the largest force of divergence in market economies. Building off the law of cumulative growth, this equation shows that even small initial differences in wealth and income will, with time, increase inexorably ceteris paribus. Piketty's argument is that in an economy marked by low rates of growth, either in productivity or in demography, (r > g) implies that inequality will tend to rise.

Piketty's research into national tax records of the 18th,19th and 20th centuries helps bear out what his equation claims. Indeed, it is out of this analysis of three centuries of tax records that Piketty derives his equation. It is a well known historical fact that it was in the 19 th century that world economic productivity began to rise more rapidly, especially in its second half. Yet, despite the phenomenal amount of growth and development that occurred in this period the average annual rate of growth from the early 19th century to 1913 was only 1-1.5%. In the short-run there was considerable volatility in the rates of growth both within and between nations. At the same time the rate of return on capital in this same period remained at its traditional levels, namely around 4-5%; and never below 2-3%. Thus, throughout the 19th century (r) was greater than (g), and so the data shows an increasing trend in income inequality up to the 1913-1945 period.

What (r > g) implies is that in a low growth environment, like the one we saw in the 19th century, where the return on capital is greater than the rate of growth of average income inequality will continue to rise unless unchecked. In the twentieth century the growth of inequality was checked by government policies aimed at confronting the challenging international political and economic landscape of the time. As this landscape changed so did government policies, and eventually capital was able to regain, if not somewhat expand, its traditional share of national income and wealth. This is because the processes of increasing wealth accumulation and concentration are automatic in capitalist market economies. The law of cumulative growth assures that those who start out with capital can turn it into much more; often without much effort. This is why Piketty claims that one implication of (r > g) in a low growth environment is an ineluctable tendency for the entrepreneur, or capitalist, to become the rentier. This means in practice that capital accumulated in the past tends more and more to dominate the present.

I think for the sake of simplicity as well as general interest in what follows I will be discussing Piketty's results about inequality from the United States. Piketty does an amazing job of compiling and presenting a large amount of data on many different countries. This enables him to make some interesting comparative judgments, and test certain claims by comparison of counter-factual scenarios with relevantly similar cases. In the rest of this essay as I discuss Piketty's results about inequality I will restrict myself to his results about the US case. I think it is simpler to talk about one country, and more interesting to discuss the US in particular. Moreover, as we will soon see, the results of Piketty's analysis show that the basic trend in the evolution of income and wealth inequality across the world in the twentieth century has followed a similar pattern.

Income Inequality and a U-shaped Growth Pattern

So then, what did Piketty's research show about income inequality? In the main, what Piketty's research showed was that for the countries he studied income inequality followed a general U-shaped growth pattern in the twentieth century. The U-shape is more pronounced in the US as opposed to some European countries as inequality has grown the most in the US since the 1970s. The basic story for the US runs as follows; one the eve of WWI levels of inequality were high; though inequality was higher in Europe than the US. During the period covered by the shocks, i.e. 1913-1945, inequality decreased. Then during the 1950s and 1960s inequality in the US plateaued, staying at a relatively stable level during these two decades. Then, beginning in the middle to late 1970s inequality in income and wealth started rising, and began taking off dramatically in the beginning of the 1980s. This increasing of the level of inequality has continues today. Interestingly, according to Piketty's results the 2007-2008 US financial crisis did little to stem the tide of rising inequality of the last thirty years.

Why, according to Piketty, did we observe this U-shaped growth of income inequality? His explanation is that the reduction in income and wealth inequality observed in the twentieth century is the result of the incredibly tumultuous series of world events that took place during its first half, and the policies governments pursued to deal with them. The events being alluded to here are clearly the two world wars, as well as the Great Depression. Why are these events significant? Not only because of the immense social and political upheavals they caused, but more directly because these kinds of disasters -just like earthquakes and hurricanes- are expensive. It cost a lot of money for governments around the world in this time to fight two world wars and combat a Great Depression in between them. Wars cause both economic and physical devastation, i.e. destruction of capital in addition to the expenditure of capital. Accumulated wealth is lost in wars both as physical assets are destroyed, but also as they are expended in pursuit of the destruction of one's enemy's accumulated wealth. Accumulated wealth is lost in economic depressions as turbulence in financial markets causes asset values to find new equilibrium prices, often below- even well below- their pre-crisis levels.

Long story short, the reduction in inequality we saw in the US, and around the world in the 1913-145 period was an entirely contingent occurrence. Piketty endorses the counter-factual claim that were it not for these exogenous shocks there would have been no reduction in inequality. What these shocks did according to Piketty was radically change the social, political, and economic environment in the twentieth century in a way that, for the first time, saw the rate of return on capital (r) drop below the rate of growth in income (g), allowing for the rapid decrease in inequality that characterizes the period from 1913-1945. This decrease happened because, due to the extreme nature of the external events raging in this period, governments needed to tax incomes, all incomes but especially high incomes, at levels never before seen. This high level of taxation was, according to Piketty, the main reason for the reduction of top incomes and thus the reduction in inequality in the period 1913-1945. Because governments needed to cover the incredibly large expenses they were incurring due to both world wars and combatting the Great Depression they taxed the wealthiest, and then used this money to pay other people to do things; for example, bear arms in the military during the wars, or build bridges, roads, and dams during the New Deal.

Clearly there must be something here that is controversial, something has to have some of these commentators and pundits all worked up. It does. Because it clashes with the new economic orthodoxy Piketty's result showing increased, and increasing, inequality since the late 1970s has been a bone of contention for more conservative pundits. Remember that the ideology of supply-side economics holds that further enriching the wealthy will cause "trickle down" effects that will boost growth and thus jobs, and thus fuel rising incomes for workers. In this way supply-side priming, usually through tax breaks, is supposed to actually increase social prosperity more than government regulations of business and income transfer schemes. However, the evidence now available suggests this has not happened, that inequality has grown since the 1970s, and primarily at the top of the income scale, while incomes in the middle and the bottom have stagnated.

Thatcher, Reagan, and Neoliberal Economism

What is the explanation for the increase in income and wealth inequality since the 1980s? Piketty's data shows that since this time the increase in inequality in society is due to an increase in the share of total national income going to those at the top of the income spectrum, specifically the top decile and the top centile in particular. This should not surprise us given that Piketty's explanation of the compression of incomes and wealth in the 1913-1945 period is that the share of total national income going to the top income earners in the highest decile and centile decreased significantly. In the case of the US the story is this; the effects of the shocks wore off over time and then capital's share of total national income began to recover, and indeed with more time even grow. This recovery was sparked in large measure with the help of the same conservative coup in economic theory that coincided with the neo-liberal revolution associated with the electoral victories of Thatcher and Reagan.

This conservative revolution in the US led to change in government attitudes and policies toward economic issues like taxation, regulation, and unions. All of the decisions made by the government in these matters have been favorable to capital, and for prospects for its accumulation. Quite significantly for Piketty the lowering of taxes on top incomes has lead to rising incomes at the top of the income scale. During the 1913-1945 period marginal tax rates on top incomes reached highs of 90%. This reduced the desire of many to seek these kinds of incomes since one will only capture a small piece of it. In essence one sees earning very high incomes as in essence working for the government after a certain point on the income spectrum. Thus the overall growth of inequality was limited to some degree. When however these high rates of taxation on top incomes were reduced, to that same degree high income earners were incentivized to seek even higher incomes. So, for Piketty favorable changes in the tax code have been beneficial to capital and enabled it to accumulate in ever larger amounts increasing inequality in the same process. The development over the last thirty years of a class of what Piketty calls super high income earning "supermanagers" who have the ability to determine their own level of remuneration contributed to the rise in inequality.

One other very significant part of the story here is the stagnation of the average worker's wages over the last thirty years. Piketty's data shows clearly what many left-leaning commentators and analysts have been saying for some time. Namely, that the minimum wage in the US has not kept pace with inflation and the changing basket of goods consumers purchase, and is now at its lowest level in terms of purchasing power since the 1960s. What makes this stagnation of wages so appalling is that wage growth has become decoupled from productivity growth. The situation in the US today is that workers are more productive than ever, and are being paid very little for their hard work. The large and increasing segments of the low-wage workforce that rely on government assistance programs to, potentially, meet basic needs are well documented. Wage stagnation has thus contributed to the growth of income and wealth inequality in the US since the 1970s. The top of the income scale has grown tremendously while the bottom has barely moved at all; and according to some other studies is likely to be somewhat negative.

This situation is also the result of conscious policy choices by the government, in particular to help bust unions. Piketty makes much of the growing wage gap after 1980 and explains it as largely the result of government under-investment in higher education. He notes that the wage gap started widening at the same time that the rate of growth of college degrees begins to slow. I think this is a dubious argument, or at best one that while containing some grain of truth is simply a distraction from the more significant cause. The collapse of unionization in the US labour force along with other changes in the government's willingness to protect workers' rights has allowed employers to impose changes in the workplace, changes that strongly favor the employer, that is, favor capital. I think on any sober analysis the collapse of workers' ability to bargain collectively, strike, and thus protect their interests through collective self-organization, as well as the related development of regional economic blocs based around free-trade like NAFTA will be seen to have much more to do with explaining the stagnation of the average US worker's wages over the last several decades than decreasing college rates of increase in the attainment of college degrees.

Global Capital Tax: Proposal and Problems

What then does Piketty propose to do about this problem of income inequality? Piketty's approach to dealing with income and wealth inequality is so simple it can be summarized in two words; tax capital. Of course the answer is more complex than this slogan suggests, but it is good enough approximation. What Piketty proposes is a progressive global annual tax on capital. In some respects this idea is self explanatory. The tax is progressive because it seeks to tax the high incomes of the wealthiest for redistributive purposes, or to achieve social goals. The sense in which the tax is global and annual need no explanation. Piketty's tax is unique is that he would calculate the tax based on the total value not just of the stock of capital itself, but the value that the capital can be very reasonably expected to produce.

It is important to note in regard to Piketty's tax strategy that his global capital tax is not meant to replace existing taxes on income or estates. Piketty sees national level taxes on incomes, inheritances, and a global level tax on capital as three legs of his strategy to combat rising inequality. Using these three different taxes society can limit inequality by appropriating part of the value of capital, and in its various forms. Remember that ( r > g) means that capital, no matter how large, will grow in size over time in line with the law of cumulative growth. Thus, unless some of the capital is transferred from the wealthiest to others less fortunate through government programs inequality will only continue to grow larger. So, by taxing the value of capital some of the grow can be shaved off and utilized for social purposes. The programs constructed to meet these social goals can, if successful, empower those not born well off, and enable them to live healthy, productive, and comfortable if not extravagant lifestyles. Moreover, any such tax on the wealthiest income earners would only apply to a small fraction of the population, and would only apply to a part of these persons' income and wealth. As such, such a capital tax as Piketty proposes is not going to be a significant source of revenue for the government. Governments today will not be able to do without the revenue they generate from income and estate taxes, and the reality is that revenue from a capital tax would contribute only a small amount to total revenue.

Here then we have another of the big reasons why some commentators, especially on the right, have had so much to say about Piketty, and invested so much effort into attempting to poke holes in Piketty's arguments and data. Namely, one of the major implications of Piketty's arguments is that in order for to society to combat rising inequality it will be necessary to raise taxes on the wealthy. The defenders of wealth and its privileges of course take umbrage with this. This explains to some measure the extent and nature of the coverage of Piketty's book. One of the facts, and one must insist on this term, that Piketty's research shows is that tax rates on the wealthiest in the US are at all time lows, and that inequality is at heights last seen in the Gilded Age. The reality of the extremity of prosperity among the top decile, and especially the top centile, contrasts sharply with the Great Recession era narrative of shared economic pain and sacrifice.

One should note that this kind of solution to the problem is not actually very unique. This is basically the same kind of strategy proposed by A.C. Pigou. His idea was simple; when the market does something you don't like, tax it until it stops doing that thing. The idea is simple. If one attaches a cost to doing the thing that society does not like then one incentivizes to the same degree the tax is large or small individuals or businesses not to do that thing. This is a simple internalization strategy. When the market produces undesirable side-effects from private economic decisions, the way to fix the problem without government forceful compulsion is to levy taxes that change the costs associated with various courses of action an economic agent might pursue. Piketty is certainly the first to propose such a global tax on capital as he does, but the basic logic behind this solution is and has been well known to economists for some time. It is in a straightforward way an extension of the same policy that would be employed if society wanted curb pollution. This is a policy idea that has been floated around for many years now. In its most recent form, as the so-called cap and trade plan, it has been used as one potential way to help address the production of greenhouse gasses that drive global climate change.

One major problem with this strategy, as pointed out by several commentators, is that this kind of solution requires a high degree of sustained agreement and cooperation between nation-states and regional economic blocs to be successful. In fact, Piketty quite clearly concedes this much about his proposal. He acknowledges that an unrealistically high level of cooperation would be a prerequisite for this kind of pan to be effective. This global capital tax is a solution that works only over the long term, and thus this policy must be vigorously enforced, and maintained over a very long, perhaps even indefinite period. The kind of international coordination necessary to accomplish such a task successfully seems at present hard to imagine. Sure, projects like the international space station exist, and certainly require much cooperation between nations. The problem, as this example so nicely illustrates, is that geo-political context matters immensely in these endeavors. When bi-lateral or multi-lateral relations deteriorate due to strategic differences, these cooperative engagements are often the first casualties. See for example the threats made by the Russians in the recent Ukraine-Crimea crisis that it will no longer take US astronauts to the international space station on its rockets. Thus, even cooperative projects that everyone is favor of, projects that do not serve one nation's interest over another's are beholden to the caprice of geo-strategic political maneuvering.

Even where self-interest, construed in a narrowly nationalistic way, is involved international cooperation can be elusive. Consider the Eurozone crisis. The only feasible solution to the economic woes of the Eurozone is greater banking and budgetary integration. This is being resisted by many citizens in many Eurozone countries. The recent elections for the EU parliament showed a strong euroskeptic bent. Just when the project of European integrations needs further deepening to continue to be viable Europeans appear inclined to send a great many anti-EU leaning politicians as their representatives to Brussels. In light of examples like these, Why should one expect that there could exist the high level of international cooperation needed to make this tax scheme work, at least in the short-run?

Where global society can come up with the political will to even put such a proposal on the agenda is a related and equally significant problem. According to Piketty's own analysis of the twentieth century it required two massively destructive and costly world wars, as well as the most severe global economic calamity ever known in order to reduce inequality to the observed levels. How then should we expect to create the political will to enact such a policy as an annual global tax on capital short of a series of equally or more devastating shocks? A great many people the world over recognize the dire potential impact of global climate change, and have successfully brought this issue to the world stage. And yet, despite having made its way on the agenda of world affairs, even an issue that threatens all nations has not been adequately or even very seriously addressed by the international community. There is a lack of political will in the international community to take firm action to address climate change. Thus, even if it is possible to generate the political will to get the issue of an annual global tax on capital on the international agenda, there is no guarantee that such a proposal could be agreed to and implemented.

One might ask, does the tax on capital have to be global? The answer is a decisive yes. For the simple reason that, if it is not then capital is likely to flee the now higher tax nation in favor of lower tax nations. Capital flight of this kind can be a significant drain on national resources. This brings up another aspect contributing to lack of global political will to address the issue of inequality, which is that many nations risk losing a lot of money. Today many nations act as what are known as 'tax havens'. The governments of these nations make money by taking a cut of the proceeds from what amounts to international tax arbitrage. Those nations doing a brisk business in this trade will be loathe to give it up. In a competitive environment agents know that they can gain advantages by engaging in such arbitrage operations. Helping individuals, firms, banks, and governments resist the temptation to engage in these practices will be a significant obstacle to successfully implementing Piketty's proposed global capital tax.

One might also ask, does the solution have to be a tax? Again, Piketty's answer is a decisive yes. In his mind the only options available for dealing with income inequality are taxation, inflation, and protectionism. In his view both of these other options are worse than taxation. One might say that taxation of capital is the best of a bad lot kind of solution. Inflation he says is a crude instrument. He is right in this. It is not a precise instrument, and can easily get away from one once it has been instigated. Protectionism, on the other hand, is simply a short-run solution that is not viable a long-term growth strategy. Again, he is right in this. This is why in his mind a solution based on taxation is the only viable way to deal with growing income inequality. That Piketty is in the end committed to a market capitalist model also contributes to his insistence that a progressive taxation scheme is the best available solution. That he restricts his options to protectionism, taxation, and inflation is in itself to capitulate in significant ways to the dominant economic orthodoxy.

Falling Short: Neoliberal Light

Piketty neglects any alternative solution to inequality that involves any larger structural transformations in the market economy, especially in the labour market. This kind of There Is No Alternative (TINA) thinking is problematic, especially so from the standpoint that Piketty himself takes up, that is the perspective of one desiring social justice.[7] If Piketty is correct in his data then the conclusions he presents call for a radical solution, one that goes well beyond tax and transfer schemes. The required transformations will necessitate making changes in the structure of workplace organization, and it will mean more government support for and protection of workers in the labour market. It will likely also involve strengthening social protections and services, in healthcare and education for example.

What is very disappointing for some readers, myself included, is that Piketty's analysis has many of the necessary pieces for a radical analysis of the history of the development of capital and of wealth inequality in the twentieth century, but fails to put them together. Like so many before him, Piketty's analysis takes him to the threshold of conventional wisdom, and no farther. Despite averring several propositions that would, or rather should, lead one to adopt a more radical analysis Piketty stops short of such an analysis. Hemmed in by the requirement that any solution be consistent with free market principles Piketty can see no other potential for addressing inequality than by taxation. While he does buck some of the core tenets of the neo-liberal consensus Piketty does not stray far from the dominant neo-classical framework.


[1] The following article from CNN is characteristic of the dominant media's perspective; http://money.cnn.com/2014/04/21/news/companies/piketty-best-seller/

[2] http://www.newrepublic.com/article/117498/pikettys-capital-sold-out-harvard-press-scrambling

[3] One could insert numerous citations here, but a quick Google search on the reader's part can confirm this.

[4] http://www.pbs.org/newshour/bb/debating-pikettys-theory-wealth-begets-wealth-widens-economic-gap/

[5] http://www.ft.com/cms/s/0/1e8c6814-e3fb-11e3-a73a-00144feabdc0.html#axzz32w1QHlvh

[6] http://www.nybooks.com/articles/archives/2014/may/08/thomas-piketty-new-gilded-age/

[7] See Donnaruma, Colin & Partyka, Nicholas. "Challenging the Presumption in Favor of Markets". Review of Radical Political Economics. Vol.44 no.1 (2012).