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Inequality • Growth • Capital

The future of inequality

Thomas Piketty - 29 January 2014

The distribution of income and wealth is one of today’s most controversial issues. The good news is that there are several possible futures. History tells us that there are powerful economic forces pushing in every direction. Which one will prevail depends on the institutions and policies that we will collectively adopt.

1. Combining efficiency and equality of opportunity in education

 Historically, the main equalising force has been the diffusion of knowledge and skills.  However, this virtuous process cannot work properly without inclusive educational institutions and continuous investment in skills. Consider the case of the US. Here is a country that was largely built as a counter-model to the wealth-based ‘patrimonial’ societies of Old Europe.  In effect, the concentration of wealth was much less extreme in the US than in Europe until World War I. The US is also the country which first developed mass education. Over the course of the twentieth century, however, US inequality surpassed European levels, first because European wealth inequalities were wiped out by the 1914-1945 violent shocks, and next because European countries decided then to set up institutions which are structurally more egalitarian and inclusive than those of the US.

In particular, today’s US education system is plagued with extreme stratification that does not seem compatible with the idea of equal opportunity. The average income of the parents of Harvard students is currently about $450,000, which corresponds to the average income of the top 2 percent of the US income hierarchy. The total absence of transparency regarding selection procedures should also be noted. To be sure, unequal access to higher education is still very high in Europe as well. In the US, France, and elsewhere, talking about the virtues of the national meritocratic model is seldom based on close examination of facts. Building higher education systems that truly combine efficiency and equal opportunity is a major challenge facing all continents in the twenty-first century. Nobody has found the ideal system yet.

2. Reconsider taxation on high incomes from labour
Equal access to education is necessary, but not sufficient.  It certainly does not guarantee that a fair and harmonious distribution of income and wealth will prevail.
The spectacular increase of US income inequality since the 1980s largely reflects an unprecedented explosion of very elevated incomes from labour; a veritable separation of the top managers of large firms from the rest of the population. One possible explanation would be that the skills and productivities of those managers rose suddenly in relation to those of other workers.  Another more plausible explanation, and more consistent with the evidence, is that top managers by and large have the power to set their own remuneration, in many cases without any clear relation to their individual productivity.

This phenomenon is seen mainly in the United States and to a lesser extent in Britain, two countries which have turned their back on the very high top income tax rates that applied there from the 1930s to the early 1980s.  The invention of confiscatory tax rates on incomes deemed to be indecent was in fact an impressive US innovation of the interwar years.

3. Tackling the excessive rate of return to capital
Beyond education and income factors, history tells us that, in the long-run, the most powerful force pushing in the direction of rising inequality is the tendency of the rate of return to capital (r) to exceed the rate of output growth (g). When r exceeds g, as it did in the nineteenth century and seems quite likely to do again in the twenty-first, initial wealth inequalities tend to amplify and to converge towards extreme levels.

It is useful to recall that output can grow for two reasons: because of population growth, and because of per capita output growth (i.e. productivity growth).  On the one hand, it seems unlikely that the demographic boom witnessed over that period will occur again as the entire world population is expected to stabilise. On the other hand, even if productivity growth continues  forever as appropriate technological  innovations  can allow for  permanent,   immaterial,  low-pollution growth, it will probably be no larger than 1-1.5% per year; a level corresponding to countries lying at the technological frontier over long periods.

Under such conditions, it is almost unavoidable that global growth rates in the twenty- first century will be significantly below returns to capital.  It is critical to realise that there is no natural force pushing the return to capital toward the growth rate. Growth has been close to zero during most of human history, while the return to capital has always been significantly positive (typically 4-5% per year for land rent in traditional agrarian societies).  According to Marx, the capital/output ratio should eventually become infinite, so that the rate of return will go to zero. But the falling-rate-of-profit hypothesis did not happen historically, and there is no logical reason why it should have. As long as wealth holders consume some of the return to their wealth – which they do – there is no reason why capitalists should ‘dig their own graves’. According to Forbes global billionaire rankings, top wealth holders have been rising more than three times faster than the size of the world economy between 1987 and 2013.

4. The case for a global progressive wealth tax
The inequality between r and g naturally leads to a very large concentration of wealth.  This stirs discontent and radically undermines our democratic values and institutions.  The ideal solution to this would be a global progressive tax on individual net worth.  Those who are trying to enter the game and start accumulating new wealth would pay little, and those who already have billions would pay a lot. This would foster mobility and keep inequality under control. Most importantly, a global wealth tax would put global wealth dynamics under public scrutiny. The lack of financial transparency and reliable wealth statistics is probably one of today’s main democratic challenges.

Of course there are alternatives, such as the authoritarian capital controls and oligarchs imprisonments seen in China or Russia.  For countries that want to preserve international economic openness and the rule of law, a global wealth tax is a superior option. Another solution is inflation. It has played a large role historically in order to reduce the kind of large public debt that we again have today. The problem is that inflation destroys the saving accounts of the lower and middle classes: it is like a tax on low wealth. A tax on high wealth seems preferable.

5. The US and the EU should lead on international cooperation
In order to move in the direction of a global wealth tax, we need a lot more international cooperation than we presently have. This is difficult but feasible. The United States and the European Union each represent one quarter of world GDP. Assuming they manage one day to speak with one voice, which would require a serious shake-up of Europe’s deeply dysfunctional federal institutions, they have the capacity to create a global registry of financial assets and to impose adequate sanctions on tax havens and other non-cooperative countries.  Short of that, we face a serious risk that a growing fraction of public opinion will turn against globalisation and vote for nationalist and protectionist responses.

Thomas Piketty is a professor of economics at the Paris School of Economics. He is the author of ‘Capital in the 21st Century’ (Harvard University Press, March 2014).

This is a contribution to the “Making Progressive Politics Work” publication which will inform the Progressive Governance Conference taking place in Amsterdam on 24/25 April, 2014

This is a contribution to Policy Network's work on Social Policy and Changing Welfare States.

Tags: Thomas Piketty , Opinion , Progressive Governance Conference , Progressive Governance , Growth , Social stability , Living standards , Policy Network , Global Progress , Competitiveness , Growth , Solidarity , Globalisation , Centre-left , Centre-left , Europe , EU , European Union , Eurozone , Southern Europe , Northern Europe , Production , Productivity , Growth , Wages , Investment , Jobs , Globalisation , Equality , Pre-distribution

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