According to French economist Thomas Piketty, there's a simple equation to explain the rise in wealth inequality in the United States: r > g.
The rate of return for owned capital (r) exceeds the overall rate of economic growth (g). Thus, families and individuals who control wealth will accumulate it at a faster rate than the economy can produce it and so will control a much larger portion of the economic pie. The rich get proportionally richer, and the poor get proportionally poorer. And unless something happens to alter the status quo, this trend will continue.
Piketty's provocative message, shared in his new book, Capital in the Twenty-First Century, as well as in a review article published Thursday to Science, comes amidst growing concern over wealth and income inequality. Two-thirds of Americans, comprised of majorities of Democrats, Republicans, and Independents, are dissatisfied with wealth and income distribution in the U.S. Currently, the richest 10% control 71% of wealth and take home 48% of income. While the former value isn't unprecedented, the latter is, and when it's accompanied with the expected widening in the gap of r > g over the coming decades, we can expect to see the top 10% control more wealth than ever before.
(Figure above: The large drop in rate of return (r) in the early-mid 1900s coincided with the massive destruction wrought by World Wars I & II)
Piketty arrived at his conclusion with the aid of researchers from around the globe, particularly economists Anthony Atkinson of the University of Oxford and Emmanuel Saez of the University of California, Berkeley. Together they accumulated a wealth of data the likes of which economics has scarcely seen: tax records for twenty countries dating back to the early 1900s. When assembled into a database, the information allowed Piketty and his colleagues a groundbreaking view of income and wealth inequality.
"Until the Piketty revolution swept through the field, most of what we knew about income and wealth inequality came from surveys, in which randomly chosen households are asked to fill in a questionnaire, and their answers are tallied up to produce a statistical portrait of the whole," Nobel Prize-winning economist Paul Krugman noted in his review of Piketty's book. But, he added, those surveys are limited in scope.
"They tend to undercount or miss entirely the income that accrues to the handful of individuals at the very top of the income scale. They also have limited historical depth. Even US survey data only take us to 1947."
Other economists respect Piketty's attempt to gather massive amounts of empirical data, but question whether or not it grants a complete picture. Kevin Hassett of the American Enterprise Institute contends that Piketty's tax data leaves out the billions of dollars given out by the federal government via programs like Medicare and income support. Garett Jones, an associate professor of economics at George Mason University argues that r won't outstrip g as Piketty predicts.
"There's no inherent tendency for capital to outpace the economy forever."
Piketty disagrees, offering a more pessimistic outlook. As population growth slows, economic growth will stagnate with it, he says, leading to more inequality. This, in turn, allows the wealthy to exact more control of democracy through monetary contributions.
But the data reveals a path for the trend in wealth inequality to slow or reverse. Piketty recommends reinstating high tax rates on upper level incomes and increasing inheritance taxes.
"When top tax rates were high from 1933 to 1980, bottom 99% incomes grew fast while top 1% incomes grew slowly. In contrast, after 1980, when top tax rates were low, bottom 99% incomes grew slowly while top 1% incomes grew fast."
But, he acknowledges that his ideas likely won't be instituted anytime soon.
"In democracies, policies reflect society’s view. Therefore, the ultimate driver of inequality and policy might well be social norms regarding fairness of the distribution of income and wealth."
Whether or not you agree with Piketty's policy recommendations, you have to respect his work to bring empiricism back to economics, a "science" too often full of political propaganda and devoid of data.
This article was first published at RealClearScience.
Source: Thomas Piketty and Emmanuel Saez. "Inequality in the long run." Science 23 MAY 2014 • VOL 344 ISSUE 6186
