Bill Gates (2014) “Why Inequality Matters“, LinkedIn Influencers, 15 October.
A 700-page treatise on economics translated from French is not exactly a light summer read—even for someone with an admittedly high geek quotient. But this past July, I felt compelled to read Thomas Piketty’s Capital in the Twenty-First Century after reading several reviews and hearing about it from friends.
I’m glad I did. I encourage you to read it too, or at least a good summary, like this one from The Economist. Piketty was nice enough to talk with me about his work on a Skype call last month. As I told him, I agree with his most important conclusions, and I hope his work will draw more smart people into the study of wealth and income inequality—because the more we understand about the causes and cures, the better. I also said I have concerns about some elements of his analysis, which I’ll share below.
I very much agree with Piketty that:
- High levels of inequality are a problem—messing up economic incentives, tilting democracies in favor of powerful interests, and undercutting the ideal that all people are created equal.
- Capitalism does not self-correct toward greater equality—that is, excess wealth concentration can have a snowball effect if left unchecked.
- Governments can play a constructive role in offsetting the snowballing tendencies if and when they choose to do so.
To be clear, when I say that high levels of inequality are a problem, I don’t want to imply that the world is getting worse. In fact, thanks to the rise of the middle class in countries like China, Mexico, Colombia, Brazil, and Thailand, the world as a whole is actually becoming more egalitarian, and that positive global trend is likely to continue.
But extreme inequality should not be ignored—or worse, celebrated as a sign that we have a high-performing economy and healthy society. Yes, some level of inequality is built in to capitalism. As Piketty argues, it is inherent to the system. The question is, what level of inequality is acceptable? And when does inequality start doing more harm than good? That’s something we should have a public discussion about, and it’s great that Piketty helped advance that discussion in such a serious way.
However, Piketty’s book has some important flaws that I hope he and other economists will address in the coming years.
For all of Piketty’s data on historical trends, he does not give a full picture of how wealth is created and how it decays. At the core of his book is a simple equation: r > g, where r stands for the average rate of return on capital and g stands for the rate of growth of the economy. The idea is that when the returns on capital outpace the returns on labor, over time the wealth gap will widen between people who have a lot of capital and those who rely on their labor. The equation is so central to Piketty’s arguments that he says it represents “the fundamental force for divergence” and “sums up the overall logic of my conclusions.”
Other economists have assembled large historical datasets and cast doubt on the value of r > g for understanding whether inequality will widen or narrow. I’m not an expert on that question. What I do know is that Piketty’s r > g doesn’t adequately differentiate among different kinds of capital with different social utility.
Imagine three types of wealthy people. One guy is putting his capital into building his business. Then there’s a woman who’s giving most of her wealth to charity. A third person is mostly consuming, spending a lot of money on things like a yacht and plane. While it’s true that the wealth of all three people is contributing to inequality, I would argue that the first two are delivering more value to society than the third. I wish Piketty had made this distinction, because it has important policy implications, which I’ll get to below.
More important, I believe Piketty’s r > g analysis doesn’t account for powerful forces that counteract the accumulation of wealth from one generation to the next. I fully agree that we don’t want to live in an aristocratic society in which already-wealthy families get richer simply by sitting on their laurels and collecting what Piketty calls “rentier income”—that is, the returns people earn when they let others use their money, land, or other property. But I don’t think America is anything close to that.
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Relevant posts:
- Niehues, J. (2014) “Cross-country differences in perceptions of inequality“, VoxEU Organisation, 28 September.
- Esposito, M. & Tse, T. (2014) “Income Inequality and Youth Unemployment“, Project Syndicate, 25 June.
- Teulings, C. (2014) “Why does inequality grow? Can we do something about it?“, VoxEU Organisation, 15 June.