The book of the year in economics is clearly Thomas Piketty's monograph titled, "Capital in the 21st Century." Piketty, through his empirical research, has done much to advance our understanding of inequality, and hence I was quite eager to read this book.
As expected, the empirical portion of the book did not disappoint. Wage, capital, returns to capital are very difficult to compute going back in time and Piketty performs a Herculian effort in trying to do so. The picture he paints is strong and convincing. Income and wealth inequality has been increasing in the US and other developed countries for the last several decades and is approaching levels unseen since the Belle Epoch (turn of the last century).
There are potentially many drivers of inequality over the last few decades. Explanations include technological change, globalization, the decreasing power of unions, and the superstar effect. Piketty goes above the fray and instead of looking at particular causes of inequality today, attempts to develop an overarching theory of capitalism and inequality.
Piketty's argument is as follows (^ below is used to denote annual changes in the variable):
Until the 20th century, Piketty demonstrates that the after-tax return on capital (r) has been greater than income growth (g) and he takes the 20th century to be an exception rather than a new normal. Then, if r is completely reinvested, K^ = r and K^ > g. Note that by definition, g = Y^. Hence, we get that (K/Y) is increasing over time. If (K/Y) is increasing and r is fairly constant, than it must be that X = r*(K/Y) is increasing over time, where X is the capital share of the economy. Hence, Piketty posits that the capital share of the economy will increase over time. Since, capital is concentrated in a few hands, inequality will therefore inexorably increase over time.
Since r > g is the key catalyst for inequality in his model, Pikkety argues for a global wealth tax to lower r. In my next post, I'll discuss some of my thoughts on this.
As expected, the empirical portion of the book did not disappoint. Wage, capital, returns to capital are very difficult to compute going back in time and Piketty performs a Herculian effort in trying to do so. The picture he paints is strong and convincing. Income and wealth inequality has been increasing in the US and other developed countries for the last several decades and is approaching levels unseen since the Belle Epoch (turn of the last century).
There are potentially many drivers of inequality over the last few decades. Explanations include technological change, globalization, the decreasing power of unions, and the superstar effect. Piketty goes above the fray and instead of looking at particular causes of inequality today, attempts to develop an overarching theory of capitalism and inequality.
Piketty's argument is as follows (^ below is used to denote annual changes in the variable):
Until the 20th century, Piketty demonstrates that the after-tax return on capital (r) has been greater than income growth (g) and he takes the 20th century to be an exception rather than a new normal. Then, if r is completely reinvested, K^ = r and K^ > g. Note that by definition, g = Y^. Hence, we get that (K/Y) is increasing over time. If (K/Y) is increasing and r is fairly constant, than it must be that X = r*(K/Y) is increasing over time, where X is the capital share of the economy. Hence, Piketty posits that the capital share of the economy will increase over time. Since, capital is concentrated in a few hands, inequality will therefore inexorably increase over time.
Since r > g is the key catalyst for inequality in his model, Pikkety argues for a global wealth tax to lower r. In my next post, I'll discuss some of my thoughts on this.
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