The History and Ethics of Inequality
This post would more appropriately be titled “books for the 20 year old politically-inclined person who has, perhaps, insufficiently examined opinions about inequality”
Why write this? Inequality is a fundamentally interesting subject. It’s also politically divisive and at the forefront of modern debates, so it can be tough to form an opinion on beyond a general “go my team!” bias. Something I’ve had to think hard about is “do you actually believe this or did Bernie Sanders just say it very well?”
I’ve taken a different approach with reviewing these books than I have in past articles. Instead of giving a brief summary, I’ve instead done a deep dive into each. I’m doing this because I’ll be reading these books for the first time over a weekend to get a better “feel” for the arguments surrounding inequality.
Capital in the Twenty-First Century
This book is a massive exploration of the dynamics of capital in recent history and its implications for society. Despite the complexity of its points and length of its analysis, the book can be summarized pretty easily:
“The inequality [return on capital] > [economic growth ] implies that wealth accumulated in the past grows more rapidly than output and wages. This inequality expresses a fundamental logical contradiction. The entrepreneur inevitably tends to become a rentier, more and more dominant over those who own nothing but their labor. Once constituted , capital reproduces itself faster than output increases. The past devours the future.” — Thomas Piketty, Capital in the Twenty-First Century
Piketty makes a compelling case for this argument. Here’s the challenge though, nobody read his book. Despite being a bestselling book that people seem to love having on their bookshelves, in the year it was published it was the bestselling book with the lowest read-rate. This is for a very good reason. This book is dense, and boring, and informative — the unholy trifecta of a coffee table book. I can sympathize. I’ve had this book on my shelf for a long time and admittedly only skimmed it. Now, though, I’m reading it so you don’t have to.
How did we get here?
Piketty begins with a summary exploration of historical political economists: Marx, Malthus, and Ricardo, all of whom witnessed massive economic transformations in their time.
Malthus saw France’s population balloon from 10 to 30 million over his life, while Britain remained stagnant at 8 million souls. This sort of sustained population growth was rare, and made Malthus worry about the risk of overpopulation. Piketty notes that, while Malthus’s ideas are mocked today for their simplicity, this unprecedented population growth had profound effects on the class distribution of the french populace. Landowners saw rents skyrocket and agricultural workers saw wages remain stagnant as the country struggled to feed its people.
Ricardo shared Malthus’s concerns and believed landowners would extract increasingly exorbitant rents, and use these revenues to accrue further control over their surroundings, leading to an explosion in power. His primary theory was that land is finite and increasingly scarce, therefore we should have increasingly high taxes on profits related to land ownership to maintain democracy.
50 years later, Karl Marx was preoccupied with the state of the workers — or the proletariat. Like Ricardo, Marx worried about problems of infinite accumulation, but Marx did not focus on landowners. He was instead concerned with the rise of the industrial capitalist that extracted value from labour without providing any value beyond capital. It’s important to temporally situate Marx. He lived in a time when it was common practice for children as young as 8 to work full-time in factories or mines for meagre wages. It took a long time for the industrial revolution to begin delivering increasing opportunities for consumption to the working class. Per Piketty:
“his principal conclusion was what one might call the “principle of infinite accumulation,” that is, the inexorable tendency for capital to accumulate and become concentrated in ever fewer hands, with no natural limit to the process. This is the basis of Marx’s prediction of an apocalyptic end to capitalism: either the rate of return on capital would steadily diminish (thereby killing the engine of accumulation and leading to violent conflict among capitalists), or capital’s share of national income would increase indefinitely ”
This dynamic would, as Marx believed, result in an uprising of the proletariat.
It’s important to outline the history Piketty presents to the reader. His framing can be roughly summarized as: economists throughout history that have witnessed large economic transformations have come up with a large variety of apocalyptic scenarios. These have not come to pass, and economists nowadays, upon seeing these fates be avoided, have decided to instead focus on “fairy tales” and “happy endings” — after all, the world hasn’t ended. Yet.
The Big Problem
The 1950–1980 period saw inequality drastically reduced in America. However, the past few decades have seen a substantial resurgence in the upper class’s dominance when it comes to share of national income. Piketty claims this is due to the upper management of large corporations having near-unlimited power to set their own wages, and that the rate of return on their wealth (r) has exceeded that of general economic growth (g).
If r>g for long enough, then the wealthy will slowly eat the world, for lack of a better phrase. If their wealth grows faster than anyone else can work to exceed, then their share of national income will constantly trend towards 100%. Setting aside Piketty’s opinions for a moment, this seems uncontroversial. It’s functionally an accounting identity. If thing #1 grows faster than thing #2, thing #1 will invariably surpass thing #2 if given enough time to grow.
Piketty’s job, then, is to prove that this doom hypothesis — r>g — is true. Then he needs to prove we can do something about it. His argument is divided in 4 parts: Income and Capital, The Dynamics of Income/Capital Ratio, The Structure of Inequality, and Regulating Capital in the 21st Century. I’ll do my best to summarize his points, though I strongly suggest you read the book — however tedious that may be.
Income and Capital
Before we can analyze income and capital, we need to know what those both mean. Let’s begin with national income:
“National income is defined as the sum of all income available to the residents of a given country in a given year, regardless of the legal classification of that income” — Piketty
National income is similar to GDP, but there’s an important distinction. GDP measures the goods and services produced in a country in any given year. National income takes GDP and subtracts from it the depreciation of capital used to generate this GDP number. The last component of national income is net income received or distributed abroad.
As a business student, I really like financial statement metaphors. GDP is like the cash flow of a country, and net income is like a country’s profits. The difference matters.
National income can then be split into 2 components: capital income and labor income. Again, this is an accounting identity. Capital and labor are the two sources of income, and must therefore sum to national income.
But what is capital?
“Capital includes all forms of real property (including residential real estate) as well as financial and professional capital (plants, infrastructure, machinery, patents, and so on) used by firms and government agencies.”
In other words, capital is anything owned. If you own something, that’s capital. Your yugioh cards are capital. A bridge is capital. The patents you own are capital. Capital is pretty interchangeable as a term with “wealth”. For the purposes of this article, assume they’re the same thing, although Piketty admits there’s some nuance in the terms.
Much like national income, capital can be split into two types: private wealth and public wealth. Everything owned is owned by an individual, corporation, or government. Most of this comes, however, in the form of private wealth. Most governments Piketty covers in his analysis have more debt than they have assets and actually negatively contribute to national wealth.
Piketty represents the capital/income ratio with the greek letter“β”. Here’s how we might use it:
“In France and Britain, Germany and Italy, the United States and Japan, national income was roughly 30,000–35,000 euros per capita in 2010, whereas total private wealth (net of debt) was typically on the order of 150,000–200,000 euros per capita, or five to six times annual national income. ”
β would then equal 5–6 in these countries. Piketty uses β as a measure to track if capital is growing faster than national income over the course of his book. Again, this makes intuitive sense; If the numerator outpaces the denominator in the capital/income ratio, we’d logically see β increase over time.
This β factor then connects to national income. If national income is composed of capital income and labor income, then we can use β to figure out how big a share capital income is of the total. If “r” is the return on capital, then capital income’s share of total income can be defined as:
α = r × β
Or, the share of national income attributable to capital income is equal to capital’s rate of return multiplied by the capital/income ratio. Piketty calls this the first fundamental law of capitalism.
This dynamic is important to understand when we look at global trends in population growth and income growth. Piketty shows the following table:
For much of huamn history, world output grew with the population. More people = more inputs = more outputs. The 1700s, however, saw a divergence from this trend, and suddenly income growth began to exceed pppulation growth by a factor of 2.
And population growth is only going to get smaller over time. So how does that matter when talking about the accumulation of capital? Put simply, when a family would have 10 children, any given child may inherit some wealth but not a great deal. Family wealth would be divided by 10 with every generation, serving as a sort of equalizer. Now we have birth rates that are more like 1.5 children per woman — not even enough to replace their parents. As a result, family wealth would become increasingly concentrated with each generation rather than divided over time.
The Dynamics of the Capital/Income Ratio
Before I begin, try spotting the difference in these two photos:
They look pretty similar right? These are graphs of the capital/income ratio for France and Britain from the 1700s to today. Both follow a trend that Piketty thinks is important: the capital income ratio follows a sort of “U-shaped curve” caused by ““violent military, political, and economic conflicts that marked the twentieth century.” Afterwards, capital shifts to a focus on rent-seeking and accumulation as it attempts to regain its previously high levels.
The way Piketty divides capital is also important. He considers four categories of foreign capital, other domestic capital, housing, and agricultural. The economic revolutions of Britain and France both saw a massive reduction in the relative value of agriculture and foreign capital, and nowadays capital is split relatively equally between housing and other domestic capital.
The vast majority of this wealth is also private. Here’s Britain’s Debt and Asset figures for the last couple centuries:
Public debt tends to exceed public assets, and at present is about equally matched. On net, public wealth is functionally zero. This means the virtual majority of the capital/income ratio is driven by private wealth.
But where does this private wealth come from? Piketty claims the large spikes in the above graph were due to significant loans given by the already-wealthy to Britain around the 1810s and 1950s. While this is recorded as public debt, the payments the government made on these loans goes into private income. Piketty also claims that “this very high level of public debt served the interests of the lenders and their descendants ”.
What I take from this is that public debt may be matching public assets, but both are geared towards servicing the private income of the wealthy. This makes some of our measures suspect; if private income is not entirely due to private capital, but also predicated on some degree of public capital, it may be that private income is less efficient than we first thought. Private individuals running their own business do, after all, rely on governmental infrastructure without which they could not conduct business.
Countries would deal with the problem of public debt by increasing inflation to reduce their debt burdens. France, for example, has inflation rates upwards of 13% that had massive impact on public debt levels; while public debt was 80% of national income in 1913, high inflation made that figure drop to 30% by 1950. Inflation became, in a way, a tool for redistributing wealth; countries could take on debt, use the proceeds of their debt issuance to provide welfare for the lower classes, jack up inflation, and have relatively low debt-service costs. This only worked for a while, however, before financiers caught on and started demanding higher interest rates to compensate.
Piketty then looks towards new states like America — do they follow the same trend? Not quite:
A major difference is that agricultural land in the 1700s was very plentiful in America. Where land was upwards of 400% of income in Britain or France, even at its inception America was only around 150%-100%. As a result, we don’t see the same U-shaped curve as in other states. Housing and Domestic capital were also comparatively low — presumably because early settlers had to start from scratch to create new homes and build up material wealth.
The ratio of Public Debt to assets also deviated from the pattern of Britain and France. Though the two are relatively well-matched, netting to near-zero, we don’t see the same spikes in public debt. This is in part due to America’s comparatively limited involvement in the world wars; France and Britain had to secure much more financing in those periods than their overseas counterparts.
Piketty does, however, change his methodology in one significant way when calculating America’s capital. The widespread use of slavery made Piketty’s exclusion of human capital unrealistic, and he adds a new category of capital as shown below:
The addition of slaves-as-capital made for an addition 150% increase in the capital/income ratio, making the American β surprisingly consistent over time relative to other nations. While Britain and France, for example, did keep slaves, the percent population of slaves was drastically lower than America, where in some places slaves accounted for 40% of the population.
America’s neighbour, Canada, had a slightly different dynamic. As the country was owned by the crown for purposes of resource extraction there was a net foreign debt dragging down the capital/income ratio. Canada was still similar to America in that the abundance of land reduced the important of agricultural land value and made for a slightly more equal societies relative to the old-world European countries.
Piketty uses all this data to come up with his second fundamental law of capitalism: β = s/g, where:
β = the capital income ratio
s = the savings rate
g = the growth rate
Note that this formula is true only in the long run. Piketty’s point is that if, for example, the savings rate in one country were 12% and growth was 2%, over time β would converge to 600%.
Where Piketty’s first fundamental law of capitalism — α = r × β — is true always, β = s/g is a function of long-term, sustained behaviour.
Here’s why we care about this:
β = s/g is particularly sensitive to changes in the denominator. And we know for a fact that economic growth is slowing, due to reduced population growth and empirical data over the past 50 years. Growth is slowing down, yet it appears people are saving at the same rates. As a result, β will continue converging on ever-higher numbers until something happens. Piketty projects our future β ratio to look something like this:
In other words, our economic landscape will grow increasingly unequal over time absent other intervention.
A key assumption Piketty makes here is that despite slowing growth, the return on capital will be relatively consistent over time. There’s significant history data to suggest that the return on capital has remained stable at around 3–4% for a very long time and will continue to do so.
This contradicts, in part, Marx’s theory of capital “eating itself” — where Marx expected diminishing returns to kick in and growth to fall to zero, we instead see technological improvements that have boosted productivity enough to compensate for diminishing marginal returns on investment. As Piketty says to summarize this part:
“modern growth, which is based on the growth of productivity and the diffusion of knowledge, has made it possible to avoid the apocalypse predicted by Marx and to balance the process of capital accumulation. But it has not altered the deep structures of capital — or at any rate has not truly reduced the macroeconomic importance of capital relative to labor. I must now examine whether the same is true for inequality in the distribution of income and wealth. How much has the structure of inequality with respect to both labor and capital actually changed since the nineteenth century?”
The Structure of Inequality
We’ve seen that capital can exceed national income many times over. We haven’t, however, fully established that this is the result of inequality. In this part of the book, Piketty outlines many of the ways in which our socieities are fundamentally unequal in their distributions of wealth, income, and rates of return. Frankly, this argument is less conceptually difficult than the first two, so I’ll be dedicating less time to explaining it.
Piketty’s summary of inequality can be shown in just a few graphs.
First, the top 1% make a lot of money. This follows a U-shaped curve with inequality compressing in the 50s-70s before again rising in the modern era. This is primarily driven by wages.
America is particularly bad among the nations Piketty looks at. He claims this is due to institutional and political factors:
The US outpaces everyone in income inequality, and policies like stable and low minimum wages have a big role to play in that.
Finally, more of our wealth is inherited than ever before:
If this seems like a lot of graphs, just imagine all the ones I didn’t show you.
Now that we’ve established inequality exists, what does Piketty want us to do about it?
Regulating Capital in the 21st Century
“Can we imagine a twenty-first century in which capitalism will be transcended in a more peaceful and more lasting way, or must we simply await the next crisis or the next war (this time truly global)? On the basis of the history I have brought to light here, can we imagine political institutions that might regulate today’s global patrimonial capitalism justly as well as efficiently?”
A tall order. To begin with, the role of governments in modern society is massive. Taxes as a percent of national income far exceed historical numbers:
Why these higher taxes? Piketty notes the growth in state welfare activities over time — in many countries total transfers based on healthcare and other welfare-type activities have reached 25–35% of national income. Taxation has increase commensurate to the construction and establishment of large social safety nets.
This is redistribution, albeit not as direct as some proponents would like. These welfare practices are fundamentally concerned with the provision of rights to a country’s citizens. These rights are typically related to education, health, and retirement. While we may criticize them for their deficiencies today, these institutions are drastically better than historical systems that had far less funding.
Piketty wants to modernize existing social welfare states. This does not necessarily include increased taxation:
“Taxation is neither good nor bad in itself. Everything depends on how taxes are collected and what they are used for. There are nevertheless two good reasons to believe that such a drastic increase in the size of the social state is neither realistic nor desirable, at least for the foreseeable future.”
Where taxes have historically grown to match growth in personal incomes, we are looking at a future wherein growth is expected to be limited to 1–1.5% — making increasing demands for taxation less palatable to citizens. Additionally, modern governmental structures would struggle to expand in size without turning into bloated bureaucracies incapable of getting anything done. For those of you who believe that’s what government already is, I guess that objection doesn’t hold for you.
Regardless, the point Piketty is getting at is that increasing total governmental revenues is not necessarily feasible or desirable. What we want instead is to make better use of the government budgets we do have.
Education and Social Mobility
One way to reduce economic inequality is public spending for education that reduces barriers to entry for the lower and middle class. However, this has not worked historically. Income inequality — based on the graphs from last section — did not decrease even while the average education level of various countries increased from grade school diplomas to high school diplomas to university degrees. The same inequalities seem to remain — and mobility is also very limited. Intergenerational reproduction of educational success is very high, particularly in America.
One reason may be prohibitively high tuition at elite institutions. Regardless of how much public spending for education there may be, Harvard still costs a lot and elite families are those most able to afford sending their children there. In Piketty’s estimation, “parents’ income has become an almost perfect predictor of university access.”
One proposal Piketty offers is a collective payment of tuition fees — similar to how the Canadian medical system works. If an educated populace is a public good in that it even improves the lives of those who don’t pursue it, then perhaps it should be entirely publicly funded. This is framed as more appealing than other proposals, “which range from charging tuition fees that vary with parents’ income to offering loans that are to be paid back by a surtax added to the recipient’s income tax.”
Pensions and the Future of Retirement
Current pension systems are based on what Piketty calls “intergenerational solidarity”, which means that:
“today’s workers pay benefits to today’s retirees in the hope that their children will pay their benefits tomorrow”
This works great in times of high economic growth, but as wage growth slows and the return to capital changes, the incentives get…. funky.
Right now, workers’ contributions to pensions are immediately paid back out to retirees. But if wages are growing at only around 1–1.5% and capital has a rate of return around 4%… Why give your money to mom and dad now in the hopes your kids will do the same when you could just invest it and get a far higher return? If r>g holds constant, pensions lose much of their appeal.
One of the difficulties Piketty notes is that modern-day pension schemes were not built whole. Instead, they were constructed piece by piece to suit the needs of their time, and there is a great deal of complexity and bureaucracy involved in their management and upkeep. His proposal is for: “a unified retirement scheme based on individual accounts with equal rights for everyone, no matter how complex one’s career path.”
Progressive Taxation
The next component of this part is Piketty’s thoughts on progressive taxation — how it works, where it fails, and what the optimal policy might look like.
The first difficulty in thinking about tax systems is that they are not entirely economic in nature. There are political, philosophical, and aesthetic judgements to be made about what constitutes “good” taxation. Proponents of a flat tax — where everyone pays the same rate, like 20% — may argue for it on the basis of fairness; Advocates of progressive taxation may instead appeal to their aesthetic objection to wealth inequality and ethical injunctions to maximize social welfare; Still others may simply call taxation theft because they disagree with governmental uses of their money or simply object to having what is “theirs” taken from them.
Needless to say, taxation is very complicated. Beyond the perspectives I listed above, there are multiple kinds of income or capital that may be taxed and various mechanisms by which tax owing might be calculated. This all leads to a gigantic, messy, divisive system that leaves every unhappy with everyone else, and constantly pursuing incremental “improvements” (read: things that align with their preferences) to glom onto the existing system.
Further, taxation is a means by which countries can compete for business. Tax havens like Ireland are able to market themselves as ideal locations for corporate HQs where they can then benefit from significant investment on the part of the international conglomerates and wealthy individuals they attract. This is all to say that even if we wanted high taxes, there are incentive structures on a global scale that may lead to a “race to the bottom” as countries compete for access to the capital of individuals and corporations.
Taxation rates on top earners have shifted over time. They were first implemented in many countries during the world wars in pursuit of additional capital, but have since become a staple of modern economies.
We can see another U-shaped curve here, albeit with a curvature smaller in magnitude than general wealth inequality. Where top income tax rates hit near-100% in many countries, they have since receded to hover around the 40–60% range in many nations.
Progressive taxation also applies to inheritances. We can see a similar pattern in the top marginal tax rate on inheritance in the same countries over time:
Piketty believes that the high tax rates outlined above were not necessarily put in place as revenue-maximizers. He contends that they were pursued as a means of “[putting] an end to such incomes and large estates, which lawmakers have for one reason or another come to regard as socially unacceptable and economically unproductive — or if not to end them, then at least to make it extremely costly to sustain them and strongly discourage their perpetuation.”
These are particularly important in places like Britiain or America, which are highly individualistic and emphasize the value of personal freedom. These countries cannot simply seize assets, only enhance the diminishing marginal utility of additional earnings through progressive taxation.
Implications on Class Inequality
In the graphs shown above, income taxation was very high for a very long period before falling. Piketty claims the fall of high marginal tax rates is a causal factor in the rise of the exorbitant executive compensation we see in modern society. In 1950, where the top marginal tax rate was upwards of 90%, it would be hard to justify giving a CEO a $1 million raise when you know 90% is going to the government regardless. Tax rates falling to 40–50%, however, make it far easier to justify giving the government their cut in exchange for retaining a talented executive.
Piketty argues for a move towards the marginal tax policies of the 1950s — at least in America. He claims that an 80% marginal tax rate on incomes exceeding $500,000 would not increase government revenue, but would lower income inequality without any reduction in overall productivity.
This is a very large claim, and he admits it is politically unfeasible. Regardless, he seems to think it necessary that such a policy be implemented if we are put a dent in inequality moving forward.
Global Capital Taxation
Finally, Piketty proposes a global tax on capital. Here’s some of the rates he’s talking about:
- 1% for net assets between $1 and $5 million
- 2% for net assets above $5 million
- 5–10% for assets above $1 billion
“The largest fortunes are to be taxed more heavily, and all types of assets are to be included: real estate, financial assets, and business assets — no exceptions. ”
This will, in Piketty’s estimation, drastically reduce global wealth inequality. Implicit in this is a global system of accounting for all various types of capital held by all individuals, and Piketty proposes policies that include the automatic transmission of bank information among all banks. This is needed so that US taxation officials, for example, can look at Swiss or Cayman bank accounts.
Why Tax Capital?
The wealthiest people in the world don’t make much money. Rather, they make far less money than their fortunes would suggest. This is for a relatively simple reason: income typically doesn’t include unrealized capital gains.
The example used is the L’óreal heiress, Liliane Bettencourt, who is the richest person in France with a total wealth of around $30 billion euros. Despite her vast wealth she reports roughly $5 million in income for tax purposes. A comically small number given her vast fortune. In this case, there is no tax evasion, no undeclared income, no fancy accounting. Liliane makes $5 million for tax purposes and that’s that.
If progressive tax systems are intended to “put an end to such incomes and large estates”, it seems that taxing someone on income equal that is a fraction of a percent of their total wealth wouldn’t achieve that goal. For this reason, Piketty proposes we tax capital in its entirety.
Piketty does not follow Karl Marx in advocating for an abolishment of private owners. He only wants capital taxed at high rates such that the money could then be (re)distributed as host governments see fit.
One down, three to go
If you thought that was long, imagine actually reading the book. For a 15-minute summary, see below.
Next, I want to look at a book that is, in many ways, an extension of Piketty’s thesis.
The Code of Capital: How the Law Creates Wealth and Inequality
The relationship between law and the interests of those who hold capital is important. Property rights are a fundamental tenet of modern economies, and the way the law classifies certain things as “property” and its associated sub-types can have large effects on what sorts of wealth can be accumulated and what sorts of income can be earned.
In this book, Katherine Pistor attempts to put forward a summary of how the law, as the title suggests, creates wealth and inequality.
Pistor’s book, which came out in 2019, directly references Piketty’s book as one source of inspiration and proof that inequality is a pressing issue. She uses Piketty’s historical analyses that suggest present-day rates of inequality surpass those experienced in the time of the french revolution to motivate her argument that the relationship between the law and capital is worth exploring. I happen to agree with her.
Pistor presents a modular view of how assets are situation in modern legal systems. Assets are categorized into such categories as land, financial instruments, intellectual property and more before being assigned some additional properties:
- Priority, which ranks competing claims to the same assets
- Durability, which extends priority claims in time
- Universality, which extends them in space
- Covertability, which operates as an insurance device that allows holders to convert their private credit claims into state money on demand and thereby protect their nominal value, for only legal tender can be a true store of value
Once appropriately coded, these assets are then used for the purpose of generating income and serving as the basis of wealth for individuals the world over. This process of coding is what Pistor cares about, and what I am also particularly interested in. Pistor also claims that the legal coding of what constitutes an asset is a factor in Piketty’s observed shift in value between varying components of capital wherein farmland was the primary source of capital before fading away in favour of financial instruments and housing.
At least, that’s what I took from Pistor’s introductory chapter. I’ll also give you her own summation of the arguments she will be making over the course of the book:
Capital is coded in law, and, more specifically, in institutions of private law, including property, collateral, trust, corporate, bankruptcy law, and contract law. These are the legal modules that bestow critical legal attributes on the select assets that give them a comparative advantage over others in creating new and protecting old wealth. Once properly coded, capital assets enjoy priority and durability, are convertible into cash, or legal tender, and, critically, these attributes will be enforced against the world, thereby attaining universality. This works because states back and, if necessary, coercively enforce the legal code of capital, whether or not they had a direct hand in choosing the coding strategy for the asset in question.
Recognizing that capital is made, and not simply the product of superior skills, shifts attention to the processes by which different as- sets are slated for legal coding and to the states that endorse relevant legal modules and offer their coercive powers to enforce them. As I will show, this process is both decentralized and, in only seeming contradiction, increasingly global. Private attorneys perform most of the work on behalf of their clients, and states, for their part, offer their own legal systems as a menu from which private parties get to pick and choose. As a result, many polities have lost the ability to control the creation and distribution of wealth.
We begin with Land.
Coding Land
“The Earth’s surface is an abundant resource for humans and other living beings. It is part of nature and, unlike financial assets, legal persons, or intellectual property, it has existed since before humans conquered the Earth.
Human conquest has taken different forms over the millennia, subjecting land to occupation, cultivation, excavation, construction, and, last but not least, legal coding. When competing groups fought over access to the same land, they often fought over land itself. Legal dispute settlement offers an alternative and perhaps more peaceful way to clarify priority rights, although the results can be as brutal as physical conquest; indeed, legal battles over land have often gone hand in hand with the battles on the ground.” — Pistor, The Code of Capital
Pistor follows the story of the Maya people of Belize in their question to have their collective use of agricultural and be recognized as a property right — in an attempt to bar the Belize government from engaging in mining activities on their land. When their case was taken to the Supreme Court, there was a snag. The Maya had a non-standard way of conceptualizing property rights. In their minds, property was for common usage, not for use as capital from which they could extract income. The Maya won their case in the Supreme Court, but their own government proceeded with the mining anyway.
The story of the Maya is important, but not for the purpose of Pistor’s argument. Instead the Maya set the stage in that their seeking of property rights to protect common goods was ironic. It was ironic because English landlords had used the same argument of property rights to destroy the commons a few hundred years earlier.
Where England in the 1500s doled out property on the basis of political or military service, a peculiar strain of landlords began seeking additional rights over “their” property. At the time, land could not be transferred after death — it would go back to the crown for later disbursement.
Yet, already by the end of the 1600s, a remarkable change had taken place. “A grand rule was emerging: whoever had the ‘general’ or ‘absolute’ property in a thing could assert the interest against everyone in the world, and whoever had the ‘special’ property (like a specific use right or collateral), could assert it against everyone but the ‘general’ or ‘absolute’ owner.” — Pistor, The Code of Capital
Landlords began staking out land claims as “theirs”, and enclosing properties to defend against outside interests. While protested at the time, these landlords eventually won and the land registry of England was created in 1881.
Not everyone was happy. Commoners didn’t like this arrangement. In fact, they disliked it so much they started hiring lawyers to fight landlords over right to use what had previously been considered “common” land. The landowners, however, had more money and therefore had better lawyers. The landlords won their disputes more often than not.
Property rights are now ubiquitous. Where British colonizers went, they brought this particular conception of property rights with them. So we are left with the treaties signed by indigenous peoples of former British-held territories wherein the indigenous people of the region signed away property rights for nominal rewards. The claim was that those living on land before settlers came could not “own” property because they had no conception of individual ownership. The fine European settlers, by contrast, discovered the land and improved it. Per an 1823 US Supreme court ruling:
the United States . . . have unequivocally acceded to that great and broad rule by which its civilized inhabitants now hold this country. They hold, and assert in themselves, the title by which it was acquired. They maintain, as all others have maintained, that discovery gave an exclusive right to extinguish the Indian title of occupancy either by purchase or by conquest; and gave also a right to such a degree of sovereignty, as the circumstances of the people would allow them to exercise.
Modern market theories of the global economy suggest that assets trading hands constitute improvements to the efficient use of such assets. However, this is heavily influenced by the initial allocation of assets. In the case of early property rights, they were instead used to extract value from existing users of the land rather than promote our current ideal of market-based efficiency. This has been the foundation of a great deal of inequality in our world, and there’s no clean solution.
Cloning Legal Persons
In other words, corporations are people too… at least in the law. Pistor looks into the legal structure of Lehman Brothers, a bank notable for its role in the 2008 financial crisis. While Lehman operated as a partnership for much of its life, when it transitioned to a corporation it, for lack of a better term, cloned itself. Hundreds of subsidiary corporations — all of which were separate legal persons — were created in Alabama, DC, the Cayman Islands, and more. The Lehman “parent company” then personally guaranteed the debts of each of its various subsidiaries. All of this happened while the true, literally-human owners of Lehman enjoyed the limited liability that comes with owning a corporation.
It wasn’t always like this. Pistor says:
The modern business corporation was not born with legal shielding devices, limited liability, and other props that grant it the legal attributes of priority, universality, and durability firmly in place. It acquired these attributes over time and through many legal battles … Of all the features of the modern business corporation, three have arguably contributed most to its success, and all three are impossible to obtain by contract alone: entity shielding, loss shifting, and the prospect of immortality.
- Entity shielding, simply put, is the idea that if the corporation goes under, it doesn’t drag its owners down with it. It creates property rights over a “pool” of assets, the value of which can be doled out but does not give access to the border “pool” in which those assets reside.
- Loss shifting is when risks or losses are offset to creditors, or even the public. Government bailouts are one way companies can shift losses.
- Finally, corporations are considered immortal and don’t die with their original creators/owners.
These three attributes do some important work for owners of capital. Entity shielding lets them take risks they wouldn’t otherwise take if their own money was on the line. Loss shifting also allows for risks otherwise unfeasible. Finally, immortality means there’s not the same limits on intergenerational wealth transfers that we have for human individuals in the form of estate taxation.
The cloning of legal persons, or creation of many sub-corporations compounds this issue. With multiple “persons” affiliated with a company, in different locations, a company can pick and choose the legal and tax systems most advantageous to its ends. This is something humans can’t do — but a corporation can. The law makes this possible.
Minting Debt
“If there is one asset that defines capitalism, it is debt — not any debt, but debt that can be easily transferred from one investor to another, and preferably debt that is convertible into state money at any time on the behest of its holders, the creditors. Convertibility of private debt on demand is typically assumed but is not always an enforceable claim. The logic of a private economy is that you can sell only if you find a willing buyer, that is, a private buyer. If private buyers re- treat, demand declines, and asset prices fall, investors who recently thought that they had huge amounts of wealth at their fingertips might lose it in no time. To lock in past gains, investors will try to convert their private assets into state money, the only financial asset that is guaranteed to keep its nominal value. The reason is that, unlike private entities, states do not have a binding survival con- straint. They can print money and they have the power to unilaterally impose burdens on their citizens in the form of taxes or austerity measures, thereby ensuring their own survival.” — Pistor, The Code of Capital
Like this quote suggests, debt is inextricably tied to questions of law and capital. Where Piketty took a broader view of debt — splitting it into public and private before moving on to other things — Pistor goes one step further and analyzes how debt is structured in the law.
The example she uses are the so-called “triple-A” mortgage debt packages that played a key role in the 2008 financial crisis. An important factor with these debt tranches was that they were, to some degree, government certified. Additionally, the method used to group poor assets together to boost ratings of stability were not technically illegal — in fact, pooling diverse assets to lower overall risk is a perfectly legitimate activity. In this case, the law allowed for a certain type of debt instrument to be used, and this had bad consequences for everyone.
On a historical level, debt did not always function as it does today. The gold standard debt instrument of the twelfth century, for example, was an IOU — a note that promised to pay someone a set amount. Genoa, a major trading hub in ancient Italy, was notable in its development of promissory notes, which allowed creditors to transfer contractual obligations to a messenger. These promissory notes would have lines like: “I promise to pay you or your messenger $2”. Now debt can be transferred!
The next step was something called a bill of exchange. These bills were, in essence, promises to procure goods that could then be traded around. I could give you a bill of exchange that says “I promise to give you 5 fish when you come knocking”, and you could go and sell that note to someone else. When that other person came around, I’d be obligated to fulfill my obligation to the bill of exchange — not necessarily to you.
This all came before the idea of debt as renting money. In fact, that practice was considered immoral. People eventually came around to the idea of issuing capital loans, and this gave rise to securitization:
“The securitization of mortgages transforms a claim for repayment of a loan that is backed by the value of the house into a claim against future cash flows made by the debtor in fulfillment of her obligations under the loan, and this claim can be traded and thus converted into cash as long as there are willing buyers.” — Pistor, the Code of Capital
Through these types of legal codes, things that were once illiquid assets (land, etc.) became liquid — because we could trade around the rights to their future cash flows. This led to some of the practices Piketty talks about — governments issuing debt and using inflation as a lever to reduce their relative debt burden over time.
Enclosing Nature’s Code
In this chapter, we will discover that the legal code can also be used to code knowledge, including of nature’s own code, by legally enclosing it to the exclusion of others. Most intellectual property rights are of only limited duration so that the fountain of wealth they create will dry out eventually. Still, there are ways to prolong their life span by altering some features of the original invention, or by recoding them with legal modules that do not have an expiration date, such as trade secrecy law. — Pistor, The Code of Capital
Intellectual property is an odd sort of asset. There’s nothing tangible to it, and it doesn’t represent something tangible in the way a security might. A lot of intellectual property is just facts about nature — even the human genome is patented, at least partially.
Knowledge is what Pistor calls a non-rivalrous good. Me having more of it doesn’t reduce the amount of knowledge you possess. Knowledge can be duplicated infinitely at the cost of only speaking it. This is not something subject to tragedy of the commons-type problems. Yet we seek to protect it anyway.
The current Patent Act in the US states:
“whoever invents or discovers any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof, may obtain a patent therefor, subject to the conditions and requirements of this title.” — Pistor, The Code of Capital
But we’ve seen earlier in the case of land just how shaky the “improvement” justification can be. Early settlers coming to indigenous lands and building a cabin without permission doesn’t seem like improvement, but that’s been enough to move the courts before. With respect to intellectual property, Pistor notes the story of scientists who genetically engineered bacteria to break down crude oil. These bacteria existed in nature already, but not in a “genetically engineered” form. The scientists were granted intellectual property rights over the bacteria.
Patents can allow for significant income generation opportunities. Where tests for a breast cancer susceptibility gene once cost $100, after a company acquired patents rights prices rose to over $3,000. Once you control access to an idea, why not charge for it?
Pistor relays the critiques of some economists who believe private ownership of knowledge is the reason we see reductions in firm-level investment in real assets. They assert that once we account for investment in intangibles, this reduced tangible investment level is then explained. Further:
“There seems to be an evident paradox in the institutional tendencies of modern capitalism: the knowledge-intensive characteristics of its technologies should favour a democratic economy made up of small firms employing non-rival knowledge; by contrast, however, thanks to knowledge private ownership, big global firms, whose shares are traded on global financial markets, are increasingly predominant in the world economy.”
One promise of market based systems is that new ways of doing things can be shared among firms as they compete for ever-greater efficiency of capital usage. Protecting processes that boost efficiency, then, runs counter to that promise.
The US also goes further in its protection of intellectual property; America seeks to enforce its people’s patent rights even in other countries. International trade committees have been made by the US for the explicit purpose of extending US intellectual property rights worldwide — with sanctions against countries who don’t cooperate. The law in this instance is in service to promoting the interests of those who hold intangible capital, to the point of infringing on the sovereignty of other nations.
Here’s a silver lining: patents have limited lifespan — they can end. Just kidding, we can totally fix that. The breast cancer patent discussed earlier is a good example of that. The patent was used until expiry, and by then the company that owned it had the biggest database on breast cancer-related genetics, which it could then claim as a trade secret. This is a form of intellectual property with no set lifespan, and the company that once held the patent still makes exorbitant amounts of money off of this trade secret.
This led to the rise of what Pistor calls “data-generating patents”. These are patents whose primary purpose is to facilitate the building of a private databse of information which can then be protected indefinitely through trade secret law.
The Digital Code
With the advent of the internet, we can see new opportunities for the creation and enclosure of capital. There are now people who create digital codes of law, creating bots to seek out copyright violators, those who use artificial intelligence to generate art, and more. This new ecosystem has major implications for society — how we deal with it will matter.
Blockchain may be considered a hallmark of bad startup ideas, but the idea in abstract is interesting. Decentralized verification of contracts give us granular, complete, and trustworthy data, all without the intervention of government. The eroding power of the state is an interesting idea — and the internet has given us the opportunity to make deals with near-zero information or transaction costs without the help of institutions.
Digital property rights are also an interesting question. Digital assets — like a video game or a book — may be tangible in the sense that they can be used in similar fashion to physical assets, but there are key differences. A digital copy of a book or video game can be infinitely copied — like knowledge — at very low cost and distributed to nearly anyone.
Cryptocurrencies like Bitcoin and Ethereum come with their own challenges. Pistor recounts how a hacker managed to extract $50 million from the DAO — an Ethereum-based organization — by exploiting a bug in its code. While these holes can be fixed, the automated nature of regulating cryptocurrency transactions and the organizations built up around them make for many opportunities to extract value in ways we may not like.
Halfway Done
The big through-line in Pistor’s book is that Capital rules by Law, and the Law is the cloth out of which Capital is cut. Those with capital can influence what things are or aren’t considered assets, and the rules thereby generated from this influence are used to extract value from everyone else in the form of rents. Pistor’s book is a good companion to Piketty’s as it takes a more granular approach to a narrower subset of questions related to how Capital has operated throughout history, and I highly recommend giving it a read.
The next book I’d like to introduce is the delightfully titled “Anti-Piketty” — which details many criticisms of Piketty’s work — and by extension, some of the motivation for Pistor’s writing.
Anti-Piketty: Capital for the 21st-Century
I’ll admit it. I’m a sucker for academic drama. Something about people quibbling over statistical methods, interpretations of data, and hunting for errors is exciting. For this reason, Anti-Piketty is the sort of book I’d call a guilty pleasure. If you were convinced by the arguments I outlined above, I really think you should consider the counterarguments I’m about to present. Better yet, read this book.
Much like Capital in the 21st Century, this book is divided into parts: Part one handles Piketty’s so-called “Apocalyptic Vision” of the future; Part two criticizes the empirical strength of his book; and Part 3 critiques Piketty’s general theory and policy.
Before I get into these arguments, I’d like to note something I found very surprising. Piketty’s central thesis, as he so clearly outlines, is as follows:
“The fundamental inequality, which I will write as r > g (where r stands for the average annual rate of return on capital, including profits, dividends, interest, rents, and other income from capital, expressed as a percentage of its total value, and g stands for the rate of growth of the economy, that is, the annual increase in income or output), will play a crucial role in this book. In a sense, it sums up the overall logic of my conclusions” — Piketty, 2014
One year later, he seems to change his mind. In a paper later published in the American Economic Review, he says this:
“I do not view r > g as the only or even the primary tool for considering changes in income and wealth in the twentieth century, or for forecasting the path of inequality in the twenty-first century. Institutional changes and political shocks — which to a large extent can be viewed as endogenous to the inequality and development process itself — played a major role in the past, and it will probably be the same in the future” — Piketty, 2015
It does not bode well for a book when its own author dismisses its central argument. With that said, let’s get into the critiques of Piketty.
An Apocalyptic Vision
First, a series of essays ask the question: “While the 1 percent of rentiers accumulates fortune in a snowball effect, what becomes of the 99 percent? In reality, are the 99 percent becoming poorer? Are they so badly off?”
The first essay is primarily concerned with how we frame inequality. “For most of human history, the difference between the rich and the poor was a difference in the kinds of things they had access to. Rich people had stuff that poor people didn’t”. But this is not the case anymore.
While only rich people drive Ferraris, the lower classes can still drive. The author highlights a quote from Jonah Goldberg, saying that:
“There’s a significant difference between not being able to feed your family and not being able to feed your family as well as a wealthier man might.”
Piketty may claim that inequality is worsening and be right, but that doesn’t mean the life of the lower and middle classes has gotten worse. In fact, their lives have drastically improved even as inequality rises. When we evaluate inequality, the book argues, we need to remember to situate the current state of the world in a historical context. In the not-too distant past, a toothache could kill even a king and foods we see as commonplace were the height of luxury. Piketty may be right that the 1%’s wealth has grown to an exorbitant degree, but has neglected to mention the nearly unimaginable increase in standards of living for the remaining 99%.
Piketty is also accused on spending an inordinate amount of time investigating inequalities in already-rich societies. Global inequality, Anti-Piketty claims, has seen immense improvement over the past couple decades: In just 20 years, an estimated 700 million people have been lifted out of extreme poverty; where the lower class once outnumbered the middle class 3:1, we now see equal numbers across both classes; working conditions have seen huge improvement in countries like Korea.
Where Piketty accuses America of having low social mobility, he is too focused on relative differences instead of seeing that two-thirds of Americans have higher real incomes than their parents, and upwards of 98% of poor households from the 90s are no longer poor.
This is all to say that Piketty seems focused specifically on inequality as a terminally bad thing, but does an inadequate job of asking if inequality actually causes bad outcomes for the 99%.
Other types of inequality
The authors of Anti-Piketty have another essay wherein they attempt to show that reducing inequality in life expectancy is another reason to believe rising inequality hurts the 99% less than Piketty thinks.
Here’s one example from Sweden, 1750 versus 2014. The Gini index is a measure of inequality, where higher numbers denote greater inequality. If the Gini Index were 1.0, for example, that would mean one person owned everything, whereas a Gini Index of 0.0 would mean perfect equality. We can see a massive reduction in lifespan inequality in Sweden over the past 160 years, primarily driven by a reduction in child and infant mortality.
People are living longer and, presumably, healthier lives despite rising inequality. This shift is tough to quantify in an economic model. How much is an extra year of life worth?
Similar trends towards inequality can be seen in education worldwide as well:
The world is getting more equal in lifespan and education, even while economic inequality increases. The authors of Anti-Piketty ask: if everything is getting better, who cares about economic inequality?
The answer the authors come up with is that Piketty has an anti-rich bias. Frankly, I found this overdone and couldn’t help but think of this meme:
Regardless, I think this section levies a strong critique of one of Piketty’s points. Piketty looked at the wealth of the 10 richest people in the world, based on Forbes magazine, for the years 1987 and 2014. By summing up the wealth of these two groups, Piketty concludes the wealth of the richest people has grown by 6.8% compounded — far exceeded the national income rate of growth and proving his thesis that the rich can grow their capital without any work.
But that isn’t quite true. The people on Forbes top 10 in 1987 and 2014 are very different. This essay actually lists the Forbes top 10 in 1987 and tells us what happened to them:
- #1, Yoshiaki Tsutsumi saw his wealth drop by 96%
- #2, Taikichiro Mori saw his wealth drop by 80%
- #3 & #4 dropped off the face of the earth and we have no data as to their current wealth
- #5, Salim Ahmed Bin Mahfouz saw his wealth drop by 72.5%
- #6, Hans and Gad Rausing have had their wealth compound at 2.7% — far less than Piketty’s 6.8% number
- #7, the Brothers Reichmann saw their wealth drop 84%
- #8, Yohachiro Iwasaki saw his wealth drop by 50%
- #9, Kenneth Roy Thomson — of Thomson Reuters fame — saw his wealth grow at 2.9%. Also below Piketty’s 6.8% number.
- #10, Keizo Saji saw his wealth compound at 1.1%, far less than Piketty’s 6.8% number.
Sure, having only 20% left on a base of billions is still a lot, but this isn’t the runaway capital accumulation Piketty claims is happening. If we looked at the Forbes top 10 in 2014 we’d see names like Bill Gates, Larry Ellison, Jeff Bezos, Larry Page, Sergey Brin, and Mark Zuckerberg. People who made stuff. Whatever you may think of Jeff Bezos’ business practices, his wealth was not inherited.
The claim in this set of essays is that the richest people in the world, whatever you may think of them, are entrepreneurs. Bill Gates had a comment on Piketty’s book that I think is apt, albeit with a conflict of interest baked in:
“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”
It’s true that Piketty collapses the distinction between these three types of people. Gates, for example, has given half his wealth to charity and has committing to donating most of it over the course of his life. Piketty’s claims that the richest people in the world are rent-seeking doesn’t seem to hold up. Their wealth, too, is not wealth in the sense of “I have $10 billion in my bank account”, and more in the sense of “my stock in Amazon is worth $10 billion” — and the difference there is important.
On a personal note, I found the first part of this book a bit polemic for my tastes. I’ve skimmed over or skipped entirely many arguments against Piketty’s theories in this review on the grounds that they’re fundamentally aesthetic or political objections rather than being data-driven. This next section, however, deals with the empirical strength of Piketty’s work — something I’m very interested in.
Criticizing the Empirical Strength of Capital in the 21st Century
The next few essays are a series of methodological and quantification-oriented critiques levied at many of Piketty’s economic arguments. I’ll do my best to summarize, but I’ll focus only on the points I see as central to Piketty’s thesis.
A Contradiction in r > g
Piketty argues that as r outpaces g, we will see the accumulation of capital such that capital’s share of national income approaches 100%. A fundamental issue with his argument is the assumption that individuals — holders of private wealth — live forever.
If someone was immortal, then sure r > g would lead to them “eating the world”. However, data from the Federal Reserve suggests that household income since the 1960s has grown at a rate of approximately 3.3%, and household wealth growth has been slightly lower at 3.2%. Why? People die, and the inheritance they pass on is taxed and distributed among their children. Piketty’s r > g doomsday scenario is limited by the mortality of the people it applies to.
Tax Rule Changes Create an Illusory Rise in Inequality
Piketty uses income tax returns to estimate the income of top earnings since the early 1900s. However, changes to the US tax code — particularly around the time when marginal tax rates plummeted — contained different rules about income that should be reported.
Reductions in marginal tax rates pushed a lot of wealthier investors to move their money from low-interest, tax-exempt assets, to higher-interest, taxable assets instead. The gross value of assets held remained constant, but the new type of asset being invested in was now taxable, making it seem like inequality had risen when it was simply going unreported previously.
These same tax code changes repealed something called the General Utilities provision that had let professionals — doctors, lawyers, et cetera — report income through their corporations. These professionals were suddenly reporting income through their personal tax returns where they hadn’t previously. Again, the levels of income remained the same, but what got captured in personal tax returns was made different through policy.
Piketty Excludes Transfer Payments
Transfer payments, like social security, healthcare, and food stamps were excluded by Piketty as part of his analysis of the bottom 99% of earner’s income. Why? Because transfers from the government weren’t taxed. Yet these comprise a sizeable chunk of the lower-class’s net income, and the amount distributed has grown over time — as Piketty himself notes in later chapters.
Wealth at Retirement Age is Weird
The net worth or net wealth of individuals at retirement age is in part calculated based on the actuarial value of their pensions, and their retirement healthcare benefits — neither of which can be transferred to younger generations as inheritance. Piketty then overestimates the amount of wealth that is accumulated and passed down to the next generation by including items that can’t be bequeathed.
Piketty’s Numbers are Before-Tax
When Piketty compares the income of top earners to that of low earners, he does this on a before-tax basis. This ignores the fact that progressive tax systems mean that the distribution of income before tax is not the same as the distribution of post-tax income. This has drastic effects on his figures showing the top 1%’s share of national income relative to the bottom 99%— a sizeable part of the top 1%’s income is taxed heavily, whereas the bottom 99% have a far lower relative tax burden.
When adding in transfer payments, benefits, and progressive taxation, this is what income growth by quintile looks like between 1979 and 2007:
The top quintile sees income growth of 54%… and every other category sees growth of 30–40%. There is inequality, for sure, but not to the degree Piketty assumes in the lighter grey bars. The rich, and everyone else, get richer.
Piketty’s Definition of Capital is Too Broad
In particular, Piketty includes items like houses, which are considered unproductive capital and don’t lend themselves to the generation of income. Remember this graph from earlier?
Housing is about 50% of what Piketty considers “Capital” in the year 2010. This is problematic to include because home ownership was extraordinarily uncommon in the 1700s — of England’s 20 million inhabitants in the late 19th century, only 36,000 were home-owners. Now over 70% of homes in England are lived in by their owners. That seems like more equality — yet Piketty’s math makes it seem like household values are increasing the capital/income ratio and thereby inequality.
Further, Piketty seems to be using market values of houses — which, due to various bubbles in housing markets, are untethered from rental income generated by homes. Using housing as a form of capital makes Piketty’s point much stronger, but may be unjustified.
Minor Errors That Add Up
The Financial Times did their own critical appraisal of Piketty’s work. In particular, they attempted to fact-check all the statistics he uses with the sources he cited. Here’s how the author of this essay tells the story:
“After referring back to the original data sources, the FT investigation found numerous mistakes in Piketty’s work: simple fat-finger errors of transcription; suboptimal averaging techniques; multiple unexplained adjustments to the numbers; and data entries with no sourcing, unexplained use of different time periods, and inconsistent uses of source data. Together, the flawed data produce long historical trends on wealth inequality that appear more comprehensive than the source data allow, providing spurious support to Piketty’s conclusion that the “central contradiction of capitalism” is the inexorable concentration of wealth among the richest individuals.
Once the data are cleaned and simplified, the European results do not show any systematic tendency toward rising wealth inequality after 1970. The U.S. source data are too inconsistent to draw a single long series. But when the individual sources are graphed, none of them supports the view that the wealth share of the top 1 percent has increased in the past few decades. There is, however, evidence of a rise in the top 10 percent wealth share since 1970.”
The errors are minor, but add up:
“Piketty adjusts his own French data on wealth inequality at death to obtain inequality among the living. However, he used a larger adjustment scale for 1910 than for all the other years, without explaining why. In the data for the United Kingdom, instead of using his source for the wealth of the top 10 percent of the population during the 19th century, Piketty inexplicably adds 26 percentage points to the wealth share of the top 1 percent for 1870 and 28 percentage points for 1810.”
“Piketty gives the same weight to Sweden as to France and the UK — even though it has only one-seventh of the population. Other inconsistencies pertain to the years chosen for comparison. For Sweden, Piketty uses data from 2004 to represent those from 2000, even though the source data itself includes an estimate for 2000.”
“Some of the biggest defects relate to the UK data, where his original sources consistently show very large declines of near 10 percentage points in wealth held by the rich in the highly inflationary 1970s. Conversely, Piketty shows the super rich held a greater share of wealth by 1980, and the top 10 percent saw their share fall only 1.5 percentage points. The official data series that Piketty says he used for the UK after 1980 shows little increase in inequality over the next 30 years, while his figures show a steep rise. So far, the official wealth data for the UK has not shown a rise in inequality when using any consistent data set over recent years.”
Systematic Number Nudging
It looks like in some cases, Piketty made inequality appear artificially lower in the mid 1900s in Sweden, and artificially higher in later decades. Here’s a graph of the discrepancies the authors found:
Historical Errors
Here’s one example of an error Piketty makes when writing about the great depression:
“The Great Depression of the 1930s struck the United States with extreme force, and many people blamed the economic and financial elites for having enriched themselves while leading the country to ruin…. Roosevelt came to power in 1933, when the crisis was already three years old and one-quarter of the country was unemployed. He immediately decided on a sharp increase in the top income tax rate, which had been decreased to 25 percent in the late 1920s and again under Hoover’s disastrous presidency. The top rate rose to 63 percent in 1933 and then to 79 percent in 1937 (2014b, 506–7). — Piketty
The problem with Piketty’s historical narrative in this instance is one of basic fact. Simply put, his dates are all wrong. As readily accessible tax records illustrate, the top marginal income tax rate was actually brought down to 25 percent by the year 1925, which is not “the late 1920s” and which was well within the presidency of Calvin Coolidge (with Herbert Hoover taking office on March 4, 1929). More troubling still for Piketty’s narrative, it was under Hoover that the rate was raised to a decidedly punitive 63 percent under the Revenue Act of “1932. And just to round out Piketty’s tax-error trifecta, the top rate increased under Franklin Roosevelt to 79 percent in 1936, not 1937 as Piketty claims.” — Anti-Piketty
There are other historical errors, and the majority of them, unsurprisingly, strengthen Piketty’s case if unchallenged. These include significant errors in his retelling of minimum wage policy where there is verifiable data that he is wrong.
Excel Data Fabrication
Piketty posted his excel spreadsheets online. When looking at his analysis of tax revenues for the United States, there’s a curious error. No data source is cited for US tax revenue between the years 1870 and 1902. Those missing 32 years? He manually created data points based on arbitrarily subtracting 5% from data of future years and creating a sort of moving average:
A series of similar choices are made where Piketty appears to invent data where none exists. These occurrences are small but many, and they add up.
Conclusion
I decided to skip the last section of this book. Many of the critiques offered by its authors are ones Piketty himself notes in his original work. A policy of globalized wealth taxation is politically unfeasible. Marginal tax rates in excess of 80% are politically unfeasible. All the authors add to this discussion is why globalized wealth taxation or high marginal tax rates would be bad — and if these policies are already not going to happen, I don’t see the point in further exploration. I’ll leave discussions of the ethical implications of Piketty’s work to Harry Frankfurt in the last, and final, section of an already too-long article.
On Inequality
Much like Anti-Piketty, On Inequality was written in part as a rebuttal to Capital in the 21st Century. Harry Frankfurt, the writer of this book, constructs an argument for why economic inequality is “morally innocent” — or Not-Bad — and that to regard inequality as bad misses the point that it is poverty to which we have an ethical obligation to fight:
“In a recent State of the Union address, President Barack Obama declared that income inequality is “the defining challenge of our time.” It seems to me, however, that our most fundamental challenge is not the fact that the incomes of Americans are widely unequal. It is, rather, the fact that too many of our people are poor.” — On Inequality, Harry Frankfurt
This distinction is important. In Frankfurt’s estimation, many of the bad qualities we ascribe to inequality are better attributed to poverty instead. Everyone could be equally wealthy but live in horrific conditions and I suspect no one would be happy with that arrangement.
Frankfurt is not, I’ll note, staging a defence of billionaires. In his essay he also critiques the excessively affluent as committing a sort of economic gluttony. The existence of the billionaire class, however, seems to only be bad in light of the billions of starving people around the world — and not bad unto itself.
Frankfurt claims that a reduction in both poverty and excessive wealth would reduce inequality, but the reduction of inequality would simply be a side effect — the principle benefit is less people starving, and more efficient use of the wealth of those who “have too much”.
Our misguided focus on inequality stems from our tendency to compare ourselves to one another. A particularly damning feature of our minds is that making more money does not make us happier — but making more money than your neighbour does. Frankfurt talks about this too:
“But, surely, the amount of money available to various others has nothing directly to do with what is needed for the kind of life a person would most sensibly and appropriately seek for himself. Thus a preoccupation with the alleged inherent value of economic equality tends to divert a person’s attention away from trying to discover — within his experience of himself and of his life conditions — what he himself really cares about, what he truly desires or needs, and what will actually satisfy him.
That is to say, a preoccupation with the condition of others interferes with the most basic task on which a person’s intelligent selection of monetary goals for himself most decisively depends. It leads a person away from understanding what he himself truly requires in order effectively to pursue his own most authentic needs, interests, and ambitions. Exaggerating the moral importance of economic equality is harmful, in other words, because it is alienating. It separates a person from his own individual reality, and leads him to focus his attention upon desires and needs that are not most authentically his own.”
Frankfurt also handles modern economic arguments surrounding redistribution of wealth. A common claim from pro-equality advocates is that money has diminishing marginal utility. They claim a dollar in the hand of someone worth millions is worth far less than a dollar given to someone with no money.
There’s some fundamental assumptions baked into this argument:
- For each individual, the utility of money invariably diminishes as total wealth increases
- With respect to money and consumption, the utility functions of all individuals are the same
Put more simply, this argument assumes all rich people enjoy extra money less, and everyone has similar needs and wants. It then follows that an equal distribution of wealth is a way of maximizing the welfare of all.
While I’m sympathetic to the aims of people proposing this argument — they do genuinely want to help people living in poverty — I agree with Frankfurt’s eventual assessment. Here’s a couple points he makes arguing against this particular argument for redistribution (paraphrased for less pretentious language):
- Some people are depressed and don’t feel happy in general. If we’re trying to maximize welfare, we’d presumably give these people less money during redistribution. This seems unfair.
- Some people have disabilities are require more money than the average person to maintain a fulfilling lifestyle. Equal distribution of money would leave these people worse off than everyone else.
- We don’t know if the happiness rich people derive from additional wealth diminishes at the margin due to a diminishment in their enjoyment of consumption, or their boredom caused by repetitive consumption. If a rich person frequently sought out highly enjoyable new experiences the more wealth they got, that doesn’t sound like diminishing marginal utility
- In general, people vary widely in what they value. Some poor people have expensive habits, some rich people have very cheap habits. Distributing money on an equal basis would not necessary maximize utility
- There are unexplored inflationary effects of redistributing money that may offset any aesthetic benefits of a more equal distribution of wealth
There’s a lot to summarize, and I haven’t quite done it justice. Regardless, I think you get the point that equal redistribution on the grounds of maximizing total utility is way more complex than it sounds — and we don’t yet have strong reasons to believe it would be a net good by the end.
I’ve mostly focused on Frankfurt’s arguments surrounding inequality, because that’s the point of this article. I’ll note, however, that he also focuses on why poverty is bad and our ethical duty to eradicate it. Nothing I’ve said in the above sections or relayed from Frankfurt’s book disagrees with the moral principle that people living in poverty is bad. His disagreement is instead with how we should go about eradicating it and what facts are morally relevant.
What I learned
Inequality is a messy subject. The act of even attempting to measure it is so incredibly difficult that I am impressed people like Piketty even make the attempt.
Though we’ve seen how Piketty’s central arguments fall apart under scrutiny, there’s a lot he wrote that is still deeply interesting. His analysis may have been exaggerated, but even with the critiques levied against him in Anti-Piketty, I still think he hit on an interesting dynamic. While inequality may not be as bad as he claims, our society’s transition to a globalized economy and community of people has made for winner-takes-all-type opportunities to, for lack of a better phrase, own the means of production. When Amazon’s web services already support 40% of web traffic, it’s tough not to see how the return on the company’s capital doesn’t outpace the income growth of other industries — swallowing them whole in the process.
Pistor’s arguments also function quite well independent of Piketty’s errors. While her stated motivation — rising inequality — may be weaker than originally anticipated, the legal dynamics she raises still exist. In particular, her comments on how the digital age will bring about new forms of capital and enclosure have convinced me that we have the potential to break from the trend lines that people like Piketty and Steven Pinker draw in their books. The capacity for global, instantaneous communication and the near-infinite duplication of certain types of capital will make it difficult to the same level of property rights we’ve had for the past couple decades. How that will change the world, I don’t know. But it will be interesting.
I do ultimately believe Harry Frankfurt is right in his own limited critique. Inequality may be objectionable on an aesthetic level, but I have yet to see strong evidence to suggest it is inextricably linked to the poverty we see in the world today. Our goal should be to lift up the hundreds of millions living in terrible conditions regardless of if it lifts up the rest of their higher-income counterparts in the process.
This concludes what is the longest single piece of writing I’ve ever written. If you liked it, found it helpful, or even have a critique, please let me know.
Inequality Reading List
While I only covered 4 books in this post, there are others that are also relevant and, quite frankly, merit their own article. Here’s a few of them, along with the original books I reviewed.
Capital in the Twenty-First Century — Thomas Piketty
The Code of Capital — Katherine Pistor
Anti-Piketty: Capital for the 21st Century — Jean-Phillipe Delsol
On Inequality — Harry Frankfurt
Poor Economics — Abhijit Banjeree & Esther Duflo
Envy in Politics — Gwyneth H. McClendon
After Piketty — Heather Boushey et. al.
Enlightenment Now — Steven Pinker