Friday, 24 October 2014

Capital in the 21st Century

Some of last week's thoughts about privatisation were prompted by reading French economist Thomas Piketty's Capital in the Twenty-First Century, passed on to me by my generous cousin Michael.

Piketty's book is economics on a grand scale.  He sets out to tell the story of global capital accumulation over the past two centuries.  To do so, he draws on an impressive (if not quite truly global) collection of historical data on wealth collated by himself and a number of other economists over the past decade, published in sources such as the World Top Incomes Database.

This is not exactly an easy book to read, but nor is it the kind of impenetrable tome produced by so many professional economists.  Anyone who has some basic economic literacy will have no trouble grasping his arguments and if its 500-plus pages seem daunting take heart, there's a fair amount of repetition involved.  If you take economic issues seriously (as we all should!) this book is essential reading.

Piketty's foil, in an intellectual sense, is Simon Kuznets, the post-war American economist who was responsible for the 'Kuznets curve'.  This was the idea that the progress of industrialisation would initially result in greater inequality of income before swinging back to greater equality as a result of market forces and economic growth.  Kuznets summed this idea up in the famous phrase, "a rising tide lifts all boats".

Kuznets' theory is so hopeful and positive we would all love it to be true, but is it?  Well, according to Piketty even the limited data used by Kuznets himself did not really support his theory.  In his more serious academic works Kuznets was cautious and circumspect, but in his popular speeches and pronouncements as president of the American Economic Association he was far more bullish about the equalising effects of capitalism.

Piketty disagrees.  His data series, stretching back as far as 250 years for countries such as France and the UK and almost as far for the USA, paint a very different picture of the dynamics of wealth inequality.  His data show that both income and wealth inequality increased steadily through the 19th century, reaching a peak in the early 1900s.  In the decades that followed the wealthiest people in society lost a large proportion of their wealth due to the triple shock of two world wars and the Great Depression.  As a result, equality was at an historic high in the post-war period, kept that way by the rapid growth necessitated by post-war reconstruction and the institution of high marginal tax rates at the top of the income scale.

This is the world Kuznets lived in, and he took it to be normal and inevitable.  However, since the 1970s the level of income inequality and the concentration of wealth have increased steadily, so that they are now almost where they were a century ago.

Why has this happened?  Piketty explains the process of wealth accumulation through the use of a number of simple, elegant equations.  One of these suggests that where the return on capital (that is, rent, interest, dividends, capital gains etc) is greater than the rate of growth in the economy, wealth inequality will automatically increase.  Hence in high growth environments inequality tends to be suppressed, but in low growth environments it will almost always grow over time.  Wealth will gradually trickle up to the top.

But if we start out equal, wouldn't the return on capital benefit everyone equally?  Perhaps, but this is purely hypothetical.  Wealth has never been even close to being distributed equally.  Certainly we have a middle class which owns modest amounts of wealth, but this modest wealth is held in safer but lower-yielding assets like housing and bank accounts.  Wealthier people hold much more of their wealth in higher-yielding assets like equities, and have the freedom to take risks in order to achieve higher growth.  This means that over time they will progressively claim more and more of the available wealth.  Nor is this a question of hard work.  Once you have the wealth (whether earned or inherited) it will continue to grow without your lifting a finger.

So, is the answer that we should continuously promote high levels of growth?  Piketty is not hopeful about this option.  Over the long run of history, it seems unlikely that growth has often risen much above one percent.  High growth rates are inevitably a result of catch-up - Europe and the USA during the post-war reconstruction, Japan during its modernisation phase, the South East Asian nations of the 1980s and 90s, most recently China and India.  In the process of building infrastructure and acquiring technology to catch up with the rest of the world, these nations experience rapid growth.  Once they have caught up, growth slows dramatically.

Hence, Piketty believes that the decades to come will overwhelmingly see low growth - no more than 2% per year on average.  Even if Kuznets was right, there will be no rapid tide to lift those boats.

So are we doomed to ever-increasing inequality?  The good news is that there are other options available.  The less good news is that the wealthy citizens of all the major economies have a lot of power and wealth, and will fiercely resist anything that reduces that wealth.  Which brings us to the question of tax.

One of the significant contributors to the relative equality in advanced countries from the 1950s to the 1970s was a highly progressive tax system, with the richest people in many countries paying rates of 70% and beyond on the top part of their income as well as substantial inheritance taxes.  These taxes funded substantial social programs - health, education, public infrastructure, income security, public housing - which predominantly benefited those on lower incomes.  Allied with this were highly regulated labour markets which oversaw improved wages and conditions.

However, the rise of neoclassical economics from the late 1970s, personified by Reagan and Thatcher, represented a reversal of these gains.  Top tax rates were cut around the world, estate taxes were reduced or even abolished, loopholes were allowed to proliferate, wages were pushed down.  The result is what we see today in Australia as elsewhere.  A small number of fabulously wealthy people, many of them beneficiaries of large inheritances, live in luxury while the majority live from day to day and the number in poverty increases.  Meanwhile our governments, deprived of sufficient tax revenue, suffer their own form of poverty, running large deficits and borrowing to stay afloat.

Piketty's answer is that we should tax wealth.  His proposed tax is modest - nothing on the sort of amounts ordinary working families can accumulate, then stepping up progressively to 5% on the largest fortunes.  He clearly thinks it would be reasonable to levy much higher amounts - he suggests that fortunes above a certain size could be seen as socially dysfunctional and could be subject to confiscatory taxes.  However, he also understands that even these modest rates will be fiercely opposed by those who would have to pay them.  If you are in any doubt, just think back to the Rudd government's attempt to levy an extra tax on mining company profits.

Such a tax is not currently on any government's radar, and conservative economists and media outlets have been quick to try and discredit Piketty's analysis.  Instead, the solutions on offer, in Australia as elsewhere in the developed nations, are guaranteed to continue the process of wealth concentration.  Deep cuts to social programs will deepen the poverty of the poorest while leaving the wealthy untouched.  Asset sales will transfer wealth from government to private hands, inevitably those of our wealthiest individuals and companies.  Piketty points out that debt has much the same effect but over a longer period - instead of transferring wealth in one hit, it is transferred bit by bit through interest payments.

It's hard not to be gloomy about all this.  The odds are stacked against a just solution.  Our media and much of our political process is firmly in the hands of the super-rich.  They will not give up their wealth without a fight.  Yet while there are scholars like Piketty to point out the truth, and to point the way to solutions that don't further impoverish the poor, there is at least the justification to keep on striving.

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