What Piketty Leaves Out by Robert Kuttner
Source Dave Anderson
Date 14/04/30/11:09
What Piketty Leaves Out

Despite some losses to financial capital during the Great Depression,
the more powerful era of equality in the U.S. began during World War

We have many reasons to be grateful to Thomas Piketty. His justly
celebrated book makes it impossible to deny that the concentration of
income and wealth are again approaching Gilded Age levels, far beyond
what is required for incentive and efficiency. For the past 15 years,
Piketty and his colleagues have put together the most comprehensive
data set on inequality ever assembled. Now, in Capital in the
Twenty-First Century, Piketty addresses his subject as a well-educated
intellectual, not a myopic number-cruncher. He is as likely to rely on
novelists Jane Austen and Honoré de Balzac as on economist Simon
Kuznets for insights on social class and inherited wealth, and the
tale he tells reconnects the economic with the political. The prose is
precise, but this is just not a technical tome, and the fine
translation by Arthur Goldhammer renders the text in clear, idiomatic

As an economic historian, Piketty begins by rebutting the theorem
propounded by Kuznets in the mid-1950s that early capitalism increases
inequality as vast fortunes are made and redoubled but that mature
capitalism tends to diffuse its benefits. Piketty demonstrates that
Kuznets was extrapolating from a special case in the history of
capital, and his optimism was premature. Rather, wealth in a
capitalist economy tends to concentrate absent exceptional
circumstances. More on those exceptions in a moment.

Wealth concentrates for several, mutually reinforcing reasons. First,
income on capital tends to grow faster than gross domestic product. If
interest, dividends, and other returns to capital (“rents,” in
classical usage) grow at 5 percent or 6 percent, as they have on
average for more than two centuries, but GDP only grows at 1 percent
or 2 percent, then the rich get richer and wealth becomes more
concentrated over time. Second, the very wealthy are able to realize
higher returns than the merely moderately wealthy, because they have
access to well-paid advisers, insider knowledge, and techniques such
as hedge-fund investing, flash trading, and other plays not available
to the ordinary small investor. Third, inequality of wealth and income
tend to be mutually reinforcing.

Piketty is also superb at demolishing several conceits that together
make up the ideology of conservative economics. The idea that workers
and capitalists are paid according to their skills or the marginal
value of their product, Piketty says, is valid only as a gross
generalization and is more like convenient myth: The labor market “is
a social construct based on specific rules and compromises.” Education
does not solve the problem of rising inequality because education is
not its main source. Top executives, he writes, increasingly “have the
power to set their own remuneration.” In a market system, monopoly
profits are supposed to be competed away. But much extreme
entrepreneurial wealth that appears to be justly earned is the
function of rigged rules and the innovations by others in the public
domain. Bill Gates, as Piketty notes, “enjoyed a virtual monopoly in
operating systems” and relied on the research of thousands of unsung
scientists and engineers.

The only exception to a relentless trend of wealth concentration that
dates to at least the French Revolution, Piketty says, is the
“historical accident” of the period between 1914 and 1945. But it is
here, just when the story gets interesting, that he often loses focus.
If something happened during those three decades that altered the
tendency of inequality to concentrate, we need to know just what
occurred—politically as well as statistically—and how the exceptional
period of greater equality might be replicated. Was it inevitable that
capitalism should revert to its long-term trend? Or could the right
policies grounded in the right politics once again bend it toward a
distribution that looked more like that of the postwar boom?

What transpired between 1914 and 1945 that changed the trajectory of
inequality? Two world wars, inflation, depression, the rise of
fascism, Bolshevism, the New Deal—and the triumph of the democracies
at a moment when domestic power alignments made possible more
egalitarian policies than usual. All this affected inequality via the
loss of a lot of inherited wealth and the weakening of finance as a
class. Then in the postwar era, we saw the strengthening of labor and
of public institutions dedicated to more generally shared prosperity.
Piketty, however, chooses to emphasize one aspect of this history—the
destruction of wealth.

When discussing the era of Balzac, Piketty writes like a social and
economic historian, but his rendering of what happened since 1914 is
more mechanical, in the spirit of a narrow technical economist. An
accidental byproduct of war and depression was to destroy capital.
Since capital was narrowly held, this accident left capital less
concentrated. Full stop. Well, not quite full stop, but there is much
more to the history of capitalism’s era of greater equality that
Piketty downplays or ignores. This simplification is a pity, since
Piketty has the intellectual equipment to dig deeper. Happily, he
leaves plenty of clues for further digging.

One of the numerous original findings of Piketty’s research is to
demonstrate that inflation, on average, was almost nonexistent in the
century before World War I and that the real returns on capital were
stable and predictable, typically about 5 percent. That meant that if
you desired an annual income of 50,000 francs, you needed capital of
about 1 million francs. Thanks to the gold standard, the world’s major
currencies—francs, dollars, pounds, and marks—were freely convertible
at predictable rates. Most of the French and British upper classes of
that era were rentiers—the major part of their income came from
capital that they had inherited or perhaps added to via
entrepreneurship. Only a minority of the great fortunes were

Piketty keeps coming back to an emblematic passage from Balzac’s novel
Le Père Goriot, in which Rastignac, an aspiring young lawyer from a
poor background, is advised by the cynical Vautrin that a far faster
route to affluence and comfort is to win the hand of Mademoiselle
Victorine, a rich man’s daughter who is neither pretty nor charming
but who is worth a million francs. Piketty notes, he could “thus
immediately achieve ten times the level of comfort to which he could
hope only to aspire years later on a royal prosecutor’s salary.”

Le Père Goriot was written in 1834 and 1835 and set in 1819. The
discussion of social class, and the greater rewards of inherited
wealth over hard work, would be entirely recognizable to French
readers nearly a century later on the eve of the Great War. Despite an
industrial revolution that intervened, changing the composition of
capital from mostly land to mostly stocks, bonds, industrial plants,
and urban real estate, the relationship of capital to rents was
remarkably stable. The only thing that changed was that the
distribution of income and wealth was even more highly concentrated on
the eve of World War I than in Balzac’s day. While more fortunes were
arguably “earned” in the period after the two wars, the tendency of
unearned wealth to cumulate continued. Michael Kinsley, reviewing the
original Forbes 400 of the early 1980s in The New Republic, calculated
that all but 59 of the 400 fortunes were rooted either in inherited
wealth, lucky timing, or government contracts. Piketty calculates that
only about one-third of the current Forbes fortunes are primarily

When World War I broke out, the stable, reliable world of capital was
destroyed. As Piketty observes, investments in France’s overseas
holdings shrunk. Czarist bonds, a favorite of the rentier class, were
soon worthless. The massive government borrowing to finance the war
triggered inflation, ended the gold standard, and destroyed the secure
relationship between capital and income. Something similar happened in
Britain. Even more than World War I, World War II demolished both
physical capital and financial capital, compressing the wealth
distribution as surely as if the wealth had been deliberately

This account is true as far as it goes, but there is a great deal more
to what occurred, a history that Piketty either misconstrues or
downplays. For example, there are immense differences between World
War I and World War II and between the dynamics in the U.S. and in
Europe, even though the end result of the wars was a brief and
exceptional era of greater equality on both sides of the Atlantic.

The period during and after World War I did not just demolish a good
deal of capital held by the rich. The 1920s were an era of stupid,
deflationary policies and needlessly high unemployment. In their
hapless effort to rebuild the prewarrentier economy, the leaders of
the interwar period chased one another to collect war debts that could
not be repaid and sought to establish prewar values for their
currencies. The result was deflation, deepening austerity, and high
unemployment. So while World War I may have wiped out a lot of French
and British wealth at the top, the aftermath did not benefit the
bottom or the middle.

World War I was a different experience for the U.S., which ended the
war as the world’s dominant industrial and financial power. Our
wartime policies briefly imposed surtaxes on the rich (who also
profited handsomely from the war boom) but did not lead to destruction
of capital. On the contrary, the extreme inequality of the Gilded Age
marched onward, right up until it peaked in 1929. While the Great
Crash and the Depression did destroy some fortunes, the more
significant era for the compression of income and wealth was World War
II and its immediate aftermath.

In Europe, World War II was massively destructive of both physical
capital and financial wealth. France suffered huge losses and Germany
even more, while Britain lost roughly one-fourth of its prewar capital
in borrowing to pay for the war. Though Piketty treats the period of
1914-1945 as a single statistical era for purposes of understanding
wealth compression in all the major Western nations, the American
experience was entirely unlike Europe’s. In the U.S., the most
interesting years are 1941-1973, not the years bracketed by the two
wars as Piketty contends.

Despite some losses to financial capital during the Great Depression,
the more powerful era of equality in the U.S. began during World War
II. The war was a massive macroeconomic stimulus; it produced full
employment, stronger unions, and investment of public capital. The
government’s wartime policies also repressed private finance in
multiple and reinforcing ways, including the Fed’s pegging interest
rates on Treasury bonds at a maximum of 2.5 percent, marginal tax
rates set as high as 94 percent, and an intensification of the
anti-speculative financial regulation of the New Deal. All of this did
not end with the war. It had a half-life well into the postwar era,
until unions were bashed and finance deregulated beginning in the

Piketty mentions some of this briefly but doesn’t focus on the
political dynamics, and he is surprisingly blasé about the role of
deliberate policy. “Neither the economic liberalization that began
around 1980 nor the state intervention that began in 1945 deserves
much praise or blame,” he contends. “The most one can say is that
state intervention did no harm.” But this can’t be true. The key
difference in the two trajectories of non-recovery after World War I
and robust recovery after World War II was in the policies pursued.

The aftermath of the first war led to depression and fascism, while
World War II was followed by a boom of widely shared prosperity. In
the reconstruction period of 1944-1948, policymakers, cognizant of the
mistakes of the Treaty of Versailles and the deflationary 1920s,
deliberately created the conditions for domestic full-employment
welfare states. There was a great deal more to the anomalous era of
shared growth than the shrinkage of inherited wealth, though it’s
certainly the case that the weakening of financial elites made
possible a politics of broad gains for the wage-earning class.

Not surprisingly, Piketty is much better informed on the nuances of
French politics and economic history. In France, where the prosperity
of the postwar boom is known as the Trente Glorieuses—30 glorious
years of high growth and full employment—Piketty reports that the
wealth distribution was already becoming more unequal again in the
late 1940s as capital began recovering its normal place. It was rather
high rates of growth, rising real incomes, and the expanding welfare
state that made the postwar boom a happy French memory.

“In North America,” Piketty writes, “there is no nostalgia for the
postwar period because the Trente Glorieuses never existed there: per
capita output grew at roughly the same 1.5–2 percent rate throughout
the period 1820-2012.” But this is a non sequitur. A two-century
average tells us nothing about particular decades, nor does the
average per capita output tell us anything about the wage dispersion.
In fact, there is great nostalgia in the U.S. for the postwar boom,
and appropriately so, precisely because it was a period of steadily
rising wages and job security—a period of both rapid growth and more
equal distribution.

He also writes, “The significant compression of income inequality over
the course of the 20th century was due entirely to the diminished top
income from capital.” But that is misleading, too. What really
happened is that the temporary weakening of capital, financially and
politically, gave progressives and social democrats an opening that
they successfully exploited for three decades after the war.

In the U.S., the postwar era (1947-1973) of increasing equality—“The
Great Compression,” as economist Claudia Goldin famously termed it—is
partly a consequence of the top quintile losing its usual capital
income. But for most of the population, the main event was the greater
equality of labor income of that period. And in some places, such as
Sweden, the social democratic era did not require war to destroy
wealth at the top (Sweden was neutral during World War II and profited
from supplying both sides). In the Swedish case, the dynamic was
entirely one of labor gaining power at the expense of capital, both
before and after the Great Depression, and using the political process
to entrench and redouble its gains.

Another factor that Piketty mostly (and surprisingly) omits is
macroeconomics. In the 1930s, the U.S. didn’t just under-employ; the
economy also underinvested, and the two problems were related. The
overhang of the losses from 1929 and the dynamics of what the
economist Irving Fisher termed “debt-deflation” left purchasing power
depressed and business with too little appetite to invest. Technical
breakthroughs like television and commercial aviation were
underexploited because of weak aggregate demand. In a classic paper in
1939, when unemployment was still more than 15 percent, the American
Keynesian Alvin Hansen estimated the investment shortfall at a
then-impressive $2 billion.

Three years later, after Pearl Harbor, in the first six months of
1942, the War Department entered orders of $100 billion—50 times
Hansen’s radical-sounding number. The economy roared back to life.
Much of the investment capital was public. The economy did an end run
around flaccid private finance, which had distributive as well as
Keynesian consequences. It turned out that you did not need to give
private capital exorbitant rewards for the economy to prosper. Indeed,
the era of the postwar boom was one in which the rentier class
suffered. The real return on capital was negative: Inflation reduced
the value of bonds, and the stock market languished. Yet thanks to low
capital costs, the economy thrived. Might there be a lesson here?

Appreciating this history is important if we want to get back to
something like the distribution of income and wealth obtained during
the postwar boom and to avoid the fate that Piketty projects of a
society in 2030 as unequal as that of the Gilded Age.

For instance, in the need to invest in a green transition is there a
possible strategy analogous to what the U.S. achieved during World War
II to use public capital to produce both social gains and a more equal
distribution of wages? In his treatment of growth and public capital,
Piketty accepts the conventional view that mature economies by
definition operate at the frontier of technical possibility. But the
new and important book The Entrepreneurial Stateby Mariana Mazzucato
suggests that this is not necessarily so. Private capital is myopic
when it comes to long-term pursuit of technological breakthroughs.
That’s why so many of the core innovations of the postwar era were the
fruit of patient public capital and public risk-taking. Is it only
during depressions and wars that public investment can make up for
private market failures, or can public capital increase productivity
growth, employment, and expand the technology frontier on an ongoing
basis? Piketty commends “new forms of democratic control of capital”
(otherwise unspecified) but does not address whether more government
support for technical advances could improve the market rate of
innovation and productivity growth.

In his final chapters on what is to be done, Piketty supports a more
progressive income tax, more egalitarian higher education, and he
issues a call for a “social state for the twenty-first century.” His
breakthrough idea is wishful: a “global tax on capital.” Well, sure,
that would be great. But if we look harder at the wartime and postwar
boom, there may be more plausible strategies within the nearer realm
of the politically possible.

A new repression of finance, meaning far tighter regulation of what
banks and hedge funds can do, would weaken both the share of the total
economic product claimed by rentiers and “super-managers”—and along
the way weaken their political power. Clearly, we will need to reduce
the sway of capital before we can imagine a global tax on it. The
crisis of 2008 was a missed opportunity, but there will be others.

Piketty’s book, at various points, is on both sides of the question of
whether the more important recent phenomenon is the increasing
concentration of capital ownership or a mutation of “meritocratic
extremism” that reflects the ability of executives to pay themselves
ever-higher salaries disconnected from what they contribute to the
economy. It’s somewhat misleading to count Wall Street bonuses or
corporate mega-salaries as “labor income.” These windfalls reflect and
reinforce the extreme inequality of our age, as well as the power of
capital as a class. Robert Solow put it well, in a respectful review
of Piketty’s book for The New Republic: “It is pretty clear that the
class of super-managers belongs socially and politically with the
rentiers, not with the larger body of salaried and independent
professionals and middle managers.”

In a short interview, Piketty says that his discussion of the postwar
recovery missed some of the political story, and he regrets
understating the important role of unions and shifting power
relations. He adds in an e-mail message, “I probably suggest too much
that recovery was mostly mechanical, which is excessive. More
inclusive institutions and better regulation policies did promote
[postwar] mobility and growth.” He also says he favors of some kind of
green transition, led by public capital.

If we want a more equal society, we need to understand both the
institutions and the politics that once undergirded greater equality.
Yes, there was the historical accident of two wars and the effect on
inherited wealth, but there was also the effort of both statesmen and
organizers to maximize the opportunity that history offered.

Right-wing American critics, whose intellectual bankruptcy on the
subject of inequality was smoked out by this book, have taken to
calling Piketty a “French Marxist” (he is a social democrat). He
shares with Marx only a passion for economic history and a quest for
an understanding of the deeper dynamics of capitalism. Piketty is just
42. It took Marx three volumes (the last two edited by Engels and
published posthumously) to complete Das Kapital. We look forward to
Piketty’s Capital in the Twenty-First Century, volume II.

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