Capital in the Twenty-First Century

by Thomas Piketty

Introduction “Social distinctions can be based only on common utility.” —Declaration of the Rights of Man and the Citizen, article 1, 1789

Modern economic growth and the diffusion of knowledge have made it possible to avoid the Marxist apocalypse but have not modified the deep structures of capital and inequality—or in any case not as much as one might have imagined in the optimistic decades following World War II. When the rate of return on capital exceeds the rate of growth of output and income, as it did in the nineteenth century and seems quite likely to do again in the twenty-first, capitalism automatically generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based.

Writing in the 1810s, Ricardo had no way of anticipating the importance of technological progress or industrial growth in the years ahead. Like Malthus and Young, he could not imagine that humankind would ever be totally freed from the alimentary imperative.

In fact, all the historical data at our disposal today indicate that it was not until the second half—or even the final third—of the nineteenth century that a significant rise in the purchasing power of wages occurred. From the first to the sixth decade of the nineteenth century, workers’ wages stagnated at very low levels—close or even inferior to the levels of the eighteenth and previous centuries. This long phase of wage stagnation, which we observe in Britain as well as France, stands out all the more because economic growth was accelerating in this period.

Like his predecessors, Marx totally neglected the possibility of durable technological progress and steadily increasing productivity, which is a force that can to some extent serve as a counterweight to the process of accumulation and concentration of private capital.

The sharp reduction in income inequality that we observe in almost all the rich countries between 1914 and 1945 was due above all to the world wars and the violent economic and political shocks they entailed (especially for people with large fortunes). It had little to do with the tranquil process of intersectoral mobility described by Kuznets.

In the first place, just as income tax returns allow us to study changes in income inequality, estate tax returns enable us to study changes in the inequality of wealth.

Inequality is not necessarily bad in itself: the key question is to decide whether it is justified, whether there are reasons for it.

This book is heavily indebted to recent improvements in the technology of research.

The history of the distribution of wealth has always been deeply political, and it cannot be reduced to purely economic mechanisms. In particular, the reduction of inequality that took place in most developed countries between 1910 and 1950 was above all a consequence of war and of policies adopted to cope with the shocks of war. Similarly, the resurgence of inequality after 1980 is due largely to the political shifts of the past several decades, especially in regard to taxation and finance. The history of inequality is shaped by the way economic, social, and political actors view what is just and what is not, as well as by the relative power of those actors and the collective choices that result. It is the joint product of all relevant actors combined. The second conclusion, which is the heart of the book, is that the dynamics of wealth distribution reveal powerful mechanisms pushing alternately toward convergence and divergence. Furthermore, there is no natural, spontaneous process to prevent destabilizing, inegalitarian forces from prevailing permanently.

The main forces for convergence are the diffusion of knowledge and investment in training and skills. The law of supply and demand, as well as the mobility of capital and labor, which is a variant of that law, may always tend toward convergence as well, but the influence of this economic law is less powerful than the diffusion of knowledge and skill and is frequently ambiguous or contradictory in its implications. Knowledge and skill diffusion is the key to overall productivity growth as well as the reduction of inequality both within and between countries.

I will show that this spectacular increase in inequality largely reflects an unprecedented explosion of very elevated incomes from labor, a veritable separation of the top managers of large firms from the rest of the population. One possible explanation of this is that the skills and productivity of these top managers rose suddenly in relation to those of other workers. Another explanation, which to me seems more plausible and turns out to be much more consistent with the evidence, is that these top managers by and large have the power to set their own remuneration, in some cases without limit and in many cases without any clear relation to their individual productivity, which in any case is very difficult to estimate in a large organization.

In slowly growing economies, past wealth naturally takes on disproportionate importance, because it takes only a small flow of new savings to increase the stock of wealth steadily and substantially. If, moreover, the rate of return on capital remains significantly above the growth rate for an extended period of time (which is more likely when the growth rate is low, though not automatic), then the risk of divergence in the distribution of wealth is very high. This 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.

When the rate of return on capital significantly exceeds the growth rate of the economy (as it did through much of history until the nineteenth century and as is likely to be the case again in the twenty-first century), then it logically follows that inherited wealth grows faster than output and income.

People with inherited wealth need save only a portion of their income from capital to see that capital grow more quickly than the economy as a whole. Under such conditions, it is almost inevitable that inherited wealth will dominate wealth amassed from a lifetime’s labor by a wide margin, and the concentration of capital will attain extremely high levels—levels potentially incompatible with the meritocratic values and principles of social justice fundamental to modern democratic societies.

Note, for example, that it was not until the coming of the twenty-first century that the wealthy countries regained the same level of stock-market capitalization relative to GDP that Paris and London achieved in the early 1900s. This comparison is quite instructive for understanding today’s world.

The French Revolution did not create a just or ideal society, but it did make it possible to observe the structure of wealth in unprecedented detail. The system established in the 1790s for recording wealth in land, buildings, and financial assets was astonishingly modern and comprehensive for its time. The Revolution is the reason why French estate records are probably the richest in the world over the long run.

It has been the demographic growth of the New World that has ensured that inherited wealth has always played a smaller role in the United States than in Europe. This factor also explains why the structure of inequality in the United States has always been so peculiar, and the same can be said of US representations of inequality and social class.

To put it bluntly, the discipline of economics has yet to get over its childish passion for mathematics and for purely theoretical and often highly ideological speculation, at the expense of historical research and collaboration with the other social sciences.

First, throughout this book, when I speak of “capital” without further qualification, I always exclude what economists often call (unfortunately, to my mind) “human capital,” which consists of an individual’s labor power, skills, training, and abilities. In this book, capital is defined as the sum total of nonhuman assets that can be owned and exchanged on some market. 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.

To appreciate the concrete form that wealth takes in today’s world, it is useful to note that the capital stock in the developed countries currently consists of two roughly equal shares: residential capital and professional capital used by firms and government. To sum up, each citizen of one of the wealthy countries earned an average of 30,000 euros per year in 2010, owned approximately 180,000 euros of capital, 90,000 in the form of a dwelling and another 90,000 in stocks, bonds, savings, or other investments.

This optimistic theory has two major defects, however. First, from a strictly logical point of view, the equalization mechanism does not guarantee global convergence of per capita income. At best it can give rise to convergence of per capita output, provided we assume perfect capital mobility and, even more important, total equality of skill levels and human capital across countries—no small assumption. In any case, the possible convergence of output per head does not imply convergence of income per head. After the wealthy countries have invested in their poorer neighbors, they may continue to own them indefinitely, and indeed their share of ownership may grow to massive proportions, so that the per capita national income of the wealthy countries remains permanently greater than that of the poorer countries, which must continue to pay to foreigners a substantial share of what their citizens produce (as African countries have done for decades).

Furthermore, if we look at the historical record, it does not appear that capital mobility has been the primary factor promoting convergence of rich and poor nations. None of the Asian countries that have moved closer to the developed countries of the West in recent years has benefited from large foreign investments, whether it be Japan, South Korea, or Taiwan and more recently China. In essence, all of these countries themselves financed the necessary investments in physical capital and, even more, in human capital, which the latest research holds to be the key to long-term growth.35 Conversely, countries owned by other countries, whether in the colonial period or in Africa today, have been less successful, most notably because they have tended to specialize in areas without much prospect of future development and because they have been subject to chronic political instability.

Part of the reason for that instability may be the following. When a country is largely owned by foreigners, there is a recurrent and almost irrepressible social demand for expropriation. Other political actors respond that investment and development are possible only if existing property rights are unconditionally protected. The country is thus caught in an endless alternation between revolutionary governments (whose success in improving actual living conditions for their citizens is often limited) and governments dedicated to the protection of existing property owners, thereby laying the groundwork for the next revolution or coup. Inequality of capital ownership is already difficult to accept and peacefully maintain within a single national community. Internationally, it is almost impossible to sustain without a colonial type of political domination.

To sum up, historical experience suggests that the principal mechanism for convergence at the international as well as the domestic level is the diffusion of knowledge. In other words, the poor catch up with the rich to the extent that they achieve the same level of technological know-how, skill, and education, not by becoming the property of the wealthy.

The central thesis of this book is precisely that an apparently small gap between the return on capital and the rate of growth can in the long run have powerful and destabilizing effects on the structure and dynamics of social inequality. In a sense, everything follows from the laws of cumulative growth and cumulative returns, and that is why the reader will find it useful at this point to become familiar with these notions.

Other things being equal, strong demographic growth tends to play an equalizing role because it decreases the importance of inherited wealth: every generation must in some sense construct itself.

Economic development begins with the diversification of ways of life and types of goods and services produced and consumed.

Finally, productivity growth in the service sector has generally been low (or even zero in some cases, which explains why this sector has tended to employ a steadily increasing share of the workforce), so that the price of services has increased more rapidly than the average of all prices.

The details are unimportant. The key point is that there is no historical example of a country at the world technological frontier whose growth in per capita output exceeded 1.5 percent over a lengthy period of time.

Until World War I, money had meaning, and novelists did not fail to exploit it, explore it, and turn it into a literary subject.

To put it simply, we can see that over the very long run, agricultural land has gradually been replaced by buildings, business capital, and financial capital invested in firms and government organizations. Yet the overall value of capital, measured in years of national income, has not really changed.

What lessons can we draw from this historical experience? First, there is no doubt that Britain’s high level of public debt enhanced the influence of private wealth in British society. Britons who had the necessary means lent what the state demanded without appreciably reducing private investment: the very substantial increase in public debt in the period 1770–1810 was financed largely by a corresponding increase in private saving (proving that the propertied class in Britain was indeed prosperous and that yields on government bonds were attractive), so that national capital remained stable overall at around seven years of national income throughout the period, whereas private wealth rose to more than eight years of national income in the 1810s, as net public capital fell into increasingly negative territory (see Figure 3.5).

Second, it is also quite clear that, all things considered, this very high level of public debt served the interests of the lenders and their descendants quite well, at least when compared with what would have happened if the British monarchy had financed its expenditures by making them pay taxes. From the standpoint of people with the means to lend to the government, it is obviously far more advantageous to lend to the state and receive interest on the loan for decades than to pay taxes without compensation.

This historical record is fundamental for a number of reasons. First, it enables us to understand why nineteenth-century socialists, beginning with Marx, were so wary of public debt, which they saw—not without a certain perspicacity—as a tool of private capital.

In the twentieth century, a totally different view of public debt emerged, based on the conviction that debt could serve as an instrument of policy aimed at raising public spending and redistributing wealth for the benefit of the least well-off members of society. The difference between these two views is fairly simple: in the nineteenth century, lenders were handsomely reimbursed, thereby increasing private wealth; in the twentieth century, debt was drowned by inflation and repaid with money of decreasing value. In practice, this allowed deficits to be financed by those who had lent money to the state, and taxes did not have to be raised by an equivalent amount. This “progressive” view of public debt retains its hold on many minds today, even though inflation has long since declined to a rate not much above the nineteenth century’s, and the distributional effects are relatively obscure.

In fact, the budgetary and political shocks of two wars proved far more destructive to capital than combat itself. In addition to physical destruction, the main factors that explain the dizzying fall in the capital/income ratio between 1913 and 1950 were on the one hand the collapse of foreign portfolios and the very low savings rate characteristic of the time (together, these two factors, plus physical destruction, explain two-thirds to three-quarters of the drop) and on the other the low asset prices that obtained in the new postwar political context of mixed ownership and regulation (which accounted for one-quarter to one-third of the drop).

This formula, which can be regarded as the second fundamental law of capitalism, reflects an obvious but important point: a country that saves a lot and grows slowly will over the long run accumulate an enormous stock of capital (relative to its income), which can in turn have a significant effect on the social structure and distribution of wealth. Let me put it another way: in a quasi-stagnant society, wealth accumulated in the past will inevitably acquire disproportionate importance.

Second, the law β = s / g is valid only if one focuses on those forms of capital that human beings can accumulate. If a significant fraction of national capital consists of pure natural resources (i.e., natural resources whose value is independent of any human improvement and any past investment), then β can be quite high without any contribution from savings. I will say more later about the practical importance of nonaccumulable capital.

There is every reason to believe that the largest fortunes are often those that are best indexed and most diversified over the long run, while smaller fortunes—typically checking or savings accounts—are the most seriously affected by inflation.

In all civilizations, capital fulfills two economic functions: first, it provides housing (more precisely, capital produces “housing services,” whose value is measured by the equivalent rental value of dwellings, defined as the increment of well-being due to sleeping and living under a roof rather than outside), and second, it serves as a factor of production in producing other goods and services (in processes of production that may require land, tools, buildings, offices, machinery, infrastructure, patents, etc.). Historically, the earliest forms of capital accumulation involved both tools and improvements to land (fencing, irrigation, drainage, etc.) and rudimentary dwellings (caves, tents, huts, etc.). Increasingly sophisticated forms of industrial and business capital came later, as did constantly improved forms of housing.

Where there is no structural growth, and the productivity and population growth rate g is zero, we run up against a logical contradiction very close to what Marx described. If the savings rate s is positive, meaning the capitalists insist on accumulating more and more capital every year in order to increase their power and perpetuate their advantages or simply because their standard of living is already so high, then the capital/income ratio will increase indefinitely. More generally, if g is close to zero, the long-term capital/income ratio β = s / g tends toward infinity. And if β is extremely large, then the return on capital r must get smaller and smaller and closer and closer to zero, or else capital’s share of income, α = r × β, will ultimately devour all of national income.

First, the return to a historic regime of low growth, and in particular zero or even negative demographic growth, leads logically to the return of capital. This tendency for low-growth societies to reconstitute very large stocks of capital is expressed by the law β = s / g and can be summarized as follows: in stagnant societies, wealth accumulated in the past naturally takes on considerable importance.

Although inequality with respect to income from labor is sometimes seen—incorrectly—as moderate inequality that no longer gives rise to conflict, this is largely a consequence of comparing it with the distribution of capital ownership, which is extremely inegalitarian everywhere

To my knowledge, no society has ever existed in which ownership of capital can reasonably be described as “mildly” inegalitarian, by which I mean a distribution in which the poorest half of society would own a significant share (say, one-fifth to one-quarter) of total wealth.

Housing is the favorite investment of the middle class and moderately well-to-do, but true wealth always consists primarily of financial and business assets.

To sum up: the reduction of inequality in France during the twentieth century is largely explained by the fall of the rentier and the collapse of very high incomes from capital. No generalized structural process of inequality compression (and particularly wage inequality compression) seems to have operated over the long run, contrary to the optimistic predictions of Kuznets’s theory. Herein lies a fundamental lesson about the historical dynamics of the distribution of wealth, no doubt the most important lesson the twentieth century has to teach. This is all the more true when we recognize that the factual picture is more or less the same in all developed countries, with minor variations.

To a large extent, we have gone from a society of rentiers to a society of managers, that is, from a society in which the top centile is dominated by rentiers (people who own enough capital to live on the annual income from their wealth) to a society in which the top of the income hierarchy, including to upper centile, consists mainly of highly paid individuals who live on income from labor. One might also say, more correctly (if less positively), that we have gone from a society of superrentiers to a less extreme form of rentier society, with a better balance between success through work and success through capital. It is important, however, to be clear that this major upheaval came about, in France at any rate, without any expansion of the wage hierarchy (which has been globally stable for a long time: the universe of individuals who are paid for their labor has never been as homogeneous as many people think); it was due entirely to the decrease in high incomes from capital.

To sum up: the top decile always encompasses two very different worlds: “the 9 percent,” in which income from labor clearly predominates, and “the 1 percent,” in which income from capital becomes progressively more important (more or less rapidly and massively, depending on the period).

Actual capital income is therefore underestimated, owing both to tax evasion (it is easier to hide investment income than wages, for example, by using foreign bank accounts in countries that do not cooperate with the country in which the taxpayer resides) and to the existence of various tax exemptions that allow whole categories of capital income to legally avoid the income tax (which in France and elsewhere was originally intended to include all types of income).