Capital in the Twenty-First Century

by Thomas Piketty

In my view, there is absolutely no doubt that the increase of inequality in the United States contributed to the nation’s financial instability. The reason is simple: one consequence of increasing inequality was virtual stagnation of the purchasing power of the lower and middle classes in the United States, which inevitably made it more likely that modest households would take on debt, especially since unscrupulous banks and financial intermediaries, freed from regulation and eager to earn good yields on the enormous savings injected into the system by the well-to-do, offered credit on increasingly generous terms.

In support of this thesis, it is important to note the considerable transfer of US national income—on the order of 15 points—from the poorest 90 percent to the richest 10 percent since 1980. Specifically, if we consider the total growth of the US economy in the thirty years prior to the crisis, that is, from 1977 to 2007, we find that the richest 10 percent appropriated three-quarters of the growth. The richest 1 percent alone absorbed nearly 60 percent of the total increase of US national income in this period. Hence for the bottom 90 percent, the rate of income growth was less than 0.5 percent per year.33 These figures are incontestable, and they are striking: whatever one thinks about the fundamental legitimacy of income inequality, the numbers deserve close scrutiny.34 It is hard to imagine an economy and society that can continue functioning indefinitely with such extreme divergence between social groups.

Recent research, based on matching declared income on tax returns with corporate compensation records, allows me to state that the vast majority (60 to 70 percent, depending on what definitions one chooses) of the top 0.1 percent of the income hierarchy in 2000–2010 consists of top managers. By comparison, athletes, actors, and artists of all kinds make up less than 5 percent of this group.42 In this sense, the new US inequality has much more to do with the advent of “supermanagers” than with that of “superstars.”

It is also interesting to note that the financial professions (including both managers of banks and other financial institutions and traders operating on the financial markets) are about twice as common in the very high income groups as in the economy overall (roughly 20 percent of top 0.1 percent, whereas finance accounts for less than 10 percent of GDP). Nevertheless, 80 percent of the top income groups are not in finance, and the increase in the proportion of high-earning Americans is explained primarily by the skyrocketing pay packages of top managers of large firms in the nonfinancial as well as financial sectors.

Why is inequality of income from labor, and especially wage inequality, greater in some societies and periods than others? The most widely accepted theory is that of a race between education and technology. To be blunt, this theory does not explain everything. In particular, it does not offer a satisfactory explanation of the rise of the supermanager or of wage inequality in the United States after 1980. The theory does, however, suggest interesting and important clues for explaining certain historical evolutions. I will therefore begin by discussing it.

In all human societies, health and education have an intrinsic value: the ability to enjoy years of good health, like the ability to acquire knowledge and culture, is one of the fundamental purposes of civilization.3 We are free to imagine an ideal society in which all other tasks are almost totally automated and each individual has as much freedom as possible to pursue the goods of education, culture, and health for the benefit of herself and others. Everyone would be by turns teacher or student, writer or reader, actor or spectator, doctor or patient. As noted in Chapter 2, we are to some extent already on this path: a characteristic feature of modern growth is the considerable share of both output and employment devoted to education, culture, and medicine.

The payment of a monthly rather than a daily wage was a revolutionary innovation that gradually took hold in all the developed countries during the twentieth century. This innovation was inscribed in law and became a feature of wage negotiations between workers and employers. The daily wage, which had been the norm in the nineteenth century, gradually disappeared. This was a crucial step in the constitution of the working class: workers now enjoyed a legal status and received a stable, predictable remuneration for their work. This clearly distinguished them from day laborers and piece workers—the typical employees of the eighteenth and nineteenth centuries.

To sum up: the best way to increase wages and reduce wage inequalities in the long run is to invest in education and skills. Over the long run, minimum wages and wage schedules cannot multiply wages by factors of five or ten: to achieve that level of progress, education and technology are the decisive forces. Nevertheless, the rules of the labor market play a crucial role in wage setting during periods of time determined by the relative progress of education and technology. In practice, those periods can be fairly long, in part because it is hard to gauge individual marginal productivities with any certainty, and in part because of the problem of specific investments and imperfect competition.

This very sharp discontinuity at the top income levels is a problem for the theory of marginal productivity: when we look at the changes in the skill levels of different groups in the income distribution, it is hard to see any discontinuity between “the 9 percent” and “the 1 percent,” regardless of what criteria we use: years of education, selectivity of educational institution, or professional experience. One would expect a theory based on “objective” measures of skill and productivity to show relatively uniform pay increases within the top decile, or at any rate increases within different subgroups much closer to one another than the widely divergent increases we observe in practice.

I begin with the English-speaking countries. Broadly speaking, the rise of the supermanager is largely an Anglo-Saxon phenomenon. Since 1980 the share of the upper centile in national income has risen significantly in the United States, Great Britain, Canada, and Australia

If the rise of the supermanager were a purely technological phenomenon, it would be difficult to understand why such large differences exist between otherwise quite similar countries.

The divergence between the various regions of the wealthy world is all the more striking because technological change has been the same more or less everywhere: in particular, the revolution in information technology has affected Japan, Germany, France, Sweden, and Denmark as much as the United States, Britain, and Canada. Similarly, economic growth—or, more precisely, growth in output per capita, which is to say, productivity growth—has been quite similar throughout the wealthy countries, with differences of a few tenths of a percentage point.21 In view of these facts, this quite large divergence in the way the income distribution has evolved in the various wealthy countries demands an explanation, which the theory of marginal productivity and of the race between technology and education does not seem capable of providing.

Is it really the case that inequality of individual skills and productivities is greater in the United States today than in the half-illiterate India of the recent past (or even today) or in apartheid (or postapartheid) South Africa? If that were the case, it would be bad news for US educational institutions, which surely need to be improved and made more accessible but probably do not deserve such extravagant blame.

It is also possible that the explosion of top incomes can be explained as a form of “meritocratic extremism,” by which I mean the apparent need of modern societies, and especially US society, to designate certain individuals as “winners” and to reward them all the more generously if they seem to have been selected on the basis of their intrinsic merits rather than birth or background. (I will come back to this point.)

The most convincing proof of the failure of corporate governance and of the absence of a rational productivity justification for extremely high executive pay is that when we collect data about individual firms (which we can do for publicly owned corporations in all the rich countries), it is very difficult to explain the observed variations in terms of firm performance.

If executive pay were determined by marginal productivity, one would expect its variance to have little to do with external variances and to depend solely or primarily on nonexternal variances. In fact, we observe just the opposite: it is when sales and profits increase for external reasons that executive pay rises most rapidly. This is particularly clear in the case of US corporations: Bertrand and Mullainhatan refer to this phenomenon as “pay for luck.”

The emergence of this middle class is no doubt the most important structural transformation to affect the wealth distribution over the long run.

In the United States, the twentieth century is not synonymous with a great leap forward in social justice. Indeed, inequality of wealth there is greater today than it was at the beginning of the nineteenth century.

Note, however, that the principal shortcoming of Figure 10.11 is that it relies on the assumption that no significant political reaction will alter the course of capitalism and financial globalization over the course of the next two centuries. Given the tumultuous history of the past century, this is a dubious and to my mind not very plausible hypothesis, precisely because its inegalitarian consequences would be considerable and would probably not be tolerated indefinitely.

To sum up: the inequality r > g has clearly been true throughout most of human history, right up to the eve of World War I, and it will probably be true again in the twenty-first century. Its truth depends, however, on the shocks to which capital is subject, as well as on what public policies and institutions are put in place to regulate the relationship between capital and labor.

To recap: the inequality r > g is a contingent historical proposition, which is true in some periods and political contexts and not in others. From a strictly logical point of view, it is perfectly possible to imagine a society in which the growth rate is greater than the return on capital—even in the absence of state intervention. Everything depends on the one hand on technology (what is capital used for?) and on the other on attitudes toward saving and property (why do people choose to hold capital?). As noted, it is perfectly possible to imagine a society in which capital has no uses (other than to serve as a pure store of value, with a return strictly equal to zero), but in which people would choose to hold a lot of it, in anticipation, say, of some future catastrophe or grand potlatch or simply because they are particularly patient and take a generous attitude toward future generations. If, moreover, productivity growth in this society is rapid, either because of constant innovation or because the country is rapidly catching up with more technologically advanced countries, then the growth rate may very well be distinctly higher than the rate of return on capital. In practice, however, there appears never to have been a society in which the rate of return on capital fell naturally and persistently to less than 2–3 percent, and the mean return we generally see (averaging over all types of investments) is generally closer to 4–5 percent (before taxes). In particular, the...

To my way of thinking, the inequality r > g should be analyzed as a historical reality dependent on a variety of mechanisms and not as an absolute logical necessity. It is the result of a confluence of forces, each largely independent of the others. For one thing, the rate of growth, g, tends to be structurally low (generally not much more than 1 percent a year once the demographic transition is complete and the country reaches the world technological frontier, where the pace of innovation is fairly slow). For another, the rate of return on capital, r, depends on many technological, psychological, social, and cultural factors, which together seem to result in a return of roughly 4–5 percent (in any event distinctly greater than 1 percent).

Note, moreover, the importance of demographic choices (the fewer children the rich choose to have, the more concentrated wealth becomes) and inheritance laws.

Interestingly, after considerable debate, Americans came to the same conclusion in the years after the Revolution: entails were forbidden, even in the South. As Thomas Jefferson famously put it, “the Earth belongs to the living.” And equipartition of estates among siblings became the legal default, that is, the rule that applied in the absence of an explicit will (although the freedom to make one’s will as one pleases still prevails in both the United States and Britain, in practice most estates are equally divided among siblings).

In other words, the reason why wealth today is not as unequally distributed as in the past is simply that not enough time has passed since 1945. This is no doubt part of the explanation, but by itself it is not enough.

Simple simulations show that a progressive estate tax can greatly reduce the top centile’s share of wealth over the long run.37 The differences between estate tax regimes in different countries can also help to explain international differences. For example, why have top capital incomes in Germany been more concentrated than in France since World War II, suggesting a higher concentration of wealth? Perhaps because the highest estate tax rate in Germany is no more than 15–20 percent, compared with 30–40 percent in France.

To sum up: the fact that wealth is noticeably less concentrated in Europe today than it was in the Belle Époque is largely a consequence of accidental events (the shocks of 1914–1945) and specific institutions such as taxation of capital and its income. If those institutions were ultimately destroyed, there would be a high risk of seeing inequalities of wealth close to those observed in the past or, under certain conditions, even higher.

Conversely, younger people, in particular those born in the 1970s and 1980s, have already experienced (to a certain extent) the important role that inheritance will once again play in their lives and the lives of their relatives and friends. For this group, for example, whether or not a child receives gifts from parents can have a major impact in deciding who will own property and who will not, at what age, and how extensive that property will be—in any case, to a much greater extent than in the previous generation. Inheritance is playing a larger part in their lives, careers, and individual and family choices than it did with the baby boomers.

In the nineteenth century, the average age of inheritance was just thirty; in the twenty-first century it will be somewhere around fifty.

It is interesting to note that the vast majority of gifts, today as in the nineteenth century, go to children, often in the context of a real estate investment, and they are given on average about ten years before the death of the donor (a gap that has remained relatively stable over time).

the fact remains that beyond a certain threshold, capital tends to reproduce itself and accumulates exponentially. The logic of r > g implies that the entrepreneur always tends to turn into a rentier.

And indeed, in the absence of modern technology, everything is very costly and takes time and above all staff.

Modern meritocratic society, especially in the United States, is much harder on the losers, because it seeks to justify domination on the grounds of justice, virtue, and merit, to say nothing of the insufficient productivity of those at the bottom.

In other words, nearly one-sixth of each cohort will receive an inheritance larger than the amount the bottom half of the population earns through labor in a lifetime. (And this group largely coincides with the half of the population that inherits next to nothing.).54 Of course, there is nothing to prevent the inheriting sixth from acquiring diplomas or working and no doubt earning more through work than the bottom half of the income distribution. This is nevertheless a fairly disturbing form of inequality, which is in the process of attaining historically unprecedented heights. It is also more difficult to represent artistically or to correct politically, because it is a commonplace inequality opposing broad segments of the population rather than pitting a small elite against the rest of society.

According to Forbes, the planet was home to just over 140 billionaires in 1987 but counts more than 1,400 today (2013), an increase by a factor of 10 (see Figure 12.1). In view of inflation and global economic growth since 1987, however, these spectacular numbers, repeated every year by media around the world, are difficult to interpret. If we look at the numbers in relation to the global population and total private wealth, we obtain the following results, which make somewhat more sense. The planet boasted barely 5 billionaires per 100 million adults in 1987 and 30 in 2013.

To be frank, I know virtually nothing about exactly how Carlos Slim or Bill Gates became rich, and I am quite incapable of assessing their relative merits. Nevertheless, it seems to me that Bill Gates also profited from a virtual monopoly on operating systems (as have many other high-tech entrepreneurs in industries ranging from telecommunications to Facebook, whose fortunes were also built on monopoly rents). Furthermore, I believe that Gates’s contributions depended on the work of thousands of engineers and scientists doing basic research in electronics and computer science, without whom none of his innovations would have been possible. These people did not patent their scientific papers. In short, it seems unreasonable to draw such an extreme contrast between Gates and Slim without so much as a glance at the facts.

Broadly speaking, the central fact is that the return on capital often inextricably combines elements of true entrepreneurial labor (an absolutely indispensable force for economic development), pure luck (one happens at the right moment to buy a promising asset at a good price), and outright theft.

There are currently more than eight hundred public and private universities in the United States that manage their own endowments. These endowments range from some tens of millions of dollars (for example, North Iowa Community College, ranked 785th in 2012 with an endowment of $11.5 million) to tens of billions. The top-ranked universities are invariably Harvard (with an endowment of some $30 billion in the early 2010s), Yale ($20 billion), and Princeton and Stanford (more than $15 billion). Then come MIT and Columbia, with a little less than $10 billion, then Chicago and Pennsylvania, at around $7 billion, and so on. All told, these eight hundred US universities owned nearly $400 billion worth of assets in 2010 (or a little under $500 million per university on average, with a median slightly less than $100 million).

The higher we go in the endowment hierarchy, the more often we find “alternative investment strategies,” that is, very high yield investments such as shares in private equity funds and unlisted foreign stocks (which require great expertise), hedge funds, derivatives, real estate, and raw materials, including energy, natural resources, and related products (these, too, require specialized expertise and offer very high potential yields).

In other words, the higher returns of the largest endowments are not due primarily to greater risk taking but to a more sophisticated investment strategy that consistently produces better results.

These results are striking, because they illustrate in a particularly clear and concrete way how large initial endowments can give rise to better returns and thus to substantial inequalities in returns on capital. These high returns largely account for the prosperity of the most prestigious US universities. It is not alumni gifts, which constitute a much smaller flow: just one-tenth to one-fifth of the annual return on endowment.

Some people think, wrongly, that inflation reduces the average return on capital. This is false, because the average asset price (that is, the average price of real estate and financial securities) tends to rise at the same pace as consumer prices.

The Norwegian sovereign wealth fund, which alone was worth more than 700 billion euros in 2013 (twice as much as all US university endowments combined), publishes the most detailed financial reports.

According to available (and notoriously imperfect) estimates, sovereign wealth funds in 2013 had total investments worth a little over $5.3 trillion, of which about $3.2 trillion belongs to the funds of petroleum exporting states (including, in addition to those mentioned above, the smaller funds of Dubai, Libya, Kazakhstan, Algeria, Iran, Azerbaijan, Brunei, Oman, and many others), and approximately $2.1 trillion to funds of nonpetroleum states (primarily China, Hong Kong, Singapore, and many smaller funds).41 For reference, note that this is almost exactly the same total wealth as that represented by the Forbes billionaires (around $5.4 trillion in 2013).

To sum up, petroleum rents might well enable the oil states to buy the rest of the planet (or much of it) and to live on the rents of their accumulated capital.

One major lesson is already clear: it was the wars of the twentieth century that, to a large extent, wiped away the past and transformed the structure of inequality. Today, in the second decade of the twenty-first century, inequalities of wealth that had supposedly disappeared are close to regaining or even surpassing their historical highs.

As I have already noted, the ideal policy for avoiding an endless inegalitarian spiral and regaining control over the dynamics of accumulation would be a progressive global tax on capital. Such a tax would also have another virtue: it would expose wealth to democratic scrutiny, which is a necessary condition for effective regulation of the banking system and international capital flows. A tax on capital would promote the general interest over private interests while preserving economic openness and the forces of competition.

The main reason why the crisis of 2008 did not trigger a crash as serious as the Great Depression is that this time the governments and central banks of the wealthy countries did not allow the financial system to collapse and agreed to create the liquidity necessary to avoid the waves of bank failures that led the world to the brink of the abyss in the 1930s.

The pragmatic response to the crisis also reminded the world that central banks do not exist just to twiddle their thumbs and keep down inflation. In situations of total financial panic, they play an indispensable role as lender of last resort—indeed, they are the only public institution capable of averting a total collapse of the economy and society in an emergency. That said, central banks are not designed to solve all the world’s problems. The pragmatic policies adopted after the crisis of 2008 no doubt avoided the worst, but they did not really provide a durable response to the structural problems that made the crisis possible, including the crying lack of financial transparency and the rise of inequality.

two-thirds of retirees (and generally three-quarters). Despite the defects of these public pensions systems and the challenges they now face, the fact is that without them it would have been impossible to eradicate poverty among the elderly, which was endemic as recently as the 1950s.