Capital in the Twenty-First Century

by Thomas Piketty

By comparing various sources of data, moreover, it is possible to estimate that the average income of the parents of Harvard students is currently about $450,000, which corresponds to the average income of the top 2 percent of the US income hierarchy.

Tuition fees create an unacceptable inequality of access, but they foster the independence, prosperity, and energy that make US universities the envy of the world.

In the United States, France, and most other countries, talk about the virtues of the national meritocratic model is seldom based on close examination of the facts. Often the purpose is to justify existing inequalities while ignoring the sometimes patent failures of the current system. In 1872, Emile Boutmy created Sciences Po with a clear mission in mind: “obliged to submit to the rule of the majority, the classes that call themselves the upper classes can preserve their political hegemony only by invoking the rights of the most capable. As traditional upper-class prerogatives crumble, the wave of democracy will encounter a second rampart, built on eminently useful talents, superiority that commands prestige, and abilities of which society cannot sanely deprive itself.”

In PAYGO schemes, based on the principle of intergenerational solidarity (today’s workers pay benefits to today’s retirees in the hope that their children will pay their benefits tomorrow), the rate of return is by definition equal to the growth rate of the economy: the contributions available to pay tomorrow’s retirees will rise as average wages rise. In theory, this also implies that today’s active workers have an interest in ensuring that average wages rise as rapidly as possible. They should therefore invest in schools and universities for their children and promote a higher birth rate. In other words, there exists a bond among generations that in principle makes for a virtuous and harmonious society.

This illustrates a more general phenomenon: the tendency of the rich countries to use the less developed world as a field of experimentation, without really seeking to capitalize on the lessons of their own historical experience.

Without taxes, society has no common destiny, and collective action is impossible. This has always been true. At the heart of every major political upheaval lies a fiscal revolution.

In November 1938, Josiah Wedgwood, in the preface to a new edition of his classic 1929 book on inheritance, agreed with his compatriot Bertrand Russell that the “plutodemocracies” and their hereditary elites had failed to stem the rise of fascism. He was convinced that “political democracies that do not democratize their economic systems are inherently unstable.” In his eyes, a steeply progressive inheritance tax was the main tool for achieving the economic democratization that he believed to be necessary.

After 1980, the game was utterly transformed, however, and the evidence suggests that executives went to considerable lengths to persuade other interested parties to grant them substantial raises. Because it is objectively difficult to measure individual contributions to a firm’s output, top managers found it relatively easy to persuade boards and stockholders that they were worth the money, especially since the members of compensation committees were often chosen in a rather incestuous manner.

The ideal tool would be a progressive global tax on capital, coupled with a very high level of international financial transparency.

The primary purpose of the capital tax is not to finance the social state but to regulate capitalism. The goal is first to stop the indefinite increase of inequality of wealth, and second to impose effective regulation on the financial and banking system in order to avoid crises. To achieve these two ends, the capital tax must first promote democratic and financial transparency: there should be clarity about who owns what assets around the world.

No one has the right to set his own tax rates. It is not right for individuals to grow wealthy from free trade and economic integration only to rake off the profits at the expense of their neighbors. That is outright theft.

Nevertheless, another classic argument in favor of a capital tax should not be neglected. It relies on a logic of incentives. The basic idea is that a tax on capital is an incentive to seek the best possible return on one’s capital stock. Concretely, a tax of 1 or 2 percent on wealth is relatively light for an entrepreneur who manages to earn 10 percent a year on her capital. By contrast, it is quite heavy for a person who is content to park her wealth in investments returning at most 2 or 3 percent a year. According to this logic, the purpose of the tax on capital is thus to force people who use their wealth inefficiently to sell assets in order to pay their taxes, thus ensuring that those assets wind up in the hands of more dynamic investors. There is some validity to this argument, but it should not be overstated.17 In practice, the return on capital does not depend solely on the talent and effort supplied by the capitalist. For one thing, the average return varies systematically with the size of the initial fortune. For another, individual returns are largely unpredictable and chaotic and are affected by all sorts of economic shocks.

In Russia, to be sure, an oligarch must take care not to tangle with the president, which can land him in prison. But if he can avoid such trouble, he can apparently live quite well on wealth derived from exploitation of Russia’s natural resources. In China things seem to be controlled more tightly.

Once currency ceases to be convertible into precious metals, however, the power of central banks to create money is potentially unlimited and must therefore be strictly regulated. This is the crux of the debate about central bank independence as well as the source of numerous misunderstandings.

Since then, everyone agrees that the primary function of central banking is to ensure the stability of the financial system, which requires central banks to assume the role of “lenders of last resort”: in case of absolute panic, they must create the liquidity necessary to avoid a broad collapse of the financial system.

create liquidity = bleed money

From this analysis, Friedman drew a clear political conclusion: in order to ensure regular, undisrupted growth in a capitalist economy, it is necessary and sufficient to make sure that monetary policy is designed to ensure steady growth of the money supply.

What in fact do central banks do? For present purposes, it is important to realize that central banks do not create wealth as such; they redistribute it. More precisely, when the Fed or the ECB decides to create a billion additional dollars or euros, US or European capital is not augmented by that amount. In fact, national capital does not change by a single dollar or euro, because the operations in which central banks engage are always loans. They therefore result in the creation of financial assets and liabilities, which, at the moment they are created, exactly balance each other. For example, the Fed might lend $1 billion to Lehman Brothers or General Motors (or the US government), and these entities contract an equivalent debt. The net wealth of the Fed and Lehman Brothers (or General Motors) does not change at all, nor, a fortiori, does that of the United States or the planet.

What happens next depends on how this monetary policy influences the real economy. If the loan initiated by the central bank enables the recipient to escape from a bad pass and avoid a final collapse (which might decrease the national wealth), then, when the situation has been stabilized and the loan repaid, it makes sense to think that the loan from the Fed increased the national wealth (or at any rate prevented national wealth from decreasing). On the other hand, if the loan from the Fed merely postpones the recipient’s inevitable collapse and even prevents the emergence of a viable competitor (which can happen), one can argue that the Fed’s policy ultimately decreased the nation’s wealth. Both outcomes are possible, and every monetary policy raises both possibilities to one degree or another.

The major innovation since 2008 has been in the duration of loans to private banks. Instead of lending for a few days, the Fed and ECB began lending for three to six months: the volume of loans of these durations increased dramatically in the last quarter of 2008 and the first quarter of 2009.

The fact that governments in the wealthiest countries (United States, Japan, Germany, France, and Britain) could borrow at exceptionally low rates (just over 1 percent) in 2012–2013 attests to the importance of central bank stabilization policies, but it also shows that private investors have no clear idea of what to do with the money lent by the monetary authorities at rates close to zero. Hence they prefer to lend their cash back to the governments deemed the most solid at ridiculously low interest rates. The fact that rates are very low in some countries and much higher in others is the sign of an abnormal economic situation.

If Europe created a stateless currency in 1992, it did so for reasons that were not simply pragmatic. It settled on this institutional arrangement in the late 1980s and early 1990s, at a time when many people believed that the only function of central banking was to control inflation. The “stagflation” of the 1970s had convinced governments and people that central banks ought to be independent of political control and target low inflation as their only objective. That is why Europe created a currency without a state and a central bank without a government. The crisis of 2008 shattered this static vision of central banking, as it became apparent that in a serious economic crisis central banks have a crucial role to play and that the existing European institutions were wholly unsuited to the task at hand.

As I noted earlier, debt often becomes a backhanded form of redistribution of wealth from the poor to the rich, from people with modest savings to those with the means to lend to the government (who as a general rule ought to be paying taxes rather than lending).

Private wealth rests on public poverty, and one particularly unfortunate consequence of this is that we currently spend far more in interest on the debt than we invest in higher education. This has been true, moreover, for a very long time: because growth has been fairly slow since 1970, we are in a period of history in which debt weighs very heavily on our public finances.

William Nordhaus, an American, argued that one ought to choose a discount rate closer to the average return on capital (4–4.5 percent a year), a choice that makes future disasters seem much less worrisome. In other words, even if everyone agrees about the cost of future disasters (despite the obvious uncertainties), they can reach different conclusions. For Stern, the loss of global well-being is so great that it justifies spending at least 5 points of global GDP a year right now to attempt to mitigate climate change in the future. For Nordhaus, such a large expenditure would be entirely unreasonable, because future generations will be richer and more productive than we are. They will find a way to cope, even if it means consuming less, which will in any case be less costly from the standpoint of universal well-being than making the kind of effort Stern envisions. So in the end, all of these expert calculations come down to a stark difference of opinion.

If democracy is someday to regain control of capitalism, it must start by recognizing that the concrete institutions in which democracy and capitalism are embodied need to be reinvented again and again.