Capital in the Twenty-First Century

by Thomas Piketty

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 the 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.

But to reach the stratosphere of “the 1 percent” and enjoy an income several tens of times greater than average (hundreds of thousands if not millions of euros per year), such a strategy is unlikely to be enough. A person who owns substantial amounts of assets is more likely to reach the top of the income hierarchy.

Each way of looking at the matter is legitimate and important in its own right, and to my mind it is essential to keep all of these different time scales in mind: the long term is important, but so are the short and the medium term.

Generally speaking, inequality tends to evolve “procyclically” (that is, it moves in the same direction as the economic cycle, in contrast to “countercyclical” changes). In economic booms, the share of profits in national income tends to increase, and pay at the top end of the scale (including incentives and bonuses) often increases more than wages toward the bottom and middle.

Looking at evolutions without capital gains also allows us to identify the structural character of the increase of inequality in the United States more clearly. In fact, from the late 1970s to 2010, the increase in the upper decile’s share (exclusive of capital gains) appears to have been relatively steady and constant: it passed 35 percent in the 1980s, then 40 percent in the 1990s, and finally 45 percent in the 2000s

Quite obviously, if the increase in inequality had been accompanied by exceptionally strong growth of the US economy, things would look quite different. Unfortunately, this was not the case: the economy grew rather more slowly than in previous decades, so that the increase in inequality led to virtual stagnation of low and medium incomes.

The emergence of a “patrimonial middle class” is a crucial issue for this study, because it largely explains why income inequality decreased during the first half of the twentieth century and why we in the developed countries have gone from a society of rentiers to a society of managers (or, in the less optimistic version, from a society of superrentiers to a somewhat less extreme form of rentier society).

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.

The demand for skills depends on, among other things, the state of the technologies available to produce the goods and services that society consumes. No matter what other forces may be involved, it seems clear that these two factors—the state of the training system on the one hand, the state of technology on the other—play a crucial role. At a minimum, they influence the relative power of different social groups.

The educational system is shaped by public policy, criteria of selection for different tracks, the way it is financed, the cost of study for students and their families, and the availability of continuing education. Technological progress depends on the pace of innovation and the rapidity of implementation. It generally increases the demand for new skills and creates new occupations. This leads to the idea of a race between education and technology: if the supply of skills does not increase at the same pace as the needs of technology, then groups whose training is not sufficiently advanced will earn less and be relegated to devalued lines of work, and inequality with respect to labor will increase.

In order to avoid this, the educational system must increase its supply of new types of training and its output of new sk...

Education and technology definitely play a crucial role in the long run. This theoretical model, based on the idea that a worker’s wage is always perfectly determined by her marginal productivity and thus primarily by skill, is nevertheless limited in a number of ways. Leave aside the fact that it is not always enough to invest in training: existing technology is sometimes unable to make use of the available supply of skills. Leave aside, too, the fact that this theoretical model, at least in its most simplistic form, embodies a far too instrumental and utilitarian view of training.

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.

In order to understand the dynamics of wage inequality, we must introduce other factors, such as the institutions and rules that govern the operation of the labor market in each society. To an even greater extent than other markets, the labor market is not a mathematical abstraction whose workings are entirely determined by natural and immutable mechanisms and implacable technological forces: it is a social construct based on specific rules and compromises.

Concretely, the particular functions and tasks that a firm needs to be performed often require workers to make specific investments in the firm, in the sense that these investments are of no (or limited) value to other firms: for instance, workers might need to learn specific work methods, organizational methods, or skills linked to the firm’s production process.

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.

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.

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. Let me turn now to the rest of the wealthy world, namely, continental Europe and Japan. The key fact is that the upper centile’s share of national income in these countries has increased much less than in the English-speaking countries since 1980.

If we calculate (somewhat abusively) an average for Europe based on these four countries, we can make a very clear international comparison: the United States was less inegalitarian than Europe in 1900–1910, slightly more inegalitarian in 1950–1960, and much more inegalitarian in 2000–2010

As noted, the vast majority of top earners are senior managers of large firms. It is rather naïve to seek an objective basis for their high salaries in individual “productivity.” When a job is replicable, as in the case of an assembly-line worker or fast-food server, we can give an approximate estimate of the “marginal product” that would be realized by adding one additional worker or waiter (albeit with a considerable margin of error in our estimate). But when an individual’s job functions are unique, or nearly so, then the margin of error is much greater. Indeed, once we introduce the hypothesis of imperfect information into standard economic models (eminently justifiable in this context), the very notion of “individual marginal productivity” becomes hard to define. In fact, it becomes something close to a pure ideological construct on the basis of which a justification for higher status can be elaborated.

It is only reasonable to assume that people in a position to set their own salaries have a natural incentive to treat themselves generously, or at the very least to be rather optimistic in gauging their marginal productivity. To behave in this way is only human, especially since the necessary information is, in objective terms, highly imperfect. It may be excessive to accuse senior executives of having their “hands in the till,” but the metaphor is probably more apt than Adam Smith’s metaphor of the market’s “invisible hand.” In practice, the invisible hand does not exist, any more than “pure and perfect” competition does, and the market is always embodied in specific institutions such as corporate hierarchies and compensation committees.

Executive compensation of several million euros a year is still more shocking today in Sweden, Germany, France, Japan, and Italy than in the United States or Britain. It has not always been this way—far from it: recall that in the 1950s and 1960s the United States was more egalitarian than France, especially in regard to the wage hierarchy. But it has been this way since 1980, and all signs are that this change in senior management compensation has played a key role in the evolution of wage inequalities around the world.

In any case, the extremely generous rewards meted out to top managers can be a powerful force for divergence of the wealth distribution: if the best paid individuals set their own salaries, (at least to some extent), the result may be greater and greater inequality. It is very difficult to say in advance where such a process might end.

Several important differences between the European and US trajectories stand out. First, it appears that inequality of wealth in the United States around 1800 was not much higher than in Sweden in 1970–1980. Since the United States was a new country whose population consisted largely of immigrants who came to the New World with little or no wealth, this is not very surprising: not enough time had passed for wealth to be accumulated or concentrated. The data nevertheless leave much to be desired, and there is some variation between the northern states (where estimates suggest a level of inequality lower than that of Sweden in 1970–1980) and southern states (where inequality was closer to contemporary European levels).

This is part of the explanation for the great wave of enthusiasm that swept over Europe in the period 1945–1975. People felt that capitalism had been overcome and that inequality and class society had been relegated to the past. It also explains why Europeans had a hard time accepting that this seemingly ineluctable social progress ground to a halt after 1980, and why they are still wondering when the evil genie of capitalism will be put back in its bottle.

In the United States, perceptions are very different. In a sense, a (white) patrimonial middle class already existed in the nineteenth century. It suffered a setback during the Gilded Age, regained its health in the middle of the twentieth century, and then suffered another setback after 1980. This “yo-yo” pattern is reflected in the history of US taxation. In the United States, the twentieth century is not synonymous with a great leap forward in social justice. Indeed, inequality of wealth is greater today than it was at the beginning of the nineteenth century. Hence the lost US paradise is associated with the country’s beginnings: there is nostalgia for the era of the Boston Tea Party, not for Trente Glorieuses and a heyday of state intervention to curb the excesses of capitalism.

The primary reason for the hyperconcentration of wealth in traditional agrarian societies and to a large extent in all societies prior to World War I (with the exception of the pioneer societies of the New World, which are for obvious reasons very special and not representative of the rest of the world or the long run) is that these were low-growth societies in which the rate of return on capital was markedly and durably higher than the rate of growth.

Concretely, this means that wealth accumulated in the past is recapitalized much more quickly than the economy grows, even when there is no income from labor.

If one saves more, because one’s fortune is large enough to live well while consuming somewhat less of one’s annual rent, then one’s fortune will increase more rapidly than the economy, and inequality of wealth will tend to increase even if one contributes no income from labor.

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.

In particular, the return on agricultural land in traditional societies, like the return on real estate in today’s societies—these being the most common and least risky forms of investment in each case—is generally around 4–5 percent, with perhaps a slight downward trend over the very long run (to 3–4 percent rather than 4–5). The economic model generally used to explain this relative stability of the return on capital at around 4–5 percent (as well as the fact that it never falls below 2–3 percent) is based on the notion of “time preference” in favor of the present. In other words, economic actors are characterized by a rate of time preference (usually denoted θ) that measures how impatient they are and how they take the future into account.

All other things equal, a more patient society, or one that anticipates future shocks, will of course amass greater reserves and accumulate more capital. Similarly, if a society accumulates so much capital that the return on capital is persistently low, say, 1 percent a year (or in which all forms of wealth, including the property of the middle and lower classes, are taxed so that the net return is very low), then a significant proportion of property-owning individuals will seek to sell their homes and financial assets, thus decreasing the capital stock until the yield rises.

Another difficulty with this theoretical model (in its strictest interpretation) is that it implies that the rate of return on capital, r, must, in order to maintain the economy in equilibrium, rise very rapidly with the growth rate g, so that the gap between r and g should be greater in a rapidly growing economy than in one that is not growing at all.

It is important to understand that the new law was based not only on a principle of equality (younger children were valued as much as the eldest and protected from the whims of the parents) but also on a principle of liberty and economic efficiency.

As I mentioned a moment ago, there are always economic and demographic shocks that affect the trajectories of individual family fortunes. With the aid of a fairly simple mathematical model, one can show that for a given structure of shocks of this kind, the distribution of wealth tends toward a long-run equilibrium and that the equilibrium level of inequality is an increasing function of the gap r − g between the rate of return on capital and the growth rate. Intuitively, the difference r − g measures the rate at which capital income diverges from average income if none of it is consumed and everything is reinvested in the capital stock. The greater the difference r − g, the more powerful the divergent force.

In Paris, where the Napoleonic Civil Code came into effect in 1804 and where inequality cannot be laid at the door of British aristocrats and the queen of England, the top centile owned more than 70 percent of total wealth in 1913, even more than in Britain. The reality was so striking that it even found expression in an animated cartoon, The Aristocats, set in Paris in 1910. The size of the old lady’s fortune is not mentioned, but to judge by the splendor of her residence and by the zeal of her butler Edgar to get rid of Duchesse and her three kittens, it must have been considerable.

Seeking to find out how rapidly the number of taxpayers decreases as one climbs higher in the income hierarchy, Pareto discovered that the rate of decrease could be approximated by a mathematical law that subsequently became known as “Pareto’s law” or, alternatively, as an instance of a general class of functions known as “power laws.”31 Indeed, this family of functions is still used today to study distributions of wealth and income. Note, however, that the power law applies only to the upper tail of these distributions and that the relation is only approximate and locally valid. It can nevertheless be used to model processes due to multiplicative shocks, like those described earlier.

In the first case, the top centile of the income hierarchy is very clearly dominated by top capital incomes: this is the society of rentiers familiar to nineteenth-century novelists. In the second case, top earned incomes (for a given distribution) roughly balance top capital incomes (we are now in a society of managers, or at any rate a more balanced society). Similarly, the emergence of a “patrimonial middle class” owning between a quarter and a third of national wealth rather than a tenth or a twentieth (scarcely more than the poorest half of society) represents a major social transformation.

Fortunately, Duchesse and her kittens ultimately meet Thomas O’Malley, an alley cat whose earthy ways they find more amusing than art classes (a little like Jack Dawson, who meets young Rose on the deck of Titanic two years later, in 1912).

It may be that the global level of capital has remained the same but that its deep structure has changed dramatically, in the sense that capital was once largely inherited but is now accumulated over the course of a lifetime by savings from earned income. One possible explanation for such a change might be increased life expectancy, which might have led to a structural increase in the accumulation of capital in anticipation of retirement. However, this supposed great transformation in the nature of capital was actually less dramatic than is sometimes thought; indeed, in some countries it did not occur at all. In all likelihood, inheritance will again play a significant role in the twenty-first century, comparable to its role in the past.

In the public mind, the idea that the age of inheritance was over was certainly even more influential than the idea of an end of capitalism. In 1950–1960, bequests and gifts accounted for just a few points of national income, so it was reasonable to think that inheritances had virtually disappeared and that capital, though less important overall than in the past, was now wealth that an individual accumulated by effort and saving during his or her lifetime. Several generations grew up under these conditions (even if perceptions somewhat exceeded reality), in particular the baby boom generation, born in the late 1940s and early 1950s, many of whom are still alive today, and it was natural for them to assume that this was the “new normal.”

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. The rebound of inheritance is still incomplete, however, and the evolution is still under way (the inheritance flow in 2000–2010 stood at a point roughly midway between the nadir of the 1950s and the peak of 1900–1910). To date, it has had a less profound impact on perceptions than the previous change, which still dominates people’s thinking. A few decades from now, things may be very different.

In fact, the main advantage of the economic flow approach is that it requires us to take a comprehensive view of the three forces that everywhere determine the flow of inheritance and its historical evolution. In general, the annual economic flow of inheritances and gifts, expressed as a proportion of national income that we denote by , is equal to the product of three forces: by = μ × m × β, where β is the capital / income ratio (or, more precisely, the ratio of total private wealth, which, unlike public assets, can be passed on by inheritance, to national income), m is the mortality rate, and μ is the ratio of average wealth at time of death to average wealth of living individuals.

Let me examine the three forces one by one. The first is the capital / income ratio β. This force expresses a truism: if the flow of inherited wealth is to be high in a given society, the total stock of private wealth capable of being inherited must also be large. The second force, the mortality rate m, describes an equally transparent mechanism. All other things being equal, the higher the mortality rate, the higher the inheritance flow. In a society where everyone lives forever, so that the mortality rate is exactly zero, inheritance must vanish. The inheritance flow by must also be zero, no matter how large the capital / income ratio β is. The third force, the ratio μ of average wealth at time of death to average wealth of living individuals, is equally transparent.4 Suppose that the average wealth at time of death is the same as the average wealth of the population as a whole. Then μ = 1, and the inheritance flow by is simply the product of the mortality rate m and the capital / income ratio β.

For partly technological reasons, capital still plays a central role in production today, and therefore in social life. Before production can begin, funds are needed for equipment and office space, to finance material and immaterial investments of all kinds, and of course to pay for housing. To be sure, the level of human skill and competence has increased over time, but the importance of nonhuman capital has increased proportionately.

The second force that might explain the natural end of inheritance is increased life expectancy, which lowers the mortality rate m and increases the time to inheritance (which decreases the size of the legacy). Indeed, there is no doubt that the mortality rate has decreased over the long run: the proportion of the population that dies each year is smaller when the life expectancy is eighty than when it is sixty. Other things being equal, for a given β and μ, a society with a lower mortality rate is also a society in which the flow of inheritance is a smaller proportion of national income. In France, the mortality rate has declined inexorably over the course of history, and the same is true of other countries. The French mortality rate was around 2.2 percent (of the adult population) in the nineteenth century but declined steadily throughout the twentieth century,8 dropping to 1.1–1.2 percent in 2000–2010, a decrease of almost one-half in a century

For one thing, the mortality rate began to rise again in France in 2000–2010, and according to official demographic forecasts this increase is likely to continue until 2040–2050, after which adult mortality should stabilize at around 1.4–1.5 percent. The explanation for this is that the baby boomers, who outnumber previous cohorts (but are about the same size as subsequent ones), will reach the end of their life spans in this period.9 In other words, the baby boom, which led to a structural increase in the size of birth cohorts, temporarily reduced the mortality rate simply because the population grew younger and larger.

the growing importance of gifts between living individuals has partly compensated for this aging effect, and in part because it may be that people are inheriting later but receiving larger amounts, since wealth tends to age in an aging society. In other words, the downward trend in the mortality rate—ineluctable in the very long run—can be compensated by a similar structural increase in the relative wealth of older people, so that the product μ × m remains unchanged or in any case falls much more slowly than some have believed.

To sum up: inheritance occurs later in aging societies, but wealth also ages, and the latter tends to compensate the former. In this sense, a society in which people die older is very different from a society in which they don’t die at all and inheritance effectively vanishes. Increased life expectancy delays important life events: people study longer, start work later, inherit later, retire later, and die later. But the relative importance of inherited wealth as opposed to earned income does not necessarily change, or at any rate changes much less than people sometimes imagine. To be sure, inheriting later in life may make choosing a profession more frequently necessary than in the past. But this is compensated by the inheritance of larger amounts or by the receipt of gifts. In any case, the difference is more one of degree than the dramatic change of civilization that is sometimes imagined.

Recall that according to Modigliani’s life-cycle theory, the primary reason for amassing wealth, especially in aging societies, is to pay for retirement, so that older individuals should consume most of their savings during old age and should therefore die with little or no wealth. This is the famous “Modigliani triangle,” taught to all students of economics, according to which wealth at first increases with age as individuals accumulate savings in anticipation of retirement and then decreases. The ratio μ should therefore be equal to zero or close to it, in any case much less than 100 percent. But this theory of capital and its evolution in advanced societies, which is perfectly plausible a priori, cannot explain the observed facts—to put it mildly. Clearly, saving for retirement is only one of many reasons—and not the most important reason—why people accumulate wealth: the desire to perpetuate the family fortune has always played a central role.