Capital in the Twenty-First Century

by Thomas Piketty

As Figure 10.9 shows, the pure rate of return on capital—generally 4–5 percent—has throughout history always been distinctly greater than the global growth rate, but the gap between the two shrank significantly during the twentieth century, especially in the second half of the century, when the global economy grew at a rate of 3.5–4 percent a year. In all likelihood, the gap will widen again in the twenty-first century as growth (especially demographic growth) slows.

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.

According to this theory, the reason why the return on capital has been historically stable at 4–5 percent is ultimately psychological: since this rate of return reflects the average person’s impatience and attitude toward the future, it cannot vary much from this level.

For example, if g = 1 percent and r = 5 percent, wealthy individuals have to reinvest only one-fifth of their annual capital income to ensure that their capital will grow faster than average income.

In British law this was the system of “entails” (the equivalent in French law being the system of substitution héréditaire under the Ancien Régime).

A more interesting case is that of Gini’s compatriot Vilfredo Pareto, whose major works, including a discussion of the famous “Pareto law,” were published between 1890 and 1910.

“Pareto’s law” or, alternatively, as an instance of a general class of functions known as “power laws.”

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.

why people accumulate wealth: the desire to perpetuate the family fortune has always played a central role. In practice, the various forms of annuitized wealth, which cannot be passed on to descendants, account for less than 5 percent of private wealth in France and at most

The growing importance of gifts since the 1970s has led to a decrease in the average age of the recipient: in 2000–2010, the average age of an heir is forty-five to fifty, while that of the recipient of a gift is thirty-five

To get a better idea of the sums involved, it may be useful to recall that household disposable (monetary) income is 70–75 percent of national income in a country like France today (after correcting for transfers in kind, such as health, education, security, public services, etc. not included in disposable income).

(Britons with means consume more of their wealth and pass on less to their children than their French and German counterparts)

is quite plausible to think that if the average return on capital is 4 percent, wealthier people might get as much as 6 or 7 percent, whereas less wealthy individuals might

have to make do with as little as 2 or 3 percent. Indeed, I will show in a moment that around the world, the largest fortunes (including inherited ones) have grown at very high rates in recent decades (on the order of 6–7 percent a year)—significantly higher than the average growth rate of wealth.

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 other words, Liliane Bettencourt, who never worked a day in her life, saw her fortune grow exactly as fast as that of Bill Gates, the high-tech pioneer, whose wealth has incidentally continued to grow just as rapidly since he stopped working.

according to a dynamic of its own, and it can continue to grow at a rapid pace for decades simply because of its size. Note, in particular, that once a fortune passes a certain threshold, size effects due to economies of scale in the management of the portfolio and opportunities for risk are reinforced by the fact that nearly all the income on this capital can be plowed back into investment.

There are currently more than eight hundred public and private universities in the United States that manage their own endowments.

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.

that the return on US university endowments has been extremely high in recent decades, averaging 8.2 percent a year between 1980 and 2010 (and 7.2 percent for the period 1990–2010).25 To be sure, there have been ups and downs in each decade, with years of low or even negative returns, such as 2008–2009, and good years in which the average endowment grew by more than 10 percent. But the important point is that if we average over ten, twenty, or thirty years, we find extremely high returns, of the same sort I examined for the billionaires in the Forbes rankings.

The second conclusion that emerges clearly from Table 12.2 is that the return increases rapidly with size of endowment. For the 500 of 850 universities whose endowment was less than $100 million, the average return was 6.2 percent in 1980–2010 (and 5.1 percent in 1990–2010), which is already fairly high and significantly above the average return on all private wealth in these periods.26 The greater the endowment, the greater the return. For the 60 universities with endowments of more than $1 billion, the average return was 8.8 percent in 1980–2010 (and 7.8 percent in 1990–2010). For the top trio (Harvard, Yale, and Princeton), which has not changed since 1980, the yield was 10.2 percent in 1980–2010 (and 10.0 percent in 1990–2010), twice as

I showed in Chapter 1, the rate of inflation in the wealthy countries has been stable at around 2 percent since the 1980s:

People sometimes believe that inflation is the enemy of the rentier and that this may in part explain why modern societies like inflation. This is partly true, in the sense that inflation forces people to pay some attention to their capital. When inflation exists, anyone who is content to perch on a pile of banknotes will see that pile melt away before his eyes, leaving him with nothing even if wealth is untaxed. In this respect, inflation is indeed a tax on the idle rich, or, more precisely, on wealth that is not invested. But as I have noted a number of times already, it is enough to invest one’s wealth in real assets, such as real estate or shares of stock, in order to escape the inflation tax entirely.

These size effects are particularly important in regard to real estate. In practice, this is the most important type of capital asset for the vast majority of the population. For most people, the simplest way to invest is to buy a home. This provides protection against inflation (since the price of housing generally rises at least as fast as the price of consumption), and it also allows the owner to avoid paying rent, which is equivalent to a real return on investment of 3–4 percent a year.

To sum up: the main effect of inflation is not to reduce the average return on capital but to redistribute it.

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 official documents, the average return on the Saudi sovereign wealth fund was no more than 2–3 percent, mainly because much of the money was invested in US Treasury bonds.

To be sure, US Treasuries offer an enviable guarantee of stability in an unstable world, and it is possible that the Saudi public has little taste for alternative investments. But the political and military aspects of the choice must also be taken into account: even though it is never stated explicitly, it is not illogical for Saudia Arabia to lend at low interest to the country that protects it militarily. To my knowledge, no one has ever attempted to calculate precisely the return on such an investment, but it seems clear that it is rather high.

and sovereign wealth funds own another 1.5 percent.

The annual rent derived from the exploitation of natural resources,

defined as the difference between receipts from sales and the cost of production, has been about 5 percent of global GDP since the mid-2000s

(half of which is petroleum rent and the rest rent on other natural resources, mainly gas, coal, minerals, and wood), compared with about 2 percent in the 1990s ...

For example, many people in France believe that rich foreign buyers are responsible for the skyrocketing price of Paris real estate. When one looks closely at who is buying what type of apartment, however, one finds that the increase in the number of foreign (or foreign-resident) buyers can explain barely 3 percent of the price increase. In other words, 97 percent of today’s very high real estate prices are due to the fact that there are enough French buyers residing in France who are prosperous enough to pay such large amounts for property.51

if one adds up the financial statistics for the various countries of the world, one finds that the poor countries also have a negative position and that the world as a whole is in a substantially negative situation.

By comparing all the available sources and exploiting previously unused Swiss bank data, Gabriel Zucman was able to show that the most plausible reason for the discrepancy is that large amounts of unreported financial assets are held in tax havens.

By his cautious estimate, these amount to nearly 10 percent of global GDP.55

The most obvious of these is that the recent crisis has not led to a depression as devastating as the Great Depression of the 1930s. Between 1929 and 1935, production in the developed countries fell by a quarter, unemployment rose by the same amount, and the world did not entirely recover from the Depression until the onset of World War II. Fortunately, the current crisis has been significantly less cataclysmic. That is why it has been given a less alarming name: the Great Recession. To be sure, the leading developed economies in 2013 are not quite back to the level of output they had achieved in 2007, government finances are in pitiful condition, and prospects for growth look gloomy for the foreseeable future, especially in Europe, which is mired in an endless sovereign debt crisis (which is ironic, since Europe is also the continent with the highest capital / income ratio in the world).

Roosevelt increased the top marginal rate of the federal income tax to more than 80 percent on extremely high incomes, whereas the top rate under Hoover had been only 25 percent.

To be sure, good economic and social policy requires more than just a high marginal tax rate on extremely high incomes. By its very nature, such a tax brings in almost nothing.

The first similarity is that taxes consumed less than 10 percent of national income in all four countries during the nineteenth century and up to World War I. This reflects the fact that the state at that time had very little involvement in economic and social life.

“regalian” functions (police, courts, army, foreign affairs, general administration, etc.) but not much more.

alone often consume 12–13 percent of national income

All told, education and health account for 20 percent of employment and GDP in the developed economies, which is more than all sectors of industry combined.

and in recent years mobility may even have decreased.26

For example, one study has shown that gifts by graduates to their former universities are strangely concentrated in the period when the children are of college age.

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.32

Tax levels in the rich countries rose (from 30–35 percent of national income in the 1970s to 35–40 percent in the 1980s) before stabilizing at today’s levels, whereas tax levels in the poor and intermediate countries decreased significantly. In Sub-Saharan Africa and South Asia, the average tax bite was slightly below 15 percent in the 1970s and early 1980s but fell to a little over 10 percent in the 1990s.

The historical evidence suggests that with only 10–15 percent of national income in tax receipts, it is impossible for a state to fulfill much more than its traditional regalian responsibilities: after paying for a proper police force and judicial system, there is not much left to pay for education and health. Another possible choice is to pay everyone—police, judges, teachers, and nurses—poorly, in which case it is unlikely that any of these public services will work well. This can lead to a vicious circle: poorly functioning public services undermine confidence in government, which makes it more difficult to raise taxes significantly. The development of a fiscal and social state is intimately related to the process of state-building as such. Hence the history of economic development is also a matter of political and cultural development, and each country must find its own distinctive path and cope with its own internal divisions.