13 June 2014

by Ellie O'Hagan, Media and Communications Officer, CLASS

Thomas Piketty’s seminal work, Capital in the Twenty-First Century, has soared to the top of the Bestsellers’ Chart and sparked debate amongst commentators, economists and politicians across the world. But at nearly 700 pages, and stuffed with cultural references from Disney to Jane Austen, what is Piketty actually arguing?

The Central Idea

Piketty’s central thesis is so provocative because it contradicts the fundamental beliefs that have enabled capitalism to become the dominant economic system of the last century.

Capitalists have always argued that capitalism’s main virtue is that it is meritocratic: anybody can become rich under capitalism if they work hard and demonstrate business acumen. And – to a greater or lesser extent – the 20th Century proved this theory to be true.

But in his book, Piketty argues that the meritocracy of the 20th Century is actually an anomaly of capitalism, which was brought about by factors such as the Great Depression and two world wars. Instead, Piketty argues, the default setting of capitalism is to accumulate capital for the already wealthy, thus widening the gap between the richest in society and the rest of us – even in countries that have a strong welfare state. He says this default setting of capitalism resumed in the 1980s and will continue indefinitely, unless there is drastic government intervention.

What does Piketty mean by “capital”?

In his book, Piketty uses the word “capital” to mean anything that can be owned and accumulate wealth. Property, stocks and shares are examples of capital. An employer’s workforce would not be categorised as capital.

How does income inequality happen?

To explain income inequality, Piketty uses: r > g

In this equation, r denotes the rate of return on capital (i.e. how much owners of capital make by investing it) and g represents economic growth (i.e. GDP).

So long as r is greater than g, which it has been in recent decades, people who own a lot of things will get exponentially richer than people who work for a living.

Piketty primarily examines capital in the United States, the United Kingdom, France, and Germany, as well as referencing Italy, Canada, and Japan, and argues that in all of these economies, the r > g ratio holds true.

Why does this matter?

Piketty does not argue in favour of total equality, but he says that such an extreme disparity between the wealth of the very rich and everybody else is bad for economic growth and bad for democracy. He argues that if trends continue, social unrest will follow. As Buttonwood’s Notebook in The Economist said:

“Democracy came about, in part, because the rising middle classes and industrial working classes demanded political recognition for their increased economic power. But if economic power has gone back to the rich, we may be sliding back into plutocracy, where government is controlled by the rich.”

So what’s to be done?

Piketty’s solution is a global tax on wealth, although he does recognise that this may be a somewhat utopian demand at the moment. In the meantime he suggests national and regional wealth taxes could be introduced. Piketty argues that a wealth tax is just one of the ways that the modern state must play a crucial role in addressing growing inequality.