In this respect, note that the phenomenon of international cross-investments is much more prevalent in European countries, led by Britain, Germany, and France (where financial assets held by other countries represent between one-quarter and one-half of total domestic financial assets, which is considerable), than in larger economies such as the United States and Japan (where the proportion of foreign-held assets is not much more than one-tenth).29 This increases the feeling of dispossession, especially in Europe, in part for good reasons, though often to an exaggerated degree. (People quickly forget that while domestic companies and government debt are largely owned by the rest of the world, residents hold equivalent assets abroad through annuities and other financial products.) Indeed, balance sheets structured in this way subject small countries, especially in Europe, to an important vulnerability, in that small “errors” in the valuation of financial assets and liabilities can lead to enormous variations in the net foreign asset position.30 Furthermore, the evolution of a country’s net foreign asset position is determined not only by the accumulation of trade surpluses or deficits but also by very large variations in the return on the country’s financial assets and liabilities.31 I should also point out that these international positions are in substantial part the result of fictitious financial flows associated not with the needs of the real economy but rather with tax optimization strategies and regulatory arbitrage (using screen corporations set up in countries where the tax structure and/or regulatory environment is particularly attractive).32 I come back to these questions in Part Three, where I will examine the importance of tax havens in the global dynamics of wealth distribution.
What Will the Capital/Income Ratio Be in the Twenty-First Century?
The dynamic law β = s / g also enables us to think about what level the global capital/income ratio might attain in the twenty-first century.
First consider what we can say about the past. Concerning Europe (or at any rate the leading economies of Western Europe) and North America, we have reliable estimates for the entire period 1870–2010. For Japan, we have no comprehensive estimate of total private or national wealth prior to 1960, but the incomplete data we do have, in particular Japanese probate records going back to 1905, clearly show that Japanese wealth can be described by the same type of “U-curve” as in Europe, and that the capital/income ratio in the period 1910–1930 rose quite high, to 600–700 percent, before falling to just 200–300 percent in the 1950s and 1960s and then rebounding spectacularly to levels again close to 600–700 percent in the 1990s and 2000s.
For other countries and continents, including Asia (apart from Japan), Africa, and South America, relatively complete estimates exist from 1990 on, and these show a capital/income ratio of about four years on average. For the period 1870–1990 there are no truly reliable estimates, and I have simply assumed that the overall level was about the same. Since these countries account for just over a fifth of global output throughout this period, their impact on the global capital/income ratio is in any case fairly limited.
The results I have obtained are shown in Figure 5.8. Given the weight of the rich countries in this total, it comes as no surprise to discover that the global capital/income ratio followed the same type of “U-curve”: it seems today to be close to 500 percent, which is roughly the same level as that attained on the eve of World War I.
The most interesting question concerns the extrapolation of this curve into the future. Here I have used the demographic and economic growth predictions presented in Chapter 2, according to which global output will gradually decline from the current 3 percent a year to just 1.5 percent in the second half of the twenty-first century. I also assume that the savings rate will stabilize at about 10 percent in the long run. With these assumptions, the dynamic law β = s / g implies that the global capital/income ratio will quite logically continue to rise and could approach 700 percent before the end of the twenty-first century, or approximately the level observed in Europe from the eighteenth century to the Belle Époque. In other words, by 2100, the entire planet could look like Europe at the turn of the twentieth century, at least in terms of capital intensity. Obviously, this is just one possibility among others. As noted, these growth predictions are extremely uncertain, as is the prediction of the rate of saving. These simulations are nevertheless plausible and valuable as a way of illustrating the crucial role of slower growth in the accumulation of capital.
FIGURE 5.8. The world capital/income ratio, 1870–2100
According to simulations (central scenario), the world capital/income ratio could be close to 700 percent by the end of the twenty-first century.
Sources and series: see piketty.pse.ens.fr/capital21c.
The Mystery of Land Values
By definition, the law β = s / g applies only to those forms of capital that can be accumulated. It does not take account of the value of pure natural resources, including “pure land,” that is, land prior to any human improvements. The fact that the law β = s / g allows us to explain nearly the entirety of the observed capital stock in 2010 (between 80 and 100 percent, depending on the country) suggests that pure land constitutes only a small part of national capital. But exactly how much? The available data are insufficient to give a precise answer to this question.
Consider first the case of farmland in a traditional rural society. It is very difficult to say precisely what portion of its value represents “pure land value” prior to any human exploitation and what corresponds to the many investments in and improvements to this land over the centuries (including clearing, drainage, fencing, and so on). In the eighteenth century, the value of farmland in France and Britain attained the equivalent of four years of national income.33 According to contemporary estimates, investments and improvements represented at least three-quarters of this value and probably more. The value of pure land represented at most one year of national income, and probably less than half a year. This conclusion follows primarily from the fact that the annual value of the labor required to clear, drain, and otherwise improve the land was considerable, on the order of 3–4 percent of national income. With relatively slow growth, less than 1 percent a year, the cumulative value of such investments was undoubtedly close to the total value of the land (if not greater).34
It is interesting that Thomas Paine, in his famous “Agrarian Justice” proposal to French legislators in 1795, also concluded that “unimproved land” accounted for roughly one-tenth of national wealth, or a little more than half a year of national income.
Nevertheless, estimates of this sort are inevitably highly approximate. When the growth rate is low, small variations in the rate of investment produce enormous differences in the long-run value of the capital/income ratio β = s / g. The key point to remember is that even in a traditional society, the bulk of national capital already stemmed from accumulation and investment: nothing has really changed, except perhaps the fact that the depreciation of land was quite small compared with that of modern real estate or business capital, which has to be repaired or replaced much more frequently. This may contribute to the impression that modern capital is more “dynamic.” But since the data we have concerning investment in traditional rural societies are limited and imprecise, it is difficult to say more.
In particular, it seems impossible to compare in any precise way the value of pure land long ago with its value today. The principal issue today is urban land: farmland is worth less than 10 percent of national income in both France and Britain. But it is no easier to measure the value of pure urban land today, independent not only of buildings and construction but also of infrastructure and other improvements needed to make the land attractive, than to measure the value of pure farmland in the eighteenth century. According to my estimates, the annual flow of investment over the past few decades can account for almost all the value of wealth, including wealth in real estate, in 2010. In other words, the rise in the capital/income ratio cannot be explained in terms of an increase in the value of pure urba
n land, which to a first approximation seems fairly comparable to the value of pure farmland in the eighteenth century: half to one year of national income. The margin of uncertainty is nevertheless substantial.
Two further points are worth mentioning. First, the fact that total capital, especially in real estate, in the rich countries can be explained fairly well in terms of the accumulation of flows of saving and investment obviously does not preclude the existence of large local capital gains linked to the concentration of population in particular areas, such as major capitals. It would not make much sense to explain the increase in the value of buildings on the Champs-Elysées or, for that matter, anywhere in Paris exclusively in terms of investment flows. Our estimates suggest, however, that these large capital gains on real estate in certain areas were largely compensated by capital losses in other areas, which became less attractive, such as smaller cities or decaying neighborhoods.
Second, the fact that the increase in the value of pure land does not seem to explain much of the historic rebound of the capital/income ration in the rich countries in no way implies that this will continue to be true in the future. From a theoretical point of view, there is nothing that guarantees long-term stability of the value of land, much less of all natural resources. I will come back to this point when I analyze the dynamics of wealth and foreign asset holdings in the petroleum exporting countries.35
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The Capital-Labor Split in the Twenty-First Century
We now have a fairly good understanding of the dynamics of the capital/income ratio, as described by the law β = s / g. In particular, the long-run capital/income ratio depends on the savings rate s and the growth rate g. These two macrosocial parameters themselves depend on millions of individual decisions influenced by any number of social, economic, cultural, psychological, and demographic factors and may vary considerably from period to period and country to country. Furthermore, they are largely independent of each other. These facts enable us to understand the wide historical and geographic variations in the capital/income ratio, independent of the fact that the relative price of capital can also vary widely over the long term as well as the short term, as can the relative price of natural resources.
From the Capital/Income Ratio to the Capital-Labor Split
I turn now from the analysis of the capital/income ratio to the division of national income between labor and capital. The formula α = r × β, which in Chapter 1 I called the first fundamental law of capitalism, allows us to move transparently between the two. For example, if the capital stock is equal to six years of national income (β = 6), and if the average return on capital is 5 percent a year (r = 5%), then the share of income from capital, α, in national income is 30 percent (and the share of income from labor is therefore 70 percent). Hence the central question is the following: How is the rate of return on capital determined? I shall begin by briefly examining the evolutions observed over the very long run before analyzing the theoretical mechanisms and economic and social forces that come into play.
The two countries for which we have the most complete historical data from the eighteenth century on are once again Britain and France.
FIGURE 6.1. The capital-labor split in Britain, 1770–2010
During the nineteenth century, capital income (rent, profits, dividends, interest …) absorbed about 40 percent of national income versus 60 percent for labor income (including both wage and non-wage income).
Sources and series: see piketty.pse.ens.fr/capital21c.
We find that the general evolution of capital’s share of income, α, is described by the same U-shaped curve as the capital/income ratio, β, although the depth of the U is less pronounced. In other words, the rate of return on capital, r, seems to have attenuated the evolution of the quantity of capital, β: r is higher in periods when β is lower, and vice versa, which seems natural.
More precisely: we find that capital’s share of income was on the order of 35–40 percent in both Britain and France in the late eighteenth century and throughout the nineteenth, before falling to 20–25 percent in the middle of the twentieth century and then rising again to 25–30 percent in the late twentieth and early twenty-first centuries (see Figures 6.1 and 6.2). This corresponds to an average rate of return on capital of around 5–6 percent in the eighteenth and nineteenth centuries, rising to 7–8 percent in the mid-twentieth century, and then falling to 4–5 percent in the late twentieth and early twenty-first centuries (see Figures 6.3 and 6.4).
The overall curve and the orders of magnitude described here may be taken as reliable and significant, at least to a first approximation. Nevertheless, the limitations and weaknesses of the data should be noted immediately. First, as noted, the very notion of an “average” rate of return on capital is a fairly abstract construct. In practice, the rate of return varies widely with the type of asset, as well as with the size of individual fortunes (it is generally easier to obtain a good return if one begins with a large stock of capital), and this tends to amplify inequalities. Concretely, the yield on the riskiest assets, including industrial capital (whether in the form of partnerships in family firms in the nineteenth century or shares of stock in listed corporations in the twentieth century), is often greater than 7–8 percent, whereas the yield on less risky assets is significantly lower, on the order of 4–5 percent for farmland in the eighteenth and nineteenth centuries and as low as 3–4 percent for real estate in the early twenty-first century. Small nest eggs held in checking or savings accounts often yield a real rate of return closer to 1–2 percent or even less, perhaps even negative, when the inflation rate exceeds the meager nominal interest rate on such accounts. This is a crucial issue about which I will have more to say later on.
FIGURE 6.2. The capital-labor split in France, 1820–2010
In the twenty-first century, capital income (rent, profits, dividends, interest …) absorbs about 30 percent of national income versus 70 percent for labor income (including both wage and non-wage income).
Sources and series: see piketty.pse.ens.fr/capital21c.
At this stage it is important to point out that the capital shares and average rates of return indicated in Figures 6.1–4 were calculated by adding the various amounts of income from capital included in national accounts, regardless of legal classification (rents, profits, dividends, interest, royalties, etc., excluding interest on public debt and before taxes) and then dividing this total by national income (which gives the share of capital income in national income, denoted α) or by the national capital stock (which gives the average rate of return on capital, denoted r).1 By construction, this average rate of return aggregates the returns on very different types of assets and investments: the goal is in fact to measure the average return on capital in a given society taken as a whole, ignoring differences in individual situations. Obviously some people earn more than the average return and others less. Before looking at the distribution of individual returns around the mean, it is natural to begin by analyzing the location of the mean.
FIGURE 6.3. The pure rate of return on capital in Britain, 1770–2010
The pure rate of return to capital is roughly stable around 4–5 percent in the long run.
Sources and series: see piketty.pse.ens.fr/capital21c.
FIGURE 6.4. The pure rate of return on capital in France, 1820–2010
The observed average rate of return displays larger fluctuations than the pure rate of return during the twentieth century.
Sources and series: see piketty.pse.ens.fr/capital21c.
Flows: More Difficult to Estimate Than Stocks
Another important caveat concerns the income of nonwage workers, which may include remuneration of capital that is difficult to distinguish from other income.
To be sure, this problem is less important now than in the past because most private economic activity today is organized around corporations or, more generally, joint-stock companies, so a firm’s accounts are clearly separate from the accounts of the ind
ividuals who supply the capital (who risk only the capital they have invested and not their personal fortunes, thanks to the revolutionary concept of the “limited liability corporation,” which was adopted almost everywhere in the latter half of the nineteenth century). On the books of such a corporation, there is a clear distinction between remuneration of labor (wages, salaries, bonuses, and other payments to employees, including managers, who contribute labor to the company’s activities) and remuneration of capital (dividends, interest, profits reinvested to increase the value of the firm’s capital, etc.).
Partnerships and sole proprietorships are different: the accounts of the business are sometimes mingled with the personal accounts of the firm head, who is often both the owner and operator. Today, around 10 percent of domestic production in the rich countries is due to nonwage workers in individually owned businesses, which is roughly equal to the proportion of nonwage workers in the active population. Nonwage workers are mostly found in small businesses (merchants, craftsmen, restaurant workers, etc.) and in the professions (doctors, lawyers, etc.). For a long time this category also included a large number of independent farmers, but today these have largely disappeared. On the books of these individually owned firms, it is generally impossible to distinguish the remuneration of capital: for example, the profits of a radiologist remunerate both her labor and the equipment she uses, which can be costly. The same is true of the hotel owner or small farmer. We therefore say that the income of nonwage workers is “mixed,” because it combines income from labor with income from capital. This is also referred to as “entrepreneurial income.”
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