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 there 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 Mechanism of Wealth Divergence: r versus g in History
Let me try now to explain the observed facts: the hyperconcentration of wealth in Europe during the nineteenth century and up to World War I; the substantial compression of wealth inequality following the shocks of 1914–1945; and the fact that the concentration of wealth has not—thus far—regained the record heights set in Europe in the past.
Several mechanisms may be at work here, and to my knowledge there is no evidence that would allow us to determine the precise share of each in the overall movement. We can, however, try to hierarchize the different mechanisms with the help of the available data and analyses. Here is the main conclusion that I believe we can draw from what we know.
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.
This fundamental force for divergence, which I discussed briefly in the Introduction, functions as follows. Consider a world of low growth, on the order of, say, 0.5–1 percent a year, which was the case everywhere before the eighteenth and nineteenth centuries. The rate of return on capital, which is generally on the order of 4 or 5 percent a year, is therefore much higher than the growth rate. 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.
For example, if g = 1% and r = 5%, saving one-fifth of the income from capital (while consuming the other four-fifths) is enough to ensure that capital inherited from the previous generation grows at the same rate as the economy. 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. For strictly mathematical reasons, then, the conditions are ideal for an “inheritance society” to prosper—where by “inheritance society” I mean a society characterized by both a very high concentration of wealth and a significant persistence of large fortunes from generation to generation.
Now, it so happens that these conditions existed in any number of societies throughout history, and in particular in the European societies of the nineteenth century. As Figure 10.7 shows, the rate of return on capital was significantly higher than the growth rate in France from 1820 to 1913, around 5 percent on average compared with a growth rate of around 1 percent. Income from capital accounted for nearly 40 percent of national income, and it was enough to save one-quarter of this to generate a savings rate on the order of 10 percent (see Figure 10.8). This was sufficient to allow wealth to grow slightly more rapidly than income, so that the concentration of wealth trended upward. In the next chapter I will show that most wealth in this period did come from inheritance, and this supremacy of inherited capital, despite the period’s great economic dynamism and impressive financial sophistication, is explained by the dynamic effects of the fundamental inequality r > g: the very rich French probate data allow us to be quite precise about this point.
FIGURE 10.7. Return to capital and growth: France, 1820–1913
The rate of return on capital is a lot higher than the growth rate in France between 1820 and 1913.
Sources and series: see piketty.pse.ens.fr/capital21c.
FIGURE 10.8. Capital share and saving rate: France, 1820–1913
The share of capital income in national income is much larger than the saving rate in France between 1820 and 1913.
Sources and series: see piketty.pse.ens.fr/capital21c.
Why Is the Return on Capital Greater Than the Growth Rate?
Let me pursue the logic of the argument. Are there deep reasons why the return on capital should be systematically higher than the rate of growth? To be clear, I take this to be a historical fact, not a logical necessity.
It is an incontrovertible historical reality that r was indeed greater than g over a long period of time. Many people, when first confronted with this claim, express astonishment and wonder why it should be true. The most obvious way to convince oneself that r > g is indeed a historical fact is no doubt the following.
As I showed in Part One, economic growth was virtually nil throughout much of human history: combining demographic with economic growth, we can say that the annual growth rate from antiquity to the seventeenth century never exceeded 0.1–0.2 percent for long. Despite the many historical uncertainties, there is no doubt that the rate of return on capital was always considerably greater than this: the central value observed over the long run is 4–5 percent a year. In particular, this was the return on land in most traditional agrarian societies. Even if we accept a much lower estimate of the pure yield on capital—for example, by accepting the argument that many landowners have made over the years that it is no simple matter to manage a large estate, so that this return actually reflects a just compensation for the highly skilled labor contributed by the owner—we would still be left with a minimum (and to my mind unrealistic and much too low) return on capital of at least 2–3 percent a year, which is still much greater than 0.1–0.2 percent. Thus throughout most of human history, the inescapable fact is that the rate of return on capital was always at least 10 to 20 times greater than the rate of growth of output (and income). Indeed, this fact is to a large extent the very foundation of society itself: it is what allowed a class of owners to devote themselves to something other than their own subsistence.
In order to illustrate this point as clearly as possible, I have shown in Figure 10.9 the evolution of the global rate of return on capital and the growth rate from antiquity to the twenty-first century.
FIGURE 10.9. Rate of return versus growth rate at the world level, from Antiquity until 2100
The rate of return to capital (pretax) has always been higher than the world growth rate, but the gap was reduced during the twentieth century, and might widen again in the twenty-first century.
Sources and series: see piketty.pse.ens.fr/capital21c
These are obviously approximate and uncertain estimates, but the orders of magnitude and overall evolutions may be taken as valid. For the global growth rate, I have used the historical estimates and projections discussed in Part One. For the global rate of return on capital, I have used the estimates for Britain and France in the period 1700–2010, which were analyzed in Part Two. For early periods, I have used a pure return of 4.5 percent, which should be taken as a minimum value (available historical data suggest average returns on the order of 5–6 percent).16 For the twenty-first century, I have assumed that the value observed in the period 1990–2010 (about 4 percent) will continue, but this is of course uncertain: there are forces pushing toward a lower return and other forces pushing toward a higher. Note, too, that the returns on capital in Figure 10.8 are pretax returns (and also do not take account of capital losses due to war, or of capital gains and losses, which were especially large in the twentieth century).
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. According to the central scenario discussed in Part One, global growth is likely to be around 1.5 percent a year between 2050 and 2100, roughly the same rate as in the nineteenth century. The gap between r and g would then return to a level comparable to that which existed during the Industrial Revolution.
In such a context, it is easy to see that taxes on capital—and shocks of various kinds—can play a central role. Before World War I, taxes on capital were very low (most countries did not tax either personal income or corporate profits, and estate taxes were generally no more than a few percent). To simplify matters, we may therefore assume that the rate of return on capital was virtually the same after taxes as before. After World War I, the tax rates on top incomes, profits, and wealth quickly rose to high levels. Since the 1980s, however, as the ideological climate changed dramatically under the influence of financial globalization and heightened competition between states for capital, these same tax rates have been falling and in some cases have almost entirely disappeared.
Figure 10.10 shows my estimates of the average return on capital after taxes and after accounting for estimated capital losses due to destruction of property in the period 1913–1950. For the sake of argument, I have also assumed that fiscal competition will gradually lead to total disappearance of taxes on capital in the twenty-first century: the average tax rate on capital is set at 30 percent for 1913–2012, 10 percent for 2012–2050, and 0 percent in 2050–2100. Of course, things are more complicated in practice: taxes vary enormously, depending on the country and type of property. At times, they are progressive (meaning that the tax rate increases with the level of income or wealth, at least in theory), and obviously it is not foreordained that fiscal competition must proceed to its ultimate conclusion.
Under these assumptions, we find that the return on capital, net of taxes (and losses), fell to 1–1.5 percent in the period 1913–1950, which was less than the rate of growth. This novel situation continued in the period 1950–2012 owing to the exceptionally high growth rate. Ultimately, we find that in the twentieth century, both fiscal and nonfiscal shocks created a situation in which, for the first time in history, the net return on capital was less than the growth rate. A concatenation of circumstances (wartime destruction, progressive tax policies made possible by the shocks of 1914–1945, and exceptional growth during the three decades following the end of World War II) thus created a historically unprecedented situation, which lasted for nearly a century. All signs are, however, that it is about to end. If fiscal competition proceeds to its logical conclusion—which it may—the gap between r and g will return at some point in the twenty-first century to a level close to what it was in the nineteenth century (see Figure 10.10). If the average tax rate on capital stays at around 30 percent, which is by no means certain, the net rate of return on capital will most likely rise to a level significantly above the growth rate, at least if the central scenario turns out to be correct.
FIGURE 10.10. After tax rate of return versus growth rate at the world level, from Antiquity until 2100
The rate of return to capital (after tax and capital losses) fell below the growth rate during the twentieth century, and may again surpass it in the twenty-first century.
Sources and series: see piketty.pse.ens.fr/capital21c.
FIGURE 10.11. After tax rate of return versus growth rate at the world level, from Antiquity until 2200
The rate of return to capital (after tax and capital losses) fell below the growth rate during the twentieth century, and might again surpass it in the twenty-first century.
Sources and series: see piketty.pse.ens.fr/capital21c.
To bring this possible evolution out even more clearly, I have combined in Figure 10.11 the two subperiods 1913–1950 and 1950–2012 into a single average for the century 1913–2012, the unprecedented era during which the net rate of return on capital was less than the growth rate. I have also combined the two subperiods 2012–2050 and 2050–2100 into a single average for 2012–2100 and assumed that the rates for the second half of the twenty-first century would continue into the twenty-second century (which is of course by no means guaranteed). In any case, Figure 10.11 at least brings out the unprecedented—and possibly unique—character of the twentieth century in regard to the relation between r and g. Note, too, that the hypothesis that global growth will continue at a rate of 1.5 percent a year over the very long run is regarded as excessively optimistic by many observers. Recall that the average growth of global per capita output was 0.8 percent a year between 1700 and 2012, and demographic growth (which also averaged 0.8 percent a year over the past three centuries) is expected to drop sharply between now and the end of the twenty-first century (according to most forecasts). Note, however, that the principal shortcoming of Figure 10.11 is that it relies on the assumption that no significant political reaction will alter the course of capitalism and financial globalization over the course of the next two centuries. Given the tumultuous history of the past century, this is a dubious and to my mind not very plausible hypothesis, precisely because its inegalitarian consequences would be considerable and would probably not be tolerated indefinitely.
To sum up: the inequality r > g has clearly been true throughout most of human history, right up to the eve of World War I, and it will probably be true again in the twenty-first century. Its truth depends, however, on the shocks to which capital is subject, as well as on what public policies and institutions are put in place to regulate the relationship between capital and labor.
The Question of Time Preference
To recap: the inequality r > g is a contingent historical proposition, which is true in some periods and political contexts and not in others. From a strictly logical point of view, it is perfectly possible to imagine a society in which the growth rate is greater than the return on capital—even in the absence of state intervention. Everything depends on the one hand on technology (what is capital used for?) and on the other on attitudes toward saving and property (why do people choose to hold capital?). 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. If, moreover, productivity growth in this society is rapid, either because of constant innovation or because the country is rapidly catching up with more technologically advanced countries, then the growth rate may very well be distinctly higher than the rate of return on capital.
In practice, however, there appears never to have been a society in which the rate of return on capital fell naturally and persistently to less than 2–3 percent, and the mean return we generally see (averaging over all types of investments) is generally closer to 4–5 percent (before taxes). 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 t
ake the future into account. For example, if θ = 5 percent, the actor in question is prepared to sacrifice 105 euros of consumption tomorrow in order to consume an additional 100 euros today. This “theory,” like many theoretical models in economics, is somewhat tautological (one can always explain any observed behavior by assuming that the actors involved have preferences—or “utility functions” in the jargon of the profession—that lead them to act that way), and its predictive power is radical and implacable. In the case in point, assuming a zero-growth economy, it is not surprising to discover that the rate of return on capital must equal the time preference θ.17 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.
In addition to being tautological, the theory raises a number of other difficulties. To be sure, the intuition that lies behind the model (like that which lies behind marginal productivity theory) cannot be entirely wrong. 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.
Capital in the Twenty-First Century Page 41