Month: December 2016

Thomas Piketty’s Capital and the year 2016

Thomas Piketty’s study of income and wealth inequality, Capital in the Twenty-First Century, was a big hit in 2014. I got to it rather late, only in 2016. But as I ploughed through it, it occurred to me that Piketty’s book actually had a lot of insights to offer into the tumultuous political year we have just lived through.

Piketty has a lot of data and theory to offer on the current nature of income and wealth distribution in advanced western economies. (The Economist did a very good precis of his book, which you can find here: But his most insightful observations come with his review of economic history. If I came away with one conclusion, it is that the post-war golden age of steady economic growth, low inequality, shared prosperity, and high social cohesion may be grinding to an end.

Piketty points out that for most of modern human history, say from the year 0 to the year 1700, the world’s population, and the world’s economy, were basically stagnant. Population grew by about 0.1% per year, as did economic output, meaning that – on average – per capita incomes barely budged between the height of the Roman Empire and the dawn of the Industrial Revolution. Intuitively, I think we know this to be true – that the average standard of living of a subject of the Ottoman Empire in the year 1700 was not markedly different to his Roman cousin living during the time of Jesus.

When growth is so slow, both in demographic and economic terms, each generation tends to replicate itself – in terms of wealth, occupation, social class and economic structure. The children of blacksmiths become blacksmiths themselves. The land-owning gentry bequeath their wealth to their children. Domestic staff give birth to domestic staff; farmworkers to farmworkers. In such a society, inherited wealth matters greatly (since the economy grows little), social hierarchies are rigid (and largely reflect inherited wealth), and social mobility – the ability to climb social classes over the course of a generation or generations – is almost non-existent (usually achieved only through marriage). Expectations are low accordingly. People “know their place”. Of course, fortunes are still made and lost, but the macro picture is overwhelmingly static. This is the world which the characters of Jane Austen and Balzac inhabit, and which Piketty evokes.

This world began to change gradually around 1700, with the onset of the industrial revolution, and then in a more accelerated fashion in subsequent centuries. So in the 100 years from the outbreak of the First World War (1913) to 2012, world output grew by 3% per year on average, world population by 1.4% on average, and per capita income by 1.6%.

Though these low single-digit figures do not sound especially dramatic to our modern ears – and indeed are what we have come to expect of a modern and healthy economy – the cumulative effect has been transformative. Per capita output growth of 1.5% on an annual basis means that over the course of a generation (thirty years), the children are 50% wealthier than the parents. This implies major changes in lifestyle and employment. New goods, services and professions are created. New fortunes are made in new industries. Old industries are disrupted out of existence. We only need to look back to 1986, and think about the demise of Kodak and the rise of Apple since, to realise this is true. When coupled with strong demographic growth, the result is an exceptionally dynamic and fluid society, especially by the standards of most of human history.

The two factors together – strong demographic and strong economic growth – play an equalising role. They are a fount of opportunity, and break down the importance of inherited wealth. They generate avenues for the creation of new wealth. Every generation is different and must in some sense construct itself, rather than replicate its predecessor. In such a scenario, social hierarchies are fluid, not fixed; mobility is high; and the vagaries of birth are less important in determining one’s fate and station.

On top of this, the twentieth century was also a period of massive wealth destruction. Two world wars, hyperinflation, the Great Depression, physical devastation, and the wrenching social and policy changes needed to mobilise and wage ‘total war’ cut huge swathes through the fortunes of many, largely destroying the aristocratic and landowning classes of Europe. It was a great social leveller.

We tend to look back on the post-war period – with its high income equality, high social mobility, and high growth – as the norm. In fact, the last 70 years is more accurately viewed as the historical exception. And, as Piketty argues in his book, this golden age may be coming to an end. Inequalities in wealth and income distribution in wealthy western economies have been steadily widening over the past 30 years (the widening in Australia has been less than other western nations, but the trend is the same). Capital-to-income ratios are approaching 1910 levels. Wealthy economies may be shifting to a lower-growth path – one that may be more normal by historical standards, but which seems little short of stagnation on the basis of modern expectations. (Much here will turn on whether the ‘fourth industrial revolution’ – automation, AI and big data – is all it is cracked up to be, or a pale whimper when compared to the telegraph, railway, electricity and steam engine). And in a quasi-stagnant economy, inherited wealth will acquire a disproportionate importance in determining economic structures.

The picture Piketty paints is a sobering one, of an era of immense prosperity, equality, mobility and social harmony coming to an end. It is one where the benefits of economic growth increasingly accrue to the top-end of the income scale; where median incomes have not moved much in the past 30 years; where wealth is increasingly concentrated, and return on wealth is increasingly important as a source of income compared to paid work; and where one of the principal structural economic innovations of the twentieth century (and one which helped stave off the dire predictions of Marxism and class conflict), the emergence of a wealth-owning middle-class, is becoming increasingly squeezed.

As Piketty explains, the social compact which governs our nations today is built on the basis of meritocracy. We believe that inequalities based on individual talent and effort are justified or at the least acceptable; but that inequalities based on other factors (birth, social class, race, religion, inherited wealth) are much less so. In the decades that followed World War Two, work, study and application became the surest way to the top. The path was open to everyone. But if society is becoming less meritocratic, with less social mobility, our tolerance for these inequalities may begin to fray. Societies can certainly exist and function with high structural inequalities, but historically they have done so only with vastly different social compacts (usually some variant of what we would call the ‘class’ system, a set of rigid social hierarchies at odds with today’s norms and values).

It is fiendishly hard to characterise the global political upheavals of 2016 into a single category, or attribute them to a single set of factors. But I think what we are seeing, manifested in many different ways across many Western nations, are the political reverberations of the story which Piketty tells.

Rising insecurity; the sense of being ‘squeezed’; a loss of faith in the political system and institutions (and a belief they have been captured by certain groups); fading belief in meritocracy and social mobility; growing resentment towards ‘elites’; greater attachment to more traditional forms of identity – these are some of its manifestations. It is hard to characterise or diagnose politically, because it draws on the traditional well-springs of both the left and the right of politics. We tend to dismiss it as populism. In its policy prescriptions, it might well be, but the anxieties it reflects are held deeply, and find at least some of their basis in Piketty’s analysis.

Like all good books, Piketty’s Capital forces you to question whole swathes of received wisdom, and imagine alternative scenarios. What if the high productivity growth of the post war era does not return? What if economic inequality continues to grow? What if our political system is unable to adapt? Would we accept a society where meritocracy is no longer the main organizing principle? Piketty might not be right in his diagnosis, but the questions he poses are worth thinking about.