Groucho Marxism

Capital in the 21st Century is a book written in 2013 by the French economist Thomas Piketty which focuses on wealth and income inequality in Europe and the United States since the 18th century. The book was an instant worldwide success, with over 2.5 million copies sold by the end of 2017. Piketty’s central thesis is that when the rate of return on capital, r, is greater than the rate of economic growth, g, over the long term, the result is concentration of wealth which causes social and economic instability. Thus, the fundamental force for divergence and greater wealth inequality can be summed up in the inequality r > g. Piketty argues further that inequality is not an accident but is a feature of capitalism that can only be reversed through state interventionism.

The book argues that the  trend towards higher inequality was reversed between 1930 and 1975 due to the fact that the two world wars and the Great Depression destroyed much wealth, particularly that owned by the elite. Since then the world has returned towards a system of ‘patrimonial capitalism’, in which the economy is dominated by inherited wealth. As a solution Piketty proposes a progressive annual global wealth tax of up to 2%, combined with a progressive income tax reaching as high as 80%, although he says that such taxes “would be politically impossible.” Without such a tax adjustment, Piketty predicts a world of low economic growth and extreme inequality. He shows that over long periods of time, the average return on investment outpaces economic growth by a wide margin.

The exceptional success of Capital in the 21st Century was widely attributed to “being about the right subject at the right time”, as The Economist put it. The book also received much praise from mainstream academic economists. However the work has also received a fair amount of criticism. One strand of critique faults Piketty for placing inequality at the centre of analysis without any reflection on why it matters. Another strand focuses on Piketty’s methodology, arguing that he relies too heavily on the mainstream ‘neoclassical’ formulation of economics in his theoretical work. Yet another strand focuses on Piketty’s definitions, arguing that he uses a narrow and misleading concepts of ‘capital’ and ‘wealth’. There have even been allegations of errors in Piketty’s data.

In 2014 the Greek economist Yanis Varoufakis wrote a critical review of Capital in the 21st Century, arguing that the book’s “chief theoretical thesis requires several indefensible axioms to animate and mobilise three economic ‘laws’ of which the first is a tautology, the second is based on an heroic assumption, and the third is a triviality.” The three laws Varoufakis refers to are described as follows. Law 1 states that w = x/z, where w = W/Y is the share of wealth W in aggregate income Y, x = X/Y is the ratio of income accruing to wealth X to aggregate income Y, and z = X/W is the ratio of income accruing to wealth X to wealth W. It is self-evident that this ‘law’ is simply an identity and is therefore devoid of theoretical content.

Law 3 states that the rate of growth of w – that is, w’/w where w’ denotes the time derivative of w – is proportional to i-e·d, where i = I/Y is the ratio of inheritance transfers I to aggregate income Y, e is the ratio of mean wealth owned by people at the time of their death to the mean wealth of people already alive, and d is the death rate. As Varoufakis points out, this ‘law’ is a simple codification of the inevitable feedback of wealth disparities when the rich bequeath their wealth to their offspring. Law 2 states that w rises if (and only if) r > g, where r = R/Y is the ratio of aggregate savings R to aggregate income Y, and g = Y’/Y is the growth rate of aggregate income Y. This ‘law’ is the theoretical workhorse that energizes Piketty’s analysis, but it rests on a crucial assumption.

This assumption is that aggregate net savings R feeds fully into aggregate wealth W, i.e. that W’ = R; and furthermore, there can be no new wealth unless there are positive net savings from which to materialize. Whilst this assumption seems plausible, the question is whether it is consistent with the particular definition of wealth Piketty uses in his analysis, which is the sum of the market value of all extent assets. Varoufakis argues not, pointing out that wealth can fall at the same time that net savings are increasing – if house prices collapse, for example. He also points out that under modern capitalism, wealth (as defined by Piketty) can effectively be conjured out of nothing through the creation of derivatives and other financial instruments.

Varoufakis is quite correct in his critique of Piketty’s analysis. But I think a more incisive critique of Capital in the 21st Century is to point out that it is unnecessary. Rather than reading this book, you can simply observe what is going on in the world around you. This is a world which now has its first trillionaire (Elon Musk). And there will surely be more to follow. It is obvious that wealth inequality tends to increase under capitalism, as anyone who has lived under capitalism since the mid-1970s should be able to tell you. Extreme wealth concentration is just a feature of the system. There is no reason read a 700-page book full of questionable data, unjustifiable assumptions, and dodgy neoclassical analysis in order to understand this.