Piketty reviewed- Economics’ new star casts murky light on inequality

Superstar economist Thomas Piketty warns in Capital in the Twenty- First Century about how growing inequalities favour higher taxes. Lukas Sustala reviews the best seller.

Inequality is back. That is the basic lesson of the economics sensation that is the book Capital in the Twenty-First Century by French economist Thomas Piketty.

He argues that the world is ripe for a return of the massive inequalities observed in the 19th century. To regain control, governments should progressively tax labour income, inheritance and capital. 

Thomas Piketty of the Paris School of Economics is not new to the subject. He is one of the most advanced scholars of inequality, both in income and wealth.

And from his years of research, he offers easy solutions to the pressing question that is on any policymaker’s mind: What can be done to reduce the growing divide in incomes and wealth?

For Piketty and most of his adepts it seems that this is a tax issue. “The right solution is a progressive tax on capital,” writes Piketty several times in his book, a solution he affirms strongly during an interview with InvestmentEurope.

One of his central claims is that there is a natural tendency within the capitalist system to favour the return to capital over the income of labour: “r > g” is the formal representation of this argument.

The return for the capital stock is higher than the (nominal) growth rate in the economy and thus inequality is set to grow if the system remains unchecked.

However, one senses that Piketty has an agenda. For a book that argues
strongly in favour of higher and more progressive taxes, the reader finds surprisingly little on the already large influence of taxes and transfers on inequality.

Indeed, numbers from the OECD show that in industrial economies the government reduces the inequality in incomes by roughly one-third already. Piketty defines capital in very broad terms (more or less referring to overall wealth), but fails to look at a significant source of wealth in OECD countries: entitlements.

In European welfare states, much of the wealth within society consists of claims on the pension system. And it remains to be seen whether the recently accumulated housing wealth is due to bubbly price movements or a fundamental growth in wealth.

Adding to that, the central claim of r > g is also causing controversy. For years now, central banks have lowered interest rates and investors have complained about “financial repression”. The largest capital market, bonds from sovereigns, is one where people might not be able to preserve their wealth in real terms.

The book runs to 696 pages, includes 96 graphs and more than 70 pages of footnotes, so it is only the more motivated summer reader who is going to dig deep into the data collection that Piketty presents. As an analysis by the Financial Times has shown, some of this data needs to be taken with a pinch of salt.

Piketty himself is in favour of a capital tax in order to improve the quality of the data, yet his book up to now seems to be the most advanced data collection on the topic.

Adding to that, even Piketty thinks that most analysis on inequality runs short. In his interview with InvestmentEurope the French economist
acknowledges that there are some other forces at work rather than taxes and capital gains.

“Education is even more important than taxation,” Piketty says. As alumni
of elite universities benefit from higher earnings, the inequality of access to good education might be even more significant than a change to the tax code.

It is perhaps ironic to note that Piketty himself is a benefiary of the rising levels of inequality he highlights. In a matter of months the MIT and LSE trained economist has become a superstar, with speaking engagements at the US Treasury and a best-selling book. In the globalised, competitive
economy Piketty has analysed, such stellar success is richly rewarded.

Mona Dohle
Mona Dohle speaks German and Dutch, she is DACH & Benelux Correspondent for InvestmentEurope. Prior to that, she worked as a journalist in Egypt and Palestine. She started her career as a journalist working for a local German newspaper. Mona graduated with an MSc in Development Studies from SOAS and has completed the CISI Certificate in International Wealth and Investment Management.

Read more from Mona Dohle

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