Whichever of the 18 worthy books on economics and finance eventually ends up winning this year’s Financial Times/McKinsey “Business Book of the Year Award,” it’s already clear which work has had the most transformational effect on this decade’s intense debate on economic policy. One of the finalists in that book competition, “Capital in the Twenty-First Century” by Thomas Piketty, has been hailed as a landmark analysis of the inexorable trends driving the modern-day economy, with Piketty’s scholarship abruptly detonating a debate that has profound implications for public policy and long-term economic theory.
Washington policymakers may sometimes be slow to embrace dramatic and innovative ideas about economics, but the impact of Piketty’s reach and relevance – especially after the financial Crash of 2008 – became even clearer when the chairman of the White House Council of Economic Advisers recently led a scholarly seminar at the World Bank Group, describing the impact of Piketty’s thinking on the Obama Administration’s approach to economic policy. If the White House itself is focusing on Piketty’s diagnosis of the ills now afflicting many Western economies, then his analysis should clearly rivet the attention of everyone who’s concerned with building shared prosperity globally.
When Jason Furman, the President’s chief economic adviser, came to the Bank as part of the Development Economics Lecture Series to analyze Piketty’s logic – describing how Piketty’s “Capital” is now being factored into the White House’s policymaking – the rapt attention of the throng in the Bank’s Old Board Room (and spilling out into the adjoining corridors) illustrated how Piketty’s work has been swaying economists’ debates.
Those debates have consumed policy-watchers not just at the Bank, the International Monetary Fund and other leading global financial institutions, but also at the Federal Reserve System and in policy journals and university economics departments worldwide. Even financial firms that epitomize Wall Street’s do-what-works, drop-all-ideology pragmatism – like Standard & Poor’s, which recently issued a candid analysis of how “too much inequality can undermine growth” – warn of the dangers of extreme inequality.
The video of the event can be viewed by clicking on the screen directly below, or by linking to the World Bank Group website: http://live.worldbank.org/lessons-for-inclusive-growth.
Furman’s DEC Lecture thus underscored the transformation in economic thinking that has been occurring, thanks in large part to Piketty. Mainstream economic institutions are newly attentive to the widening economic divide – the chronic gaps within each nation, and the enduring chasm between developed and developing nations. Furman himself helped contribute to the knowledge-base about inequality when he served on the Bank staff as a Senior Advisor to then-Chief Economist Joseph Stiglitz.
Furman’s lecture was the latest in a series of Bank discussions on inequality, including an InfoShop forum with Chrystia Freeland – formerly a journalist with the Financial Times and Thomson Reuters who is now a member of the Canadian Parliament – discussing her celebrated work “Plutocrats: The Rise of the New Global Super-Rich and the Fall of Everyone Else.” Freeland applauded the voluminous Bank research – including the work of Branko Milanovic, the esteemed former Bank economist who is now at the City University of New York – that has helped lay the foundations of the inequality debate.
Given the linear logic that was spelled out in Furman’s data-rich DEC Lecture, it’s little wonder that Piketty’s research has inspired accolades from scholars like Milanovic, the author of “The Haves and the Have-Nots,” who has hailed “Capital” as “one of the watershed books of economic thinking.” Piketty’s work has also been praised as “the most important economics book of the year, and maybe of the decade” by Nobel Prize-winning economist Paul Krugman of the New York Times, and has been lauded as “an extraordinarily important” work “of vast historical scope, grounded in exhaustive fact-based research” by Martin Wolf of the Financial Times.
Introducing his lecture, entitled “Lessons for Inclusive Growth, from the U.S. and the World,” Furman said that “the ultimate test of economic performance” is “ensuring that the benefits of growth are broadly shared.” Such a broad sharing of prosperity may once have been a standard feature of advanced Western economies – but for at least the last 30 years, income inequality and wealth inequality have dramatically widened. Piketty’s meticulous work shows why.
As Furman detailed, Piketty’s data-driven research confirms what many economy-watchers have long suspected – and what many long-suffering wage-earners have long felt amid the aftermath of the Crash of 2008 and the Great Recession that followed: The trend toward the concentration of capital in modern-day industrialized economies is intensifying.
Crucially, Piketty contends that such a concentration is not an accident: Instead, the “rich get richer” phenomenon is a fundamental feature of the way that income and wealth are distributed in modern-day capitalism, for a straightforward reason: The rate of return to capital, over the long term, is higher than the rate of return to labor.
Capital-income inequality is thus self-perpetuating. As Furman explained: “How much wealth you have today is a function of how much income you had in the past, and a function of your rate of return, which itself is higher for higher-wealth households.”
Or as Piketty, aided by his skillful translator Arthur Goldhammer, more poetically declares: “The past devours the future.”
Distilling Piketty’s nuanced analysis down to its most vital points:
- “A market economy based on private property, if left to itself, contains powerful forces of convergence, associated in particular with the diffusion of knowledge and skills. But it also contains powerful forces of divergence, which are potentially threatening to democratic societies and to the values of social justice on which they are based.
- “The principal destabilizing force has to do with the fact that the private rate of return on capital, r, can be significantly higher for long periods of time than that rate of growth of income and output, g. Wealth accumulated in the past grows more rapidly than output and wages.
- “The inequality r > g implies that wealth accumulated in the past grows more rapidly than output and wages. This inequality expresses a fundamental logical contradiction. The entrepreneur inevitably tends to become a rentier, more and more dominant over those who own nothing but their labor. Once constituted, capital reproduces itself faster than output increases. The past devours the future.
- “The consequences for the long-term dynamics of the wealth distribution are potentially terrifying, especially when one adds [the fact that] the return on capital varies directly with the size of the initial stake and [the fact that] the divergence in the wealth distribution is occurring on a global scale.”
Such a “potentially terrifying” trend of an ever-compounding gap, which would stratify society into rigid social classes, can be eased, however, by corrective public policies – such as adopting progressive taxation, raising inheritance taxes and periodically raising the minimum wage – if a society can summon the willpower to prevent the coagulation of a “patrimonial capitalism” dominated by inherited wealth.
If Piketty's deterministic analysis were to sow defeatist despair – a feeling that ever-worsening inequality is inevitably "just the way the system is destined to work" – it might deflate the pressure for activist reforms. Counseling against fatalism, however, Furman said that “I wouldn’t be too defeatist” about the irreversibility of the trend that Piketty discerns. He asserted that the Obama Administration’s changes to tax policy, and the adoption of the Affordable Care Act, in 2009 and 2010 had helped overcome a decade’s worth of growing inequality.
Furman noted that some of the Bank’s economists have not (or at least, not yet) “fully endorsed” the Piketty-like perspectives advanced in recent months by the IMF – whose researchers issued an influential “IMF Staff Discussion Note” with Piketty-like ideas on the importance of promoting stability by restraining runaway inequality. IMF Managing Director Christine Lagarde has been outspoken about the urgency that the IMF has devoted to the issue: “I hear people say, ‘Why do you bother about inequality? It is not the core mandate.’ Well, sorry, it is also part of the mandate. Our mandate is financial stability. Anything that is likely to rock the boat financially and macroeconomically is within our mandate.”
The newly energized debate underscores the importance of the World Bank Group’s recent assertion that achieving its twin goals – eliminating extreme poverty and promoting shared prosperity – will require more than just spurring overall economic growth: It will also require focusing on the distribution of wealth.
It's significant that Piketty’s work has, thus far, withstood every attempt, from the left or the right, to refute it. An initially provocative Financial Times analysis tried to poke holes in Piketty’s data, but that attack proved to be off the mark when it was more rigorously examined. (To its credit: When corrected, the Financial Times decorously backed away from its overly broad claims.)
The resilience of Piketty’s logic has hardly deterred, however, the predictable attacks by the carping claque of free-market fundamentalists who readily denounce any idea that challenges their never-levy-taxes, always-cut-services dogma. Hurling the accusation that any discussion of inequality must inevitably be warmed-over Marxism, laissez-faire absolutists have eagerly spewed evidence-free invective to denounce Pietty’s modest suggestion that some well-targeted tax increases on those with higher incomes can help defuse an eventual social explosion.
Yet, in their more lucid moments, there's a tone of grudging respect within at least some of their denunciations. Notably, a scholar at the American Enterprise Institute – a think tank that lately seems to be softening some of the hard edges of its rhetoric about the supposed magic of lightly regulated markets – has admitted that “Piketty and . . . inequality researcher Emmanuel Saez [of the University of California at Berkeley] are arguably the most important public intellectuals in the world today.”
Free-marketeers’ Pavlovian reaction is part of what has been dubbed “the Piketty Panic,” as last-ditch libertarians try to defend what Stiglitz calls “that most cherished of conservative myths, the insistence that we’re living in a meritocracy in which great wealth is earned and deserved.”
The “Aux barricades!” mobilization of the pro-plutocracy platoon is understandable, given the genuine threat that Piketty’s rigorous reasoning poses to their ideological idées fixes: “The soft Marxism in ‘Capital,’ if unchallenged, will spread among the clerisy,” wrote the AEI scholar, “and [will] reshape the political economic landscape on which all future policy battles will be waged.” For the moment, however, anti-government zealots' ad hominem attacks and light-on-facts tirades have merely highlighted their own lack of evidence amid their failure to refute Piketty’s logic.
Furman’s DEC Lecture clarified the insights within Piketty’s research – and echoed some of the points that Freeland made in her earlier InfoShop forum, about how to “make capitalism better and [make it] work better” and about how to make the market-based economy more sustainable for the long run. Enlightened self-interest should lead the plutocratic class to “be out there advocating for a wealth tax” to reduce inequality, said Freeland, if only to forestall an eventual rebellion.
As a proud but increasingly nervous member of the plutocratic One Percent recently wrote, “peasants with pitchforks” will someday threaten the monied oligarchy if there is no way to ease the intensifying social tensions. "Inequality is at historically high levels and getting worse every day. Our country is rapidly becoming less a capitalist society and more a feudal society," wrote wealthy entrepreneur Nick Hanauer in Politico. "Unless our policies change dramatically, the middle class will disappear, and we will be back to late-18th-century France. Before the revolution. . . . It won’t last. If we don’t do something to fix the glaring inequities in this economy, the pitchforks are going to come for us. No society can sustain this kind of rising inequality. . . It’s not 'if,' it’s 'when.' "
The insights of Furman and Freeland, in their recent DEC Lecture and InfoShop presentations, reminded the World Bank Group audiences and their colleagues in the global development community that far-sighted economic policies, along with appeals to enlightened self-interest, can help build economic resilience. Sound planning for sustainable growth can maximize the wealth-creating benefits of well-regulated markets – while helping avoid the excesses of the wealth-concentrating “forces of divergence” that can destabilize economies by undermining shared prosperity.