By Maria Dahl, Junior Consultant at the Organisation for Economic Co-operation and Development (OECD), Paris
“Common sense is more useful than left or right” Dr. Thomas Piketty at the OECD
One of the perks of working at the OECD is being invited to presentations by economists of the hour. The most recent invitee was Dr. Thomas Piketty, who spoke about his latest publication, Capitalism in the 21st Century. His book has managed to put inequality at the centre stage of policy debates and for this reason we owe him a debt of gratitude, said the Secretary General of the OECD.
I have to admit that I have only read the introduction of Dr. Piketty’s rather long book (one of the similarities between his book and Karl Marx’s Das Kapital). (In your correspondent’s defence his book is the most unread this summer and even Hilary Clinton comments on it without having read it.) Thus, his presentation served as a good resume of the main findings that Dr. Piketty wanted to highlight. I attempt to summarise the presentation below.
The return of the patrimonial (or wealth based) society is very worrying. The future will see a higher concentration of wealth as the rate of return after tax, minus the growth rate (r – g) will continue to be high – due to both high return and low growth rates. Inequality is therefore set to increase in the 21st century. One of the main issues in mainstream economics is that wealth is assumed constant when in fact it can increase and decrease with time (Dr. Piketty explains that the reason for this error is because economists do not know the real ratio between capital and income.) We are now seeing an increase in wealth (where wealth equals capital divided by income), partly to do with higher asset prices. In this type of society, the middle class (i.e. the 40% of the distribution between the bottom 50% and the top 10%) owns as much wealth as the bottom 50% of the distribution (around 5% or less of the aggregate wealth). Fortunately, due to the First World War the patrimonial middle class still owns 20-30% of wealth. However, the top 1% owns 60% of the wealth.
Decreasing public wealth with increasing private wealth, where the increase in private wealth is much higher than the decrease of public wealth. Dr. Piketty emphasized this is not necessarily a negative thing – our aggregate wealth has increased.
So why is inequality increasing? It is not entirely because of a changing pattern of demand and supply of skills. For example, there is a huge difference of wealth and income between the top 10% and 1% (and even 0.1%) of the distribution. Why are top managers and CEOs getting 10 million a year instead of 1 million? Productivity cannot have increased so drastically, as it does not correlate with performance. Also, an incentive based argument does not seem to hold either due to diminishing marginal utility. (In fact, this leads rather to excessive risk taking with such large sums of money at their disposition.) The evidence shows – not surprisingly – that in countries where the tax is relatively lower for high income brackets salaries tend to be much higher for top managers. The lower tax makes the extra million worth it. Of course, while growth is slow your wealth will be proportionally bigger. The difference in r and g (defined above) is not purely described by the pure life cycle approach (where people accumulate wealth for their life time), but has to do with prestige and ensuring the success of their children’s future. This accumulation of wealth was also more easily done in France where higher tax brackets were purposely not set high; because they did not see the need once the revolution abolished all aristocracy.
Although the book analyses inequality trends rather than consequences of the inequality rise, Dr. Piketty does emphasize that this increase has not come with higher productivity (mentioned above) or job creation. What good does higher inequality thus do, if it means worse standards of living for the lower percentiles of society?
Dr. Piketty lays out some rather socialistic solutions (another similarity between him and Karl Marx), calling for very high tax rates for the wealthiest. This has made him a little unpopular with many politicians and economists, but let us not forget that a high tax rate for top income brackets was historically part of the democratic process (even in the United States). He also added that higher taxes are not the only solution; education is even more important. A few interesting statistics on exclusive education include: the average income of a Harvard parent is equivalent to the income of the top 2% of the distribution and at the French grande écoles this lies around the top 9%; this study also finds a correlation between parental donations and their child’s acceptance to American universities. He also criticised the current system of property tax where households with high mortgages were taxed as much as those with low or no mortgage, resulting in a regressive tax. A wealth tax – where mortgages would be taken into account – could be an alternative solution. This should also include wealth stored in banks – but this would obviously necessitate international cooperation to avoid capital flight. He urged us to act because at the end of the day “common sense is more useful than left or right”. Something politicians and economists alike should start to realise.