A review of Capital in the Twenty-First Century, by Thomas Piketty

In Capital in the Twenty-First Century Thomas Piketty makes an ambitious argument about how capitalism doesn’t do what we want or expect. A revised edition might comment on a more modest idiosyncrasy: his daunting book became a bestseller, despite asking readers to work through almost 600 pages of graphs and recondite arguments about such topics as “The Ups and Downs of Ricardian Equivalence.” As Capital shot up the charts this spring, Amazon informed disappointed buyers it had no more bound copies to ship them, and the publisher ordered six additional printings to meet the unanticipated demand. By writing the “big-think book of the moment,” the New York Times reported, Piketty has “joined the rare company of the ultraserious big thinker whose big idea truly commands the public stage.”

An economics professor at France’s School for Advanced Studies in Social Sciences, Piketty summarizes Capital’s argument by contending that

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.

Piketty covers some of this material insufficiently, however. He has very little to say, for example, about how the diffusion of knowledge and skills has given workers in the early 21st century wages 30 times larger than those received by their counterparts in the most advanced economies of the early 19th century. And Capital asserts strenuously, but demonstrates unpersuasively, that “divergence”—a growing gap in the economic circumstances and market power of the few who are rich vis-à-vis the many who are not—is a threat to capitalist economies.

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First let’s look at the merits. Piketty has done a real service to the public and the economics profession by collecting and assembling data on income growth and distribution over a long period. Many will use the data in the future, but we must hope that they recognize, as Piketty does repeatedly, that the data are very crude. Also, Piketty reminds us that economics alone does not determine our future. Like Adam Smith, Friedrich Engels, and other early inquirers, he places economics among other social sciences, explaining candidly that the data are so rough partly because the concepts they measure sprawl across more than one science.

His use of, as opposed to his presentation of, this data is far more problematic. Piketty draws on many available sources of information, but some of these change considerably over time, and others are very limited as to what they reveal and what they don’t address at all. How much can we really learn about the distribution of income in the century or more before there was an income tax? What’s more, there were many years in which the income tax applied to only a small part of the population. And, of course, when tax laws changed, so did the income reported on tax forms.

Wealth data have the same problems, along with others unique to that economic category. How does anyone know the valuation over time of privately held assets? Who values the old masters, for example, some of which are held by families for generations? And how do we get a time series or a decadal estimate of owner-operated businesses? Can anyone hope to adjust the data for the changing rules about tax rates and inter vivos gifts? How does Piketty assign the market value of pension funds and health plans? These are just a few of the questions that invite skepticism, especially about his wealth distributions.

I do not doubt that the distribution of wealth is highly skewed, but it becomes less skewed if it includes Social Security and private pension wealth. Piketty excludes them. Most of the saving in advanced economies is done by people with high incomes. Piketty never makes a clear statement of the evidence showing that the wealth distribution in capitalist countries poses a large social cost, although he clearly believes that. There is no doubt that he desires greater equality, but there is no analysis of the trade-offs involved in creating or being a more egalitarian society.

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More serious, I believe, is his decision to discuss the spread in the distribution of income using pre-tax income data, leaving out the effect of redistributive transfer programs. Table 1 shows the consequences. By 2010, the after-tax and -transfers share received by the highest 1% of earners was back close to where it was in 1989. And for the lowest quintile, the share was between the 1979 and 1989 shares. Further, Piketty never discusses the large changes in people’s position over time from bottom to top and top to bottom within the income distribution. Positions are not frozen: most people occupy more than one quintile of the income distribution over the course of a lifetime. We might hope for even greater mobility; but first we must explain what we see.

Before Tax (%) 1979 1989 2007 2010
Lowest 20% 6.2 4.9 4.8 5.1
Middle 20% 15.8 15.0 13.4 14.2
Highest 20% 44.9 49.3 54.6 51.9
Highest 1% 8.9 12.2 18.7 14.9


After Tax (%)  1979 1989 2007 2010
Lowest 20% 7.4 5.7 5.6 6.2
Middle 20% 16.5 15.7 14.3 15.4
Highest 20% 42.0 47.3 51.4 48.1
Highest 1% 7.4 11.8 16.7 12.8

Source: Congressional Budget Office (2014)

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Economists learn early that consumption, not income before taxes and transfers, is a main concern of consumers. Present and future consumption depend on the after-tax and -transfer share, called disposable income. I cannot think of a valid reason for using income before taxes and transfers in all Piketty’s calculations. He is wrong, and it is misleading.

Inheritance is one of Piketty’s main concerns. He quotes frequently from Balzac’s novels about the problem of heirs living idle lives as rentiers. But how real is that now? The Rockefeller, Mellon, Morgan, and other fortunes of the turn of the century went not to perpetuate family wealth but to expand and upgrade the National Gallery of Art, the Metropolitan Museum, and other famous institutions like the Metropolitan Opera. Then there are colleges and universities, and art museums and other cultural institutions around the country. Bill Gates and Warren Buffett have given much of their wealth to charitable foundations, encouraging others around the world to do the same. If that doesn’t happen in Piketty’s native France, perhaps the problem is that the incentives for donating are wrong. Piketty points out that the annual inheritance in France is about 2.5% of total private wealth…but never makes clear why this is a cause for alarm. 

Piketty is not a complete Marxist. He shows, for example, that Marx’s claim about capital satiation (excessive capital stock) is unlikely to be true. But he makes the same two major errors that Marx made. First, he focuses almost entirely on capital and income from capital. His major point is that the return earned by capital has been about 5% for much of recorded history. If so, it is almost always above the growth rate of income, causing capital to accumulate over time. Like Marx, he believes the rentier capitalists will gobble up more of the slowly growing income as the income distribution shifts ineluctably in their favor. “The central thesis of this book,” Piketty writes, “is precisely that an apparently small gap between the return on capital and the rate of growth can in the long run have powerful and destabilizing effects on the structure and dynamics of social inequality.”

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Piketty never asks why the supposed crisis of capitalism has not happened anywhere in the past 200 years. The ratio of capital to income, his main concern, has equaled its current levels in the past. Since it did not continue to rise then, there is good reason to believe it will not continue to rise now. In the United States and the advanced economies of Europe, investment is relatively low. Instead of the immiseration of the working class, which Marx predicted, workers’ incomes rose and the distribution of income narrowed as capitalism brought rising productivity, increased skills, and higher incomes for middle-class workers. People saved, using some of their newly acquired wealth to educate their children to be teachers, accountants, engineers, lawyers, doctors, and scientists.

The second Marxian error that Piketty repeats is neglect of voting as a means of setting the tax rate. The United States, the United Kingdom, and Sweden had marginal tax rates at 90% or higher for many years. Voters chose to reduce those rates because they collected little revenue and reduced investment and growth. Piketty urges a return to the very high marginal rates, less to raise revenue for the government, the obvious purpose of a tax system, than to express disapproval of the people with the highest incomes. The fact that France has a higher marginal tax rate than Germany and other countries helps to explain why its economy has remained stagnant for a decade. Ambitious young French men and women have moved to London, Frankfurt, and Berlin, where opportunities are greater and the future seems brighter.

Much of the most productive capital in the 21st century is so-called human capital, the skills honed by advanced education or by practice. Piketty recognizes human capital when he writes: “All of these countries [Japan, South Korea, Taiwan, and China] themselves financed the necessary investments in physical capital and, even more, in human capital, which the latest research holds to be the key to long-term growth.” This seems to contradict his main theme: it isn’t income from capital but from educated labor that provides incentives for growth. It becomes a major determinant of the spread between top and bottom in the distribution of income.

Most analyses propose improved educational opportunities as a means of spurring growth and benefitting the disadvantaged. I would add the desirability of greatly increased on-the-job training, both at work and in vocational schools. Piketty doesn’t mention education or training. He prefers much higher marginal income tax rates and a universal wealth tax.

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Friedrich Hayek saw the problem very differently. Instead of a growing rentier class that shoved its way ever upward, he said that the luxuries of today become tomorrow’s necessities. In 1955 economist Simon Kuznets described, on the basis of data about the distribution and growth of income, the “Kuznets Curve”: Unskilled workers enter the labor force, earning low wages but acquiring skills. At first the low wage and increasing profits widen the income distribution. As workers’ productivity increases, so does their income, causing the spread in the income distribution to narrow. That describes the United States in the 19th and 20th centuries, and the experience of Korean, Cuban, and other immigrants to America recently. And it broadly describes the experience of many other countries including, most recently, China. There, labor has moved from farm to factory, becoming more productive overall, but markedly more productive in some cases and only marginally more productive in others.

Piketty cites Kuznets’s work but dismisses it as overly optimistic, expressing a preference for Marx’s pessimism despite producing no evidence (because there is none) that producer capital (as opposed to human capital) has greatly increased. Most of Piketty’s charts show that real estate wealth has grown rapidly. Surely, however, most of the increase in real estate assets results from the increase in labor income that spread home ownership far down the income distribution. We learn that French data offer no evidence of a rising share of income going to owners of capital, the despised rentiers.

The reader who relied entirely on Capital in the Twenty-First Century would never know that democratic capitalism is the only system humans have developed that maintains both growth in living standards and freedom for individuals. Because it is a human institution, it is imperfect. Libraries are full of books proposing improvements, some practical, others utopian. Except in periods of crisis, voters reject most of these changes. Ordinary citizens, that is, seem to understand what Piketty and his admirers do not: democratic capitalism deserves to be judged on the basis of whether it is the best system available, not the best imaginable.

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It is impossible, as a consequence, not to despair about the praise scores of reviewers have heaped on this wordy, repetitious book. One Nobel laureate in economics, Paul Krugman, praised Capital as “a magnificent, sweeping meditation” that “integrates economic growth, the distribution of income between capital and labor, and the distribution of wealth and income among individuals into a single frame.” A second, Robert M. Solow, titled his review, “Thomas Piketty Is Right,” and called the book a “new and powerful contribution.” Joseph Stiglitz, yet another winner of the Nobel prize in economics, wrote that Capital “lends further weight to the already overwhelming body of evidence concerning the soaring share of income and wealth at the very top” and “raises fundamental issues concerning both economic theory and the future of capitalism.” Branko Milanovic, formerly a senior economist at the World Bank, praised Piketty: “we are in the presence of one of the watershed books in economic thinking.”

To read these encomiums is puzzling, and then troubling. For the past two generations economists taught their students to derive policy recommendations from formal models that account most successfully for the relevant evidence. Surprisingly, they now endorse Piketty, who resorts to stories from 19th-century French and English literature time and again at points in his argument when evidence is required but never provided. Why do they lavishly praise a book that makes no effort to meet this most basic standard? Has the academic profession become so politicized that it praises a bad book because the author strongly favors more and much greater income redistribution? The self-satisfied “reality-based community” is all too ready to inhabit a congenial fantasy.