BB Articles Homepage gallery

Capital in the Twenty-First Century book review

capitalThomas Piketty is a French economist and adviser to the Socialist Party, but he achieved rock-star status on the American chat shows, discussing his recent book Capital in the Twenty-First Century.

It is yet another of those anti-capitalist books that will make their author a millionaire – like Naomi Klein’s No Logo and Ja-Hoon Chang’s 23 Things They Don’t Tell You About Capitalism. Except that this one does not just take its title from Karl Marx’s Capital. It shares much of the same attitude to capital, and in similar vein advocates an 80% global tax on accumulated wealth.

Like all such bestsellers, the book claims to have discovered a simple fact. It is the historical fact that the rich really do keep getting richer, at the expense of the poor, and that is just going to continue, unless something is done.

On the basis of a lot of historical analysis and plenty of anecdote, Piketty has concluded that the rate of return on capital is always greater than the overall rate of economic growth. Or to put it in a scientific-looking way, as he does, (r > g). In other words, capital owners will keep on earning more than the rest of us, and will get increasingly richer than the rest. That, he figures, will be very bad for invention and progress, and will undermine our whole economic system.

In case you are going to ask where one might find this aristocratic rentier class of wealth-hoggers, Piketty says that the only thing that knocks them back is the occasional war. But then the cycle starts over and the rich start getting richer than the rest of us once again, until the next war intervenes.

But there is a very much easier way to explain why Piketty’s theory does not actually fit the facts. The real scourge of capital owners is not just war, but everyday market forces and competition.

The suggestion that capital owners simply get richer and richer without trying is plainly false. It suggests that capital is like a tree that regularly drops fruit into its owner’s lap. But even a tree has to be pruned and watered. Capital is something you have to create, and have to grow, apply, service, manage, maintain and protect before it produces anything at all. Capital owners can fail at any one of those stages, and inevitably, they eventually do. It is hard to create capital and wealth, and all too easy to lose it.

Nor does it even make sense to talk about ‘the’ rate of return on capital. Utility investments, or for that matter Treasury Bills and Gilts, may produce pretty certain returns, but those returns are low. By contrast, anyone risking their own money in a venture that has a considerable chance of failing will want the prospect of a very high return if it does happen to work.

The idea of risk, and that capital can be lost to risk, is hardly mentioned in Piketty’s book at all. Perhaps he has spent too long in cushy, subsidized Paris. But even a small risk undermines his thesis that the returns on capital will keep on rising faster that overall growth from now until some military misfortune overtakes it. After all, it is difficult enough to predict what an investment’s returns will be even in a year or two, not just for a century or a millennium.

If returns were certain, the Canarsie people who in 1626 traded Manhattan Island to the Dutch for $24-worth of beads would now be able to buy it back twice over, skyscrapers and all, and get $1bn in change. But returns are never certain. Not just war, but crime, folly, misfortune, greed or simple miscalculation destroys capital.

Things look quite different when you add risk into Piketty’s equation. Far from capital being a gravy-train, the risk-adjusted return on capital is actually modest – and falling, as it has been for decades. Returns in any sector naturally fall as the best returns have already been picked off.

In any case, capitalists and workers are not two distinct classes of people. Workers invest in pension and savings plans, giving them capital holdings of their own.

Nor is life just about physical or financial capital. Perhaps the most important kind of capital in our service economy is actually human capital. There is nothing exclusive about that, it is a form of capital that we all have. And we invest in it – going to college, learning skills, moving jobs. These are investments that have a massive payback – and it is everyone, not just a few wealthy people, who benefit from that.

It is not just wealth that makes people wealthy. Hard work, application and brains are even more effective. Witness the many waves of European immigrants to America, who improved their own lives and made their own fortunes without having any capital to start with.

Piketty sees only inequality, because he looks only at the pattern of raw income. That ignores the fact that we pay taxes on that income in order to support health, education and welfare programmes, plus much else that benefits the poorest. Post-tax, wealthy capitalist countries are the most equal – and it is better to be poor in a country like that than in a poor non-capitalist country.

But huge redistribution is a good way to make a country poor. Penalise capital owners and there is no reason for anyone to create or nurture capital. Countries that follow Piketty’s prescription have less investment, fewer savers to fund projects, and a politics based on envy rather than growth. Big capital taxes give you Cyprus-style instability, French-style capital flight, or Zaire-style ruin. The result is lower growth, from which the poor suffer most. And does anyone really expect any government to administer an 80% wealth tax without corruption?

Reviewed by Eamonn Butler

Dr Eamonn Butler is Director of the Adam Smith Institute. His new book is The Economics Of Success: 12 Things Politicians Don’t Want You to Know (Gibson Square £12.99, e-book £8.99).