5 Aug 2016

My Review of Capital in the 21st Century, Part Two

Hail readers!

I am at last back to civilisation, and will remain here for the next week or so. Although I am very busy—I need to pay my tuition fee to Amsterdam, I need to procure various documents, and of course there’s work to be done on the Ark—I have taken the effort to continue writing here on the Magical Realm. As part of these efforts, here is the second part of my review of Thomas Piketty’s Capital. (For the first part, look here.)

My review of Capital in the 21st Century, part two.

Previously, I wrote a review on the first third or so of Capital that I had read. As you may be able to guess, this review will concern the theses presented in the next third of the book—as well as to elaborate further on some of the initial theses, which reoccur throughout the book.

In Capital, Piketty presents a number of new topics. He moves away from the definition of the capital income ratio, its evolution throughout time, and other abstract macroeconomic indicators; instead he treats inequality in a more visceral, recognisable sense: he talks about what kind of incomes and wealth the upper and lower deciles possess.

For example, the top 1% of a nation’s earners get anything from a couple of percent of national economy (equating to a wage of about 5 or 6 times the average)—as was the case in 1970s Sweden, the most egalitarian nation on record—to as much as 20% (as is the case in the United States presently).

In terms of capital, the picture is more stark and has always been so. In the heyday of inegalitarianism—such as in Belle Epoque France or, worse, 1900s Britain—the top 1% held about 60% of all the nation’s wealth. Note also that the yields of this capital was potentially even more unequal—as Piketty shows, those with large fortunes get better returns than those with more modest ones.

Piketty goes on to detail at least three more very important features of inequality. Firstly, capital income is much more significant than wage income the higher up the social strata you go. For the lower class—about half the population—capital income is insignificant. For the middle class (the top 40% or so) capital income is more significant but still small.

But go up to the 1%, and capital income is significant—though a minority. By the time you get to the top 0.1%, capital income makes up the majority of that class’s income.

Secondly, Picketty reveals that the ‘middle class’ phenomenon was very real and relatively recent. Up to the turn of the twentieth century, the top 10% of society owned as much as 90% of the nation’s wealth—as was the case in Britain. But by the middle of the century, the top 40% of society owned about 35% of the nation’s wealth. The bottom half of society still owns close to nothing—not much has changed in that regard—but it is interesting to note that a middle class does exist.

Thirdly, Piketty links inequality of capital directly to the macroeconomic metrics of the capital/income ratio, the rate of return on capital, and the rate of growth of the economy. He explains why inequality became noticeably less pronounced after the war—in no small part because of the political consensus that developed, but also because of the high growth and large shocks to capital that the period saw—and why the 21st century, with its slower growth and higher capital ratio, is becoming more unequal.

Anyway, the point of all this is that Capital in the 21st Century is an extremely relevant and very persuasive work of non-fiction. Piketty’s vast reams of detailed, long-term (think 200+ years) and highly considered data are a masterpiece. Other economists—such as Kuznets—are like pygmies in the presence of a giant like Piketty.

Nevertheless, I do have one or two nitpicks with Piketty—most notably when it comes to the role education plays in inequality, and more so, on the public policy that has been the norm for the past couple of decades where it concerns education.

Is Education Unequal? And if so, what?

Piketty believes unequal access to education—and, in particular, university education—is an important driver of inequality. However, I disagree with this, for two reasons. On a first point of order, I think that university education in most European countries is as equal as it’s ever going to be. (I will elaborate on this shortly.) And on a second point of order, I think Piketty—like most of the political class—is wrong to focus on education as the remedy.

But firstly, allow me to clarify what I mean when I say that university education in Europe is as equal as it’s ever going to be. Piketty, when arguing that university education is unequal, focuses on the usual metrics: the parent’s income and education as predictors of the child’s education and future income. The fact that the two are correlated—as most of us know, kids from well-educated and rich families are more likely to end up in university than other kids—is something Piketty doesn’t like.

But two things need to be clarified. Firstly, the philosopher in me needs to point out that this may be an inequality of outcomes and not necessarily an inequality of opportunity. Throughout most of Europe, there are negligible tuition fees. There also grants, loans, and scholarships to help disadvantaged pupils. In Denmark, they even pay students to attend university.

(Note that I do not include Britain when I say ‘most of Europe’. Here, the government has abolished grants, there are very few scholarships, and tuition fees are very high. Going to university involves accruing large amounts of debt if you’re not from a well-off family, and that debt disproportionately affects poorer students.)

The fact that university education in Europe is available to all is enough to make many centre-right minded people happy. If there is equality of opportunity, it is reasoned that any inequality of outcomes is because the poorer students don’t want to go to university and don’t want to work as hard.

I for one am skeptical of such an argument, which is why my disagreement with Piketty is of a different sort. I fully agree that poorer students are disadvantaged in going to university—for the simple fact that their parents don’t value university education. If you’re from a poorer, manual-labour background, it is hard to understand why university education is valuable.

So yes; we can certainly complain about this, and formulate policy to try and encourage students from poorer backgrounds to go to university—to inculcate that sense that education is valuable.

But ultimately, none of this is as important as Piketty makes out. Such a scheme may increase social mobility, but it will not change inequality—and indeed, it may have unintended consequences.

This is because of the very simple fact that while well-paying professional jobs—like engineers, doctors, programmers, what have you—do indeed require university-level education, they are ultimately finite. We can’t all be engineers and doctors. Making millions of young people go to university is therefore a waste of valuable time and money.

As many young graduates are discovering, going to university only to end up doing a job you could have done without a degree is the ultimate disappointment. It is grossly wasteful, too: going to university for three years costs the graduate and the taxpayer around £30,000—and the figure is rising. Going for four or five years to do a Master’s (as many increasingly are) adds another £20,000 onto that. But that’s just the tip of the iceberg. Going for four or five years to do a useless degree followed by a useless master also stops you being in the labour market for four or five years. Once more, this means tens of thousands of pounds of lost earnings. It means thousands of pounds of lost tax revenue. And it means less experience doing a job.

I’m not even done yet! This in turn has social externalities. It means getting a mortgage later; it means less money to pay for pensions. It frequently means waiting longer to have a child—hence the lower fertility rate of many European countries. (Caveat: this is of course just one factor of many.)

So you see, I think Piketty is deeply mistaken to place so much faith on university education. University is increasingly becoming a tool for social disunity rather than progression.

So What Should Be Done, Instead?

Although I disagree with Piketty on the issue of education, he is right about two other things. For one, capital: its tendency to grow increasingly concentrated and bring increasingly large returns is a major force for ‘economic divergence’ (i.e. rampant inequality). Therefore, Piketty is absolutely right that an important way to reduce inequality would be through the taxation of income from capital, and—also—the taxation of inheritance.

Piketty also uses that data to reveal that inequality is also, of course, from wages as well as from capital. Indeed, the reason that current day Europe is more egalitarian than the present day US is not because of capital—which in any case is larger in Europe—but because incomes are more compressed. Since income from wages makes up about three quarters to two-thirds of all income, a more compressed wage restructure results in a much more equal country (even if capital incomes are very unequal).

So, it logically follows that we also need to compress the wage structure. In fact, I propose that is a far more important goal than putting students in university.

How can this be done, you might wonder? Piketty has one obvious answer: fight against the supermanager. Piketty shows than in the Anglo-Saxon countries, increasingly large CEO compensation—directly in the form of pay-packets, but even more so through stocks and bonuses—is an important reason for why inequality of wages has increased since the 1980s in Britain and the United States.

CEO compensation is an issue of the complex social structures and institutions that exist in firms. One way to reduce CEO compensation would be to change the structures of corporate governance: to give workers and unions more say in management’s pay (to move to a ‘stakeholder model’ as in Germany, in other words) and to give shareholders more say in CEO salaries. (The latter, albeit, will tend to increase CEO compensation in times of strong stock market performance, but it will at least prevent CEOs from increasing their pay packets when firms are actually doing badly.)

Another way would be to change social norms. Firms, like everything else, operate in the social structures that exist in that country. If huge CEO pay-packets are frowned upon—as they are in Switzerland and Sweden, for example—then it is the case that supersalaries are less common.

A final, and simpler way to reduce CEO salaries would be to tax them. Piketty shows that when the Anglo-Saxon nations had high rates of marginal taxation—as high as 98%, which was the case for Britain in the 70s—CEO pay-packets were a lot smaller. (Why? Because the firm’s management aren’t going to give their money away to the government.)

Personally, I think we could go even further. Of course lowering the insane CEO compensation would leave more money for the rest of us, but who will get that money? The middle-management lower down? Or the workers—the janitors, the people at the tills, the rank and file?

That’s why I think Piketty needs one more ingredient in his egalitarian soup: unionisation. This also ties in with my point regarding education. We can’t make everyone a doctor or a lawyer. But what we can do is make sure that even the burger-flippers at McDonald’s get paid a decent wage.

Indeed, the Scandinavian countries do this, and with considerable success. Unionisation is why the Danish McDonald’s workers gets paid around 240,000 Danish Kroner—that’s €30,000 or $40,000—instead of $20,000, as they do in the US. Double the workers’ wages and you’ll find greater social cohesion. And nor will you have to obsess over who goes to university: you won’t need a degree to live a reasonably comfortable life.

The International Element

Another aspect that Piketty makes clear is that any means to reduce inequality—through taxation especially—will have to contend with the global reality of capital and highly-paid workers. Piketty believes that a tax on capital should be Europe-wide, or even global.

Can this be achieved? I believe so. The EU can certainly mandate minimum taxes—it already does so, in fact: every EU country must have a primary VAT rate of at least 15%. They have to apply fuel duty at a minimum level. It doesn’t seem implausible that the EU could, say, mandate a minimum 15% rate of corporate tax, or require a minimum tax on income from capital.

And the EU might even strong-arm other countries into doing the same. Tasty trade deals for the US might come with strings attached—minimum rates of tax. I’m sure the EU could also negotiate deals with the South American countries, Japan, and possibly India—with which it has very good relations.

Final Words

As I’ve said: Piketty’s Capital is a fantastic work of non-fiction. It approaches the issue of income inequality with a rigorousness, nuance and intellectualism that few can manage. It turns abstract and misinformed public debate into concrete data.

I do disagree with some of Piketty’s conclusions, but so far I am keen on reading more.

No comments:

Post a comment