Capital is about the distribution of income and wealth. For the most part, this is a distillation of Piketty's published academic work, which includes the collection and analysis of a large quantity of historical data on income and wealth distribution in a number of countries of the world. Of course, data cannot speak for itself - we need theory to organize how we think about the data, and Piketty indeed has a theory, and uses that theory and the data to arrive at predictions about the future. He also comes to some policy conclusions.
Here's the theory. Piketty starts with the First Fundamental Law of Capitalism, otherwise known as the definition of capital's share in national income, or
(1) a = r(K/Y),
where a is the capital share, r is the real rate of return on capital, K is the capital stock, and Y is national income. Note that, when we calculate national income we deduct depreciation of capital from GDP. That will prove to be important. The Second Fundamental Law of Capitalism states what has to be true in a steady state in which K/Y is constant:
(2) K/Y = s/g,
where s is the savings rate, and g is the growth rate of Y. So where did that come from? If k is the time derivative of K, and y is the time derivative of Y, then in a steady state in which K/Y is constant,
(3) k/K = y/Y.
Then, equation (3) gives
(4) K/Y = k/y = (k/Y)/(y/Y) = s/g,
or equation (2). It's important to note that, since Y is national income (i.e. output net of depreciation), the savings rate is also defined as net of depreciation.
So, thus far, we don't have a theory, only two equations, (1) and (2). The first is a definition, and the second has to hold if the capital/output ratio is constant over time. Typically, in the types of growth models we write down, there are good reasons to look at the characteristics of steady states. That is, we feel a need to justify focusing on the steady state by arguing that the steady state is something the model will converge to in the long run. Of course, Piketty is shooting for a broad audience here, so he doesn't want to supply the details, for fear of scaring people away.
Proceeding, (1) and (2) imply
(5) a = r(s/g)
in the steady state. If we assume that the net savings rate s is constant, then if r/g rises, a must rise as well. This then constitutes a theory. Something is assumed constant, which implies that, if this happens, then that must happen. But what does this have to do with the distribution of income and wealth? Piketty argues as follows:
(i) Historically, r > g typically holds in the data.
(ii) There are good reasons to think that, in the 21st century, g will fall, and r/g will rise.
(iii) Capital income is more more concentrated among high-income earners than is labor income.
Conclusion: Given (5) and (i)-(iii), we should expect a to rise in the 21st century, which will lead to an increasing concentration of income at the high end. But why should we care? Piketty argues that this will ultimately lead to social unrest and instability, as the poor become increasingly offended by the filthy rich, to the point where they just won't take it any more. Thus, like Marx, Piketty thinks that capitalism is inherently unstable. But, while Marx thought that capitalism would destroy itself, as a necessary step on the path to communist nirvana, Piketty thinks we should do something to save capitalism before it is too late. Rather than allow the capitalist Beast to destroy itself, we should just tax it into submission. Piketty favors marginal tax rates at the high end in excess of 80%, and a global tax on wealth.
Capital is certainly provocative, and the r > g logic has intuitive appeal, but how do we square Piketty's ideas with the rest of our economic knowledge? One puzzling aspect of Piketty's analysis is his use of net savings rates, and national income instead of GDP. In the typical growth models economists are accustomed to working with, we work with gross quantities and rates - before depreciation. Per Krusell and Tony Smith do a nice job of straightening this out. A key issue is what happens in equation (2) as g goes to zero in the limit. Basically, given what we know about consumption/savings behavior, Piketty's argument that this leads to a large increase in a is questionable.
Further, there is nothing unusual about r > g, in standard economic growth models that have no implications at all for the distribution of income and wealth. For example, take a standard representative-agent neoclassical growth model with inelastic labor supply and a constant relative risk aversion utility function. Then, in a steady state,
(6) r = q + bg,
where q is the subjective discount rate and b is the coefficient of relative risk aversion. So, (6) implies that r > g unless g > q and b is small. And, if g is small, then we must have r > g. But, of course, the type of model we are dealing with is a representative-agent construct. This could be a model with many identical agents, but markets are complete, and income and wealth would be uniformly distributed across the population in equilibrium. So, if we want to write down a model that can give us predictions about the income and wealth distribution, we are going to need heterogeneity. Further, we know that some types of heterogeneity won't work. For example, with idiosyncratic risk, under some conditions the model will essentially be identical to the representative agent model, given complete insurance markets. Thus, it's generally understood that, for standard dynamic growth models to have any hope of replicating the distribution of income and wealth that we observe, these models need to include sufficient heterogeneity and sufficient financial market frictions.
Convenient summaries of incomplete markets models with heterogeneous agents are in this book chapter by Krusell and Smith, and this paper by Heathcote et al. In some configurations, these models can have difficulty in accounting for the very rich and very poor. This may have something to do with financial market participation. In practice, the very poor do not hold stocks, bonds, and mutual fund shares, or even have transcations accounts with banks in some circumstances. As well, access to high-variance, high-expected return projects, for example entrepreneurial projects, is limited to very high-income individuals. So, to understand the dynamics of the wealth and income distributions, we need to understand the complexities of financial markets, and market participation. That's not what Piketty is up to in Capital.
How might this matter? Well suppose, as Piketty suggests, that g declines during the coming century. Given our understanding of how economic growth works, this would have to come about due to a decline in the rate of technological innovation. But it appears that technological innovation is what produces extremely large incomes and extremely large pots of wealth. To see this, look at who the richest people in America are. For example, the top 20 includes the people who got rich on Microsoft, Facebook, Amazon, and Google. As Piketty points out, the top 1% is also well-represented by high-priced CEOs. If Piketty is right, these people are compensated in a way that is absurdly out of line with their marginal productivities. But, in a competitive world, companies that throw resources away on executive compensation would surely go out of business. Conclusion: The world is not perfectly competitive. Indeed, we have theories where technological innovation produces temporary monopoly profits, and we might imagine that CEOs are in good positions to skim off some of the rents. For these and other reasons, we might imagine that a lower rate of growth, and a lower level of innovation, might lead to less concentration in wealth at the upper end, not more.
Capital is certainly not a completely dispassionate work of science. Piketty seems quite willing to embrace ideas about what is "just" and what is not, and he can be dismissive of his fellow economists. He says:
...the discipline of economics has yet to get over its childish passion for mathematics and for purely theoretical and often highly ideological speculation, at the expense of historical research and collaboration with the other social sciences.Not only are economists ignoring the important problems of the world, the American ones are in league with the top 1%:
Among the members of these upper income groups are US academic economists, many of whom believe that the economy of the United States is working fairly well and, in particular, that it rewards talent and merit accurately and precisely. This is a very comprehensible human reaction.Sales of Capital have now put Piketty himself in the "upper income group." Economists are certainly easy targets, and it didn't hurt Piketty's sales to distance himself from these egghead ivory-tower types. This is a very comprehensible human reaction.
To think about the distribution of income and wealth, to address problems of misallocation and poverty, we need good economic models - ones that capture how people make choices about occupations, interhousehold allocation and bequests, labor supply, and innovation. Economists have certainly constructed good models that incorporate these things, but our knowledge is far from perfect - we need to know more. We need to carefully analyze the important incentive effects of taxation that Piketty either dismisses or sweeps under the rug. Indeed, Piketty would not be the first person who thought of the top 1% as possessing a pot of resources that could be freely redistributed with little or no long-term consequences. It would perhaps be preferable if economists concerned with income distribution were to focus more on poverty than the outrageous incomes and wealth of the top 1%. It is unlikely that pure transfers from rich to poor through the tax system will solve - or efficiently solve - problems of poverty, in the United States or elsewhere. My best guess is that our time would be well spent on thinking about human capital accumulation and education, and how public policy could be reoriented to promoting both in ways that have the highest payoff.