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Capital in the 21st Century: Review article

Christopher Sheil

Capital in the Twenty-First Century by Thomas Piketty was published in the United States by Harvard University Press on 28 March. The book claims to define the ‘central contradiction of capitalism’, no less, expressed as ‘r > g’. 

The reception reads like a fairy tale. Three American Nobel laureates promptly awarded Piketty high praise. In the New York Review of Books, Paul Krugman described the work as a ‘magnificent, sweeping, meditation on inequality … that will change both the way we think about society and the way we do economics’. In a reception at the City University of New York Graduate Centre, Joseph Stiglitz welcomed the book for providing ‘a framework for thinking about the evolution of inequality and wealth’. In the New Republic, Robert Solow, a veteran Keynesian and key figure with Paul Samuelson in defining America’s post-war neoclassical synthesis, reviewed the work under the headline, ‘Thomas Piketty is right’. The author, a 42-year old French economics professor, was invited to lecture the IMF and meet with the White House Council of Economic Advisers and the head of the US Treasury, Jacob Lew, before setting off on a whirlwind tour of packed lecture theatres through a string of leading US universities.

Already hotly anticipated on the internet, Capital in the Twenty-First Century shot up the US bestseller lists, where it still sits as the biggest selling book at Amazon and the biggest selling work of non-fiction on the New York Times list. Across the Atlantic, there was a launch in Britain a couple weeks later, where the book has now also soared up the charts. All this action has in turn sent the book back up the bestselling lists in France, where it was first published last year. In other words, it’s safe enough to say that Capital in the Twenty-First Century is probably the biggest selling book in the English and French speaking world right now, and Japanese, Chinese and Indian translations are in preparation. The idea of a ‘rock star economist’ is an oxymoron if ever there was one, and yet this is how Piketty is now commonly described in the media. Astonishing but true, the biggest intellectual topic of conversation in the world today is social inequality.

Although millions of words have already been written on the book, the Australian reception has been muted. Reviews have belatedly appeared in the nation’s two print-media outlets, but there has been almost no discussion outside the internet, and certainly nothing like the noise elsewhere. Here I will consider Piketty’s argument and offer a few reflections.

The argument

At the outset, it must be understood that Piketty uses ‘the words “capital” and “wealth” interchangeably, as if they were perfect synonyms’ (p. 47). Unlike the economics of production, which classically separates the three factors of land, capital and labour, Piketty has focused on the economics of distribution and categorises ‘capital’ as the market value of everything owned by the residents and government of a country, provided it can be traded.

‘Capital’ thus refers to the total non-financial assets (‘land, dwellings, commercial inventory, other buildings, machinery, infrastructure, patents, and other directly owned professional assets’) and financial assets (‘bank accounts, mutual funds, bonds, stocks, financial investments of all kinds, insurance policies, pension funds, etc.’), less liabilities (debt). With some justification, Piketty generally leaves publicly owned capital aside, and he specifically excludes so-called ‘human capital’, except in slave societies (notably the American South). ‘Capital’ is anything that you can sell in a market to raise financial capital, which is basically the term’s everyday rather than the physical production usage.

At the base of the work, the foundation on which everything else ultimately stands, Piketty derives capital-income ratios for many countries and the world at large, which stretch back one or two centuries, with occasional excursions all the way back to Antiquity, believe it or not. He does this very cleverly and simply by dividing the value of the stock of national capital by the flow of national income in each given year, just using whatever the currency was at the time. This gives the author a universal yardstick for comparisons, solving countless measurement issues across time both within and between countries in one blow.

What we’re really reading here, then, is a narrative of world history, mainly but not exclusively covering the full modern period, through the prism of the stock of capital in whatever place and year, expressed as a ratio of the annual income. Does it matter whether a country has a stock of capital equal to twice its annual income, or four times, or six times, or a filthy rich ten times, which is where we could be heading if we continue on the present path? Suffice it to say immediately that the book makes a strong argument that social inequality grows whenever the capital stock grows. Strictly, inequality doesn’t have to grow with capital, but as capital is everywhere concentrated among the few, it always will, unless restrained. This might seem like stating the obvious, but Piketty kicks the argument up a level by seriously seeking to prove the point and offering some possible solutions.

The picture below shows the capital-income ratios for the United Kingdom, France and Germany from 1870 to the present, the mid- to late-modern period:

Note the U-shape that describes the period encompassing the two world wars and bottoms out in 1950, a period with low capital stocks, from which Europe did not decisively turn until 1980. One way or another, the book is an investigation into whether the post-war period up to 1980 — known in France as the ‘Trente Glorieuses’ (the 30 glorious years, from 1945 to 1975) and in the rest of the developed world as the ‘Golden Age’ — should be regarded as the norm or an anomaly. As can be seen, the capital stock in the glorious golden years was only worth about 2-3 years’ income. Over the recent decades, the neo-liberal decades, the ratio has climbed to 4-6 years’ income and is rising rapidly, as shown in the figure below, which tracks the eight richest (per capita) countries in the world — including Australia, where the ratio has rocketed up from three to five times.

Piketty argues that we’re probably heading back to the ratios that were common in what is remembered as the ‘Belle Époque’ (the beautiful era) or ‘Gilded Age’ before the Great War, symbolised by the Titanic and marked by extreme inequality. If we want some idea of what the future holds, he reckons we should look at 1914, not 2014, and especially not the anomalous 1945-1980 era.

The method

To isolate the share of national income claimed by capital, Piketty announces the ‘first fundamental law of capitalism’, a somewhat tongue in cheek expression (as with the title of the book, after Marx). Piketty is pretty well read in economics, history and literature, and often writes with a knowing smile. The style is utterly scholarly, the temper remarkably calm and even, but it’s hard not to feel in the company of someone who feels he’s got the argument beat, such that the tone is generous, open, cheery and optimistic, despite the epic horror story that is ultimately what the book is about.

As it happens, the ‘first fundamental law of capitalism’ extends an economist’s version of a joke by positing a simple accounting identity: α = r x β, where α is the share of national income going to capital, r is the rate of return on capital and β is the capital-income ratio. Piketty is serious about the need to understand the identity. When it comes to capitalism in its own terms, there’s nothing so important as knowing the share of the national income capital’s getting, which this identity isolates. If, for example, the average annual rate of return on capital, r, is 5 per cent and the amount of capital in play, β, is equal to six times the national income, then the first fundamental law of capitalism tells us that capital’s share, α, will be 5 per cent of 600 per cent = 30 per cent. The return to labour will be the residual 70 per cent, the capital/labour split, the split that matters to just about everyone, one way or the other.

       Piketty posits a second formula — there are only two formulae at the centre of the book — to explain the variations in β in the long run, flagged as the ‘second fundamental law of capitalism’. The relations are more complex but the arithmetic is just as elementary: β = s/g, where g is the income growth rate and s is the rate of saving (as distinct from consuming). The ups and downs of the interaction between a nation’s income and saving rates determines how much capital accumulates. There is another insidery joke here (which isn’t made apparent till 60 pages on), because the ‘second fundamental law of capitalism’ is actually the neoclassical model of economic growth defined by Robert Solow, locating where Piketty stands within the schools of economics, which is with the neoclassical synthesis. The Keynesian neoclassical synthesis — as implemented, not necessarily in the way that Keynes himself might have — was a synthesis of market prices and macroeconomic leverage over equilibrium within the context of full employment. The Piketty synthesis — or, as Krugman put it, his 'unified field theory of inequality' — integrates market pricing and leverage over distribution within the context of moderate inequality. The post-war Keynesians were interested in saving because of its relationship with production; Piketty is interested in its relationship with distribution. 

Yet to pigeon-hole the author as a distributive Keynesian would sell him short. Piketty fully accepts the market in principle, but hedges his bets throughout on whether things ever really operate as theory says they should, only takes market information seriously over the long term, and is keen to draw insights from wherever they might come. It’s ridiculous to describe Piketty as a Marxist, as is the wont of the Fox News et al crowd, but he's akin insofar as Marx was also concerned about inequality, as of course were Smith, Malthus, Ricardo and all the classical school. Piketty has some interesting asides about Marx, including the observation that Karl was writing in a context where there had been no wage rise to speak of for about 60 years and some of his sources suggested that the capital-income ratio, β, was greater than ten times. With a 5 per cent rate of return, r, capital would have been claiming over 50 per cent of income, α, which anyone might have wondered about. It’s refreshing to read a book in which Marx figures as just another scholar in the field, but Piketty makes no bones about how badly he thinks Karl got the springs of growth wrong. No; what Piketty wants is to make capitalism work a little better; to head off the extreme inequality that the current rise in the capital-income ratio probably implies, and to do this in a modest and open-ended way, and in particular, in a way that will not harm income growth. Pushed all the way, ultimately Piketty is a classicist in orientation, as amended by neoclassical reasoning minus its stupidities plus any sensible augmentations. As he puts it, he 'sees economics as a sub-discipline of the social sciences, alongside history, sociology, anthropology, and political science' (p. 573).      

To sum up, Piketty tests his research against the neoclassical growth model over modern history in a bid to figure out just how high the capital ratio can or might go and the implications for inequality. The genre is known as ‘cliometrics’, although the work is more textured than that tag implies. The author is sensitive to the sin of anachronism, notably in contrasting 19th century cynicism over the relationship between wealth and merit with 20th century rationalisations that appeal to justice and virtue, not to mention productivity. One of the work’s charms is the way aspects of the thesis are illustrated with the changing social consciousness of inequality in contemporaneous novels (and more recently, on television). Yet the real power here stems from the awesome research it draws on. This is a big book: 577 pages of text, 18 tables, almost 100 graphs, 76 pages of notes, and this is merely the beginning. The research also includes a dense 97-page online appendix of data and notes that lead in turn to hundreds perhaps thousands more pages of data and analysis, much of it published by Piketty and his colleagues over the past 15 years. No one has doubted that this book is based on the biggest store of data on inequality known to humankind. The former head of the US Treasury under Bill Clinton, Larry Summers, has suggested that the empirical findings alone are a ‘Nobel prize-winning contribution’.

The nub in theory

The book is divided into four parts and the theoretical issues come to a head at the end of Part Two, which looks at the capital/labour split and where Piketty pursues the question of how the rate of return is determined, the r in the now famous r > g. As a starting point — and this is why the book must command respect — Piketty reports his empirical findings, which suggest that the average annual r has basically always been about 4-5 per cent. There are minor shifts and qualifications associated with the figures (variations according to demand, asset classes, boundary and size issues, risks, etc.), but after all is added, subtracted and averaged, 4-5 per cent is the bottom empirical line. The history is shown below in the case of the United Kingdom between 1770 and 2010 (France shows similar results from 1820):

Make no mistake, here we are at the nub of the argument, for the resilience of r in the face of rising stocks of capital defies the good old law of supply and demand. In theoretical terms, Piketty’s explanation is that ‘the elasticity of substitution between labor and capital is greater than one’, which enables capital to defend its return, thereby generally ensuring that r > g. This is a complex technical issue that non-economists often find difficult to grasp and I’m not going to attempt an exposition here, but will make five quick points.

First, you might get the issue if you imagine a world where capital can substitute robots for labour at will, in which case the rate of substitution would be limitless. Secondly, the issue takes the thesis straight into what is famously known as the ‘war of the two Cambridges’ that raged in the 1960s between the two claimants to Lord Keynes’ legacy, Joan Robinson’s camp from Cambridge, England, and Solow’s camp from Cambridge, Massachusetts. Piketty (rather glibly) upholds Solow. Thirdly, and I don't imply any self-aggrandisement, this is precisely the issue at the nub of my own book on the commercialisation of Australia’s water infrastructure. This is because any scholar will end up in this zone when they find the contradiction, and my answer was that capital defended r at the physical cost of the production function. Piketty is not of course just referring to capital in a physical sense and I mention this only because, fourthly, while he presses his theoretical point, careful readers will also notice that he quietly allows for another answer, as the trend is

consistent not only with an elasticity of substitution greater than one but also with an increase in capital’s bargaining power vis-a-vis labor over the past few decades, which has seen an increased mobility of capital and heightened competition between states eager to attract investments. It is likely that the two effects have reinforced each other in recent years, and it is also possible that this will continue into the future. In any event, it is important to point out that no self-corrective mechanism exists to prevent a steady increase of the capital/income ratio, β, together with a steady rise in capital’s share of the national income, a. (p. 221)

In other words, while Piketty rightly (in my view) presses the theoretical (as distinct from my market failure) explanation, he quietly allows for other answers, so you don’t really need to agree with him here to appreciate the rest of the thesis. Fifthly, as you will imagine, the relationship between r and g and the question of the elasticity of factor substitution is under Force Ten scrutiny around the world at the moment, and it will be intriguing to see how it pans out. The problem the neoclassical orthodoxy faces is that, if it doesn’t agree with Piketty, the empirical evidence still stands, placing the onus on the critics to come up with an alternative answer, all of which look to me like much more dangerous political dynamite, i.e., Piketty is offering policy makers a neat polite way out, i.e., conservative critics might be wise to be careful what they wish for.

Patrimonial capitalism

There are two more kickers in the story. First, there is a novel feature of inequality today that is most pronounced in the US, which has led the way in the rise of what the author calls ‘supermanagers’ with the result that inequalites are ‘probably higher than in any other society at any time in the past, anywhere in the world, including societies in which skill disparities were extremely large’. The curve for the top 10 per cent looks like this:

Note that we are only talking about total income (not just wealth). As can be seen, a 15 per cent share has been transferred to the top 10 per cent since 1980. If the curve continues, the top 10 per cent will claim 60 per cent by 2030. More finely, the distribution decomposes into this:

I.e., about three-quarters of the transfer has gone to the top 1 per cent (and within this, roughly half went to the top 0.1 per cent). This is novel in that, while inequality overall was more extreme in the Belle Époque, back in those days the top 1 per cent lived almost exclusively off their wealth, i.e., they didn’t work. Today, income from capital exceeds income from labour only in the top 0.1 per cent. While not so widespread, the same pattern is apparent in Australia (think Sol Trujillo or Alan Joyce): 

The above looks immediately artificial in contrast with Europe and Japan:

Piketty takes the so-called 'marginal productivity theory of distribution' to the incomes of the ‘supermanagers’ with devastating effect. ‘It may be excessive to accuse senior executives of having their ‘hands in the till’", says the French professor, 'but the metaphor is probably more apt than Adam Smith’s metaphor of the market’s invisible hand’.

This brings us to wealth, where things are not pre-1914 yet, but heading there, with the top 10 per cent in the US now claiming a 70 per cent share:

The kicker here is the looming social power of inheritance. It should be appreciated that g, the rate of growth, has slowed and is likely to continue to be slow into the future, partly as a consequence of slowing population growth and partly because of slow productivity growth. The book has some marvellous discussion of both these issues, and nothing can be said about the future with certainty, but the bottom line is that, in a context where r > g, the stock of capital automatically looms larger as g slows down. This is obvious if you think about it, and there’s no point delaying over the issue. As an arithmetic inevitability, the stock of capital from the past will loom larger relative to diminishing future growth, and larger in any event so long as r > g, such that, ultimately, since wealth begets power, welcome to patrimonial capitalism. As Piketty puts it:

The inequality r > g implies that wealth accumulated in the past grows more rapidly than output and wages. This inequality expresses a fundamental logical contradiction. The entrepreneur inevitably tends to become a rentier, more and more dominant over those who own nothing but their labor. Once constituted, capital reproduces itself faster than output increases. The past devours the future. (p. 571)

To these long-term dynamics one should add the sub-kickers that ‘the return on capital varies directly with the size of the initial stake and that the divergence in the wealth distribution is occurring on a global scale.’

It will be well to conclude with the following graph that shows the full sweep of the relationship between r and g for the world from Antiquity and includes careful but not infallible projections to 2100. (For economists, this is not only after tax and losses r, as the caption says, but g minus depreciation with balanced foreign accounts, as explained pp. 43-45, i.e., these are both net results):

Note the anomalous period from the Great War to the glorious golden years, when r actually fell below g, for the only time in history. This goes to the optimism with which the work concludes, for it shows that r does not have to be higher than g. The anomaly stems from much wealth being destroyed in big shocks (the world wars and the Great Depression), which was followed by strong catch-up growth in an institutional context that featured progressive taxes, demand management, and a strong trade union movement. Although r cannot rise forever, if left unrestrained, inequality will likely continue to grow and might well exceed any levels seen before in history. The message here is that there are any number of ways of dealing with it. Piketty thinks a modest tax on capital at the top (globally, or effectively globally) should do the trick.

The book

    Capital in the Twenty-First Century is a much better book than represented above. I’ve charged like a bull through Piketty’s china shop. The work is beautifully nuanced, never strident, and never dogmatic. There are many illuminating passages along the way, including a mini-essay on public debt I particularly appreciated (and discussions on the 'social state', European unification, climate change, China, petroleum rents, sovereign wealth funds, and more). The work will be useful in all kinds of ways, if only because it’s a storehouse of salient social statistics and discussions that take in the full scope of the field. As many have noted, including Piketty, it’s possible to appreciate the book’s first three parts and make up your own Part Four, which goes to policy.

That said, it would be wrong to imagine that the thing is a page-turner. Piketty has done his best to tell a story about statistics, but there’s no way a story about statistics is ever going to be fun. You don’t have to know maths above the primary grades to follow the story, but if you can’t even bear that much, you might as well forget about it. Piketty narrates in the first person, invokes all the available devices to make himself clear and precise and easy to follow, there are nice turns of phrase, and no woolly words, but the going is more David Foster Wallace than Jonathan Franzen, let alone Stephen King. This work is about as pleasant to read as any economic history can be that’s seeking to withstand expert scrutiny and be accessible to lay-citizens, but that’s not saying a lot about pleasantness. The reader must work her way through, but can be assured that the time will not be wasted, and in a few places near the middle of the book, there are some wonderful passages where world history comes alive in powerful ways via the comparative method.

In my own field, this is a major contribution to social history, where the traditional approach is to conceptualise classes in relation to production. There’s no denying how useful and downright interesting it is to also conceptualise classes in relation to distribution. Consider the breadth of the following, which describes the order of inequality magnitudes for all countries in all periods for which data is available; in other words, as a rule of thumb for the historical order of modern society everywhere and at all times:

the upper 10 per cent of the labour income distribution generally receives 25-30 per cent of total labour income, whereas the top 10 per cent of the capital income distribution always owns more than 50 per cent of the wealth (and in some societies as much as 90 per cent). Even more strikingly, perhaps, the bottom 50 percent of the wage distribution always receives a significant share of total income (generally between one-quarter and one-third, or approximately as much as the top 10 per cent), whereas the bottom 50 per cent of the wealth distribution owns nothing at all, or almost nothing (always less than 10 per cent and generally less than 5 per cent of total wealth, or one-tenth as much as the wealthiest 10 per cent). Inequalities with respect to labor usually seem mild, moderate, and almost reasonable (to the extent that inequality can be reasonable — this point should not be overstated). In comparison, inequalities with respect to capital are always extreme. (p. 244)

Apart from social historians, this should also become a common point of reference in policy and political circles.

Conclusion: the upshot

Politically, the work has brought an international left to life that includes almost everybody except the neo-liberals, leaving the latter seriously on the defensive for the first time in recent memory. This is not to say that every non-neo-lib loves the book. The jury is out on the question of whether the ‘elasticity of substitution is greater than one’. Larry Summers thinks not. James Galbraith jnr has pooh-poohed everything in the name of the original ‘war of the Cambridges’. He has his points (as always), but it’s difficult to see why they need detract from the analysis. Others will no doubt think the whole situation outrageous, Piketty's approach too modest, and call for stronger society-changing action. Even among the most ardent supporters of policy change, there are disagreements all over the place about the best solutions, and alternative proposals are tumbling out by the day – including a new brace from the OECD last week. Last year's Nobel laureate, Robert Shiller, has argued for governments to devise 'inequality insurance'. The policy movements are likely to play out over some time, and it’s hard to tell the effects, if any, at this stage, but there’s no doubting that the conversation is underway everywhere, and for this alone, Thomas Piketty warrants congratulations. If the first step toward change is to raise our collective consciousness of the issue, he’s ticked the box.

The work is pregnant with other issues crying for attention, but only two more points can be afforded. In the first place, no book becomes a blockbuster unless it resonates with the spirit of the times. Capital in the Twenty-First Century has been brought to the surface by a steadily rising tide of concern about its subject worldwide. Internationally, the book has arrived after much excellent work by Galbraith, Krugman, Stiglitz, Robert Reich and many others in the wake of the GFC and the ‘Occupy Wall Street’ movement. It’s no coincidence that Barack Obama has made inequality the key theme of his administration; that the IMF has just produced a report showing that inequality offers nothing to help economic growth; and that Oxfam has been pressing the issue. Even the Pope recently tweeted that ‘inequality is the root of social evil’. In Australia, one thinks of the work of people such as John Quiggin, Frank Stilwell, and especially Andrew Leigh’s work with Piketty’s Oxford collaborator, Anthony Atkinson. There are of course countless others, but the point is that the fruit has ripened in well fertilised soil.

In the second place, as we head toward some new form of the late 19th/early 20th century social order, we might do well to remember that 1890-1914 was not just a time of ugly inequality and no opportunity for nearly all, but a very creative period. Electricity, the telephone, the motor car, cinematography, aeronautics and the radio were all created, as were factory acts, public education, social security, mass trade unionism, the women’s movement, the labour movement, the universal franchise, income tax, and indeed, Australia itself. It’s eerie to think that, as we approach the 100-year anniversary of the Guns of August, we also find ourselves going back to the same social order, having to get creative all over again. Back then, capital was civilised by an alliance between working-class social and political movements and middle-class liberal reformers. The potential for a broad movement seems just as propitious today, given we’re talking about the interests of at least 90 per cent of individuals, perhaps 99 per cent. The odds look good, unless the wealthy already have the democracy sown up. It would a devilish result if Piketty’s optimism proves to be misplaced because his thesis proves to have already become only too true. 


Suggested citation

Sheil, Christopher, 'Capital in the 21st Century: Review article', Evatt Journal, Vol. 13, No. 3, May 2014<>


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