The economics of inequality, by Thomas Piketty (Harvard, £16.95)
Thomas Piketty’s Capital in the Twenty-First Century had a massive impact when it came out last year. Now comes the prequel. We have not had to wait for quite as long as for Harper Lee’s Go Set a Watchman but the idea is the same—after the bestseller, let’s publish the back catalogue. This book appeared in French in 1997 but has only now been translated into English. It has been partly updated but much of the analysis precedes his subsequent masterwork. And it shows. Piketty clears the ground by taking us through many of the economic issues in understanding inequality, but it lacks broad historical sweep. Instead we get a useful review of the issues in which the tenets of neoliberal economics are tested, but no alternative account is put forward.
Capital in the Twenty-First Century advanced a simple, bold proposition—that the rate of return on capital exceeds the growth rate of the economy: r>g. (An economic principle that is absent from this earlier book, though one can see its origins in some of the analysis.) It is only the turbulent destruction of wealth such as we saw in Europe in the first half of the 20th century which enables societies to break free from the consequences of this iron law, Piketty argues. That proposition caught the imagination because it painted a picture of a society of “patrimonial capitalism” where you lived on assets accumulated by previous generations. But that model has faced some very serious and telling challenges.
Piketty is bold to focus on the ownership of assets, not just income. But it is the high earnings of bankers and senior business leaders which stand out as a driver of inequality in today’s United States—not an elite living off inherited wealth. And when it comes to inequality of incomes the pattern is complicated. America has seen widening inequality of income but that has not been repeated across the west. In Britain, too, we saw widening inequality in the 1980s, but inequality has been broadly stable recently. In the recession many benefits rose with inflation whereas wages did not grow at all or even fell—that is why the Chancellor, George Osborne, justifies his freeze in benefits. And meanwhile the earnings of the top 20 per cent have been particularly hit by the big falls in bankers’ bonuses.
Behind this, the underlying question is whether you see modern capitalism as fundamentally a benign force. Piketty is not a Marxist, but like Karl Marx he sees capitalism as enriching the few and not the many because of high returns to owners of capital. But capitalism both needs and creates prosperous consumers—hence Joseph Schumpeter’s observation that “The capitalist engine is first and last an engine of mass production which unavoidably means also production for the masses.” And that engine is now operating globally, whereas Piketty tends to focus on nation states in advanced western countries. The spread of forms of capitalism across the world has manifestly reduced the inequality between a worker in China or Brazil compared with one in the US or Europe.
When it comes to wealth there is a significant inequality staring us in the face that Piketty fails to focus on. Many British families confront what looks like a particularly vivid example of his iron law of inequality. The value of the house they own (and hence the imputed rent they get from it) has risen by far more than their earnings. This is driving a new form of inequality—between the insiders who have already got on to the property market and the outsiders for whom barriers to entry are just too great. In large swathes of southern England, research carried out by the Resolution Foundation shows that families with modest incomes may be having to devote half their income to paying mortgages or rents, leaving little left over. But in both of his books, Piketty is surprisingly uninterested in the actual assets individuals own that enable them to capture the high returns to assets which he proposes.
The rise in English house prices does not look like an example of his theory—a lot of it is straightforward failure to match supply to demand. We now have a planning system that makes it hard to build new houses—though at last attempts are being made to redress this. And that power to obstruct development is not an example of the pernicious effects of capitalism—if anything it is the opposite. The right of property owners to develop their own land has been heavily constrained since the Second World War—essentially, development has been collectivised. The underlying philosophy appears to be that the green fields of England are a form of shared natural wealth which should not be built on without an elaborate political process. You may or may not agree with this—I think it has gone too far. It is not an example of untrammelled capitalism. Yet it is what has led to high house prices and the barriers to young people getting on the housing ladder. This creates real anger and is one of the forces driving the radical left who believe they are speaking up for the dispossessed—ironically dispossessed not by capitalism but by the socialisation of planning rights after the war.
After housing, the other major form of personal wealth ownership in the United Kingdom is pensions. Again, there are insiders with generous occupational pensions and outsiders who are unlikely ever to build up such an asset. We now have young people who are working hard in firms to earn revenues that are being used to plug pension deficits. These are deficits in pension schemes for older and retired workers which have been closed to today’s workers. Research we commissioned at the Resolution Foundation showed that this is having a massive effect—running up to £100bn. It is one of the main reasons why the recovery in gross domestic product (GDP) did not immediately feed through into higher living standards. Again this does not have much to do with Piketty’s argument.
In both cases there is a clear pattern—the inequality is between the generations. It is the baby boomers, born between 1945 and 1965, who have ended up with the valuable houses and the gold-plated pensions. This inequality offends our sense of fairness but it also offends the hope at the heart of the modern social contract that each generation will be better off than the one which went before. This inequality in the ownership of wealth between the generations is now a deep problem in the structure of our society and some others such as the US. But Piketty’s iron law does not particularly help us to explain it because his proposition does not tell us how ownership of capital is distributed.
I believe the explanation is simple: we have made it very hard to build houses and very hard to run a company pension scheme. These were ultimately political decisions which have been shaped by the interests of the incumbent generation. Home-owners protest about new house building. And members of occupational pensions press for ever more heavy-handed regulation to protect their asset but this pushes up the costs so that companies withdraw from offering them to their next generation of employees. This is what a generation can do if it fails to recognise the claims of future generations and instead harnesses all the powers of modern government to protect their narrow interest. This is the key driver of a new and pernicious inequality and Piketty has little to say on it.
Above all Piketty is right to focus on inequality as a serious issue. When I was working for Margaret Thatcher 30 years ago, I calculated estimates which showed that an unemployed person on benefits had a higher living standard than a manual worker after the war. But those comparisons missed the point. You live in the society which is around you and how you are relative to other members of that society now is what matters—not that you have access to technologies or services which may not even have existed a generation earlier. Before Piketty, Michael Marmot had shown that where you are relative to others affects your status, your ability to control your own life and your health. Nowadays we all recognise that inequality matters.
The relativities which matter most, however, may not be the enormous ones politicians focus on—how most people live compared with a Russian oligarch. Instead it is the little local inequalities that matter most. As David Hume observed: “It is not a great disproportion between ourselves and others which produces envy but on the contrary proximity. A common soldier bears no envy for his general compared to what he will feel for his sergeant or corporal.” The trouble is that these are the subtle kind of relationships which are not really susceptible to conventional public policy. The renewed focus on inequality challenges both political parties. It certainly sets a trap for Labour. Any serious modern form of socialism, however diluted, has to be honest with the electorate—if they want more money for public services they have to pay for them. There is not some group who are so rich and also so numerous that their incomes or assets can be taxed to pay for the nation’s healthcare or our benefits without the rest of us having to contribute more. The figures do not add up. The failure to level with voters on this issue was the underlying weakness of the last Labour government. With the exception of the famous and much agonised upon 1 per cent increase in national insurance contribution there was no real attempt to broaden the tax base. Instead their contract with the financial services industry was that we will leave you alone and let you keep paying the bonuses provided we can tax them to pay for expansion of the welfare state. But this was not a solid base for funding a modern welfare state. It is why the underlying deficit was growing even in the good times and why the financial crash of 2007/08 had such a devastating effect on the public finances.
You cannot just tax the rich to pay for a big welfare state. Instead you need the kind of appeal to the mutual obligations of all citizens to fund a common insurance scheme, which is what Clement Attlee and William Beveridge believed in. That kind of argument can also be used by one nation Conservatives to explain why we all have to chip in. But it then faces the question of whether people do believe any longer that we are all in this together. Modern liberal societies may now be too diverse for people to agree that we should all fund a welfare state. Bashing the rich then becomes an understandable but unworkable way out of this problem.
For Conservatives there is another danger: if the gap in income and wealth widens and they appear not to care about it. It is tempting to argue that wealth is a reward for exceptional talent and risk taking. This is tantamount to arguing that the rich are rich because they are better than the rest. This sticks in the craw. There is a British aversion to seeing wealth as a reward for exceptional virtue. I much prefer the wisdom of Friedrich Hayek in a great and humane chapter of The Constitution of Liberty. He argues there are a series of accidents and chance events which put some people on the path to riches and exclude others. The distribution of these rewards is not shaped by some moral principle and we should not defend it by claiming it is. This seems to me to be much closer to Tory tradition. A pop star or a City whizz kid may earn far more than a nurse or a scientist but the market does not distribute its gains according to some set of moral judgements on relative worth. The only moral justification of these outcomes is that an attempt to impose our moral judgements of relative merit across the jobs market would involve unworkable and intrusive interference.
But this must not license inactivity. There are real things to be done to reduce inequality. So, for example, the government’s approach to paying its employees can protect the low paid while rigorously scrutinising proposals to pay anyone more than the Prime Minister. The Chancellor’s bold move on the living wage could well compress the wage range for the less affluent half of earners. And the apprenticeship levy could boost investment in training so that less well paid workers get a chance to move on and move up. Above all, younger generations have to be given the chance to participate in the “property-owning democracy” too.
Thomas Piketty’s Capital in the Twenty-First Century had a massive impact when it came out last year. Now comes the prequel. We have not had to wait for quite as long as for Harper Lee’s Go Set a Watchman but the idea is the same—after the bestseller, let’s publish the back catalogue. This book appeared in French in 1997 but has only now been translated into English. It has been partly updated but much of the analysis precedes his subsequent masterwork. And it shows. Piketty clears the ground by taking us through many of the economic issues in understanding inequality, but it lacks broad historical sweep. Instead we get a useful review of the issues in which the tenets of neoliberal economics are tested, but no alternative account is put forward.
Capital in the Twenty-First Century advanced a simple, bold proposition—that the rate of return on capital exceeds the growth rate of the economy: r>g. (An economic principle that is absent from this earlier book, though one can see its origins in some of the analysis.) It is only the turbulent destruction of wealth such as we saw in Europe in the first half of the 20th century which enables societies to break free from the consequences of this iron law, Piketty argues. That proposition caught the imagination because it painted a picture of a society of “patrimonial capitalism” where you lived on assets accumulated by previous generations. But that model has faced some very serious and telling challenges.
Piketty is bold to focus on the ownership of assets, not just income. But it is the high earnings of bankers and senior business leaders which stand out as a driver of inequality in today’s United States—not an elite living off inherited wealth. And when it comes to inequality of incomes the pattern is complicated. America has seen widening inequality of income but that has not been repeated across the west. In Britain, too, we saw widening inequality in the 1980s, but inequality has been broadly stable recently. In the recession many benefits rose with inflation whereas wages did not grow at all or even fell—that is why the Chancellor, George Osborne, justifies his freeze in benefits. And meanwhile the earnings of the top 20 per cent have been particularly hit by the big falls in bankers’ bonuses.
Behind this, the underlying question is whether you see modern capitalism as fundamentally a benign force. Piketty is not a Marxist, but like Karl Marx he sees capitalism as enriching the few and not the many because of high returns to owners of capital. But capitalism both needs and creates prosperous consumers—hence Joseph Schumpeter’s observation that “The capitalist engine is first and last an engine of mass production which unavoidably means also production for the masses.” And that engine is now operating globally, whereas Piketty tends to focus on nation states in advanced western countries. The spread of forms of capitalism across the world has manifestly reduced the inequality between a worker in China or Brazil compared with one in the US or Europe.
When it comes to wealth there is a significant inequality staring us in the face that Piketty fails to focus on. Many British families confront what looks like a particularly vivid example of his iron law of inequality. The value of the house they own (and hence the imputed rent they get from it) has risen by far more than their earnings. This is driving a new form of inequality—between the insiders who have already got on to the property market and the outsiders for whom barriers to entry are just too great. In large swathes of southern England, research carried out by the Resolution Foundation shows that families with modest incomes may be having to devote half their income to paying mortgages or rents, leaving little left over. But in both of his books, Piketty is surprisingly uninterested in the actual assets individuals own that enable them to capture the high returns to assets which he proposes.
The rise in English house prices does not look like an example of his theory—a lot of it is straightforward failure to match supply to demand. We now have a planning system that makes it hard to build new houses—though at last attempts are being made to redress this. And that power to obstruct development is not an example of the pernicious effects of capitalism—if anything it is the opposite. The right of property owners to develop their own land has been heavily constrained since the Second World War—essentially, development has been collectivised. The underlying philosophy appears to be that the green fields of England are a form of shared natural wealth which should not be built on without an elaborate political process. You may or may not agree with this—I think it has gone too far. It is not an example of untrammelled capitalism. Yet it is what has led to high house prices and the barriers to young people getting on the housing ladder. This creates real anger and is one of the forces driving the radical left who believe they are speaking up for the dispossessed—ironically dispossessed not by capitalism but by the socialisation of planning rights after the war.
After housing, the other major form of personal wealth ownership in the United Kingdom is pensions. Again, there are insiders with generous occupational pensions and outsiders who are unlikely ever to build up such an asset. We now have young people who are working hard in firms to earn revenues that are being used to plug pension deficits. These are deficits in pension schemes for older and retired workers which have been closed to today’s workers. Research we commissioned at the Resolution Foundation showed that this is having a massive effect—running up to £100bn. It is one of the main reasons why the recovery in gross domestic product (GDP) did not immediately feed through into higher living standards. Again this does not have much to do with Piketty’s argument.
In both cases there is a clear pattern—the inequality is between the generations. It is the baby boomers, born between 1945 and 1965, who have ended up with the valuable houses and the gold-plated pensions. This inequality offends our sense of fairness but it also offends the hope at the heart of the modern social contract that each generation will be better off than the one which went before. This inequality in the ownership of wealth between the generations is now a deep problem in the structure of our society and some others such as the US. But Piketty’s iron law does not particularly help us to explain it because his proposition does not tell us how ownership of capital is distributed.
I believe the explanation is simple: we have made it very hard to build houses and very hard to run a company pension scheme. These were ultimately political decisions which have been shaped by the interests of the incumbent generation. Home-owners protest about new house building. And members of occupational pensions press for ever more heavy-handed regulation to protect their asset but this pushes up the costs so that companies withdraw from offering them to their next generation of employees. This is what a generation can do if it fails to recognise the claims of future generations and instead harnesses all the powers of modern government to protect their narrow interest. This is the key driver of a new and pernicious inequality and Piketty has little to say on it.
"You live in the society which is around you and how you are relative to other members of that society now is what matters—not that you have access to technologies or services which may not even have existed a generation earlier"This book does however offer some useful and lucid analysis of equality issues. Piketty reminds us of the effects of family structure—do we care about the individual or the household? The family is one of the most effective mechanisms we have got for redistributing from rich to poor and across generations. But it may not work as well as it used to because of the phenomenon of assortative mating in which well-educated women and well-educated men marry each other, meaning that two-earner couples concentrate earning power rather than redistributing it. He has a useful discussion of the extent to which education can be seen as tool to reduce inequality—where he is a bit of a sceptic. He also shows how sometimes the tools of conventional economic analysis have disguised distributional issues.
Above all Piketty is right to focus on inequality as a serious issue. When I was working for Margaret Thatcher 30 years ago, I calculated estimates which showed that an unemployed person on benefits had a higher living standard than a manual worker after the war. But those comparisons missed the point. You live in the society which is around you and how you are relative to other members of that society now is what matters—not that you have access to technologies or services which may not even have existed a generation earlier. Before Piketty, Michael Marmot had shown that where you are relative to others affects your status, your ability to control your own life and your health. Nowadays we all recognise that inequality matters.
The relativities which matter most, however, may not be the enormous ones politicians focus on—how most people live compared with a Russian oligarch. Instead it is the little local inequalities that matter most. As David Hume observed: “It is not a great disproportion between ourselves and others which produces envy but on the contrary proximity. A common soldier bears no envy for his general compared to what he will feel for his sergeant or corporal.” The trouble is that these are the subtle kind of relationships which are not really susceptible to conventional public policy. The renewed focus on inequality challenges both political parties. It certainly sets a trap for Labour. Any serious modern form of socialism, however diluted, has to be honest with the electorate—if they want more money for public services they have to pay for them. There is not some group who are so rich and also so numerous that their incomes or assets can be taxed to pay for the nation’s healthcare or our benefits without the rest of us having to contribute more. The figures do not add up. The failure to level with voters on this issue was the underlying weakness of the last Labour government. With the exception of the famous and much agonised upon 1 per cent increase in national insurance contribution there was no real attempt to broaden the tax base. Instead their contract with the financial services industry was that we will leave you alone and let you keep paying the bonuses provided we can tax them to pay for expansion of the welfare state. But this was not a solid base for funding a modern welfare state. It is why the underlying deficit was growing even in the good times and why the financial crash of 2007/08 had such a devastating effect on the public finances.
You cannot just tax the rich to pay for a big welfare state. Instead you need the kind of appeal to the mutual obligations of all citizens to fund a common insurance scheme, which is what Clement Attlee and William Beveridge believed in. That kind of argument can also be used by one nation Conservatives to explain why we all have to chip in. But it then faces the question of whether people do believe any longer that we are all in this together. Modern liberal societies may now be too diverse for people to agree that we should all fund a welfare state. Bashing the rich then becomes an understandable but unworkable way out of this problem.
For Conservatives there is another danger: if the gap in income and wealth widens and they appear not to care about it. It is tempting to argue that wealth is a reward for exceptional talent and risk taking. This is tantamount to arguing that the rich are rich because they are better than the rest. This sticks in the craw. There is a British aversion to seeing wealth as a reward for exceptional virtue. I much prefer the wisdom of Friedrich Hayek in a great and humane chapter of The Constitution of Liberty. He argues there are a series of accidents and chance events which put some people on the path to riches and exclude others. The distribution of these rewards is not shaped by some moral principle and we should not defend it by claiming it is. This seems to me to be much closer to Tory tradition. A pop star or a City whizz kid may earn far more than a nurse or a scientist but the market does not distribute its gains according to some set of moral judgements on relative worth. The only moral justification of these outcomes is that an attempt to impose our moral judgements of relative merit across the jobs market would involve unworkable and intrusive interference.
But this must not license inactivity. There are real things to be done to reduce inequality. So, for example, the government’s approach to paying its employees can protect the low paid while rigorously scrutinising proposals to pay anyone more than the Prime Minister. The Chancellor’s bold move on the living wage could well compress the wage range for the less affluent half of earners. And the apprenticeship levy could boost investment in training so that less well paid workers get a chance to move on and move up. Above all, younger generations have to be given the chance to participate in the “property-owning democracy” too.
