This NYT interview gives Thomas Piketty an opportunity to provide an overview of his approach to understanding income inequality. It is based upon an historical analysis of inequality. He found that income inequality was higher when the rate of return on capital exceeded the rate of growth in output by a factor of 5-6. The long term growth in real output is around 1.5%. The rate of return on capital can be much higher. For example, the well managed endowments of Harvard and Yale provide a real rate of return after all expenses of over 7%. One of the reasons for the high rate of return is that each of these endowments is very large. The fund managers can take more risk with a portion of the funds, and both Harvard and Yale have the resources to hire the best managers who are able to evaluate a wide variety of investment opportunities. Capital ownership is more concentrated than wage income and those with larger shares of capital, like Harvard and Yale, earn a higher return on the their assets.
Ironically, income inequality was greatly reduced by the unfortunate events of war and the Great Depression which destroyed enormous amounts of accumulated capital. The period after WW ll was a period of rapid growth in output in relation to the return on capital. That led to greater income equality during the post-war period. Slower growth in output since 1970, and a higher rate of return on capital has led to the rise in inequality since 1970 in Europe. The rise in inequality in the US is also the result of institutional changes. Top management has been able to capture a larger share of compensation from cooperative boards. The rise in management compensation is unrelated to growth in productivity, or in corporate performance relative to industry performance according to Piketty.
Hopefully, we will not have to depend upon war and depression to reduce the growth in inequality. It is possible to accomplish this through democratic process but it will be strongly resisted. Piketty believes that it will take a coordinated effort by governments to implement changes in tax policy that are required prevent a continuous rise in inequality as global growth stabilizes at 1.5% and the return on capital remains much higher than the growth in output.
It should not escape our attention that Piketty's form of historical research, and his focus on distribution, departs dramatically from the bulk of the research in the economics profession. Historical research is viewed as unscientific by many economists, and the profession is more concerned with building mathematical models of an abstract economy that has never existed. It is unlikely that Piketty's research will have much of an impact on the profession which views itself as the queen of the social sciences because of the attention that it gives to mathematical models. Moreover, the kind of changes that will required to reduce the growth in inequality will require assistance from other social scientists who better understand many of our institutions and our forms of social organization.