Thomas Piketty rocked the intellectual world this past spring when his 700-page hardcover, Capital in the Twenty-First Century, became a bestseller in the United States. The epic historical tome takes a poetically long arc, covering the entire world history of capitalism from its birth nearly 300 years ago in Western Europe, to its modern domination of the world economy. It is probably the most compelling systemic critique of capitalism since Karl Marx’s Das Kapital was published back in 1867.
I will explain some parallels between Marx and Piketty below, after I first summarize the theory laid out in Piketty’s work.
Piketty’s central point of the book was to point out that under most normal circumstances, wealth in a capitalist economy will tend to grow faster than the economy as a whole – at least as measured before the effects of taxation. (This is his famous formula, r >g .) This is the condition, Piketty argues, that must inevitably lead to an increasing share of the economy’s income going to a handful of wealthy capitalists, rather than the working- and middle-class majority – what people in the Occupy movement referred to as the “99 Percent.”
To put it in simple mathematical terms, we can use Piketty’s First Fundamental Law of Capitalism: a = rB, where B is the capital-income ratio, a is the share of income going to capital, and r is the rate of return on capital. This can be rewritten as B = a/r, which better explains the contradiction. As B increases due to the typical condition r > g, then either a must increase, or r decrease, or some combination of both.
The “golden age of capitalism” in the 30 years after World War II can be explained in Europe mainly by a collapse of B between 1910 and 1950, after a long period of wartime destruction, debt inflation, confiscatory taxation and loss of colonial assets. The overall European capital-income ratio plummeted from nearly 700% at the turn of the 20th century, to just over 200% by 1950. That meant less capital to service with cash flows. The European economy also rebounded very quickly after the World Wars were behind them, so much so that there were periods where Piketty’s g actually exceeded r !
In the United States, the nation’s private and public infrastructure was not decimated by bombs and tanks in the first half of the 20th century. Nor did they lose a ton of wealth to colonial independence movements. But the U.S. did develop a highly progressive tax system in the period between the beginning of World War I and the end of World War II. That tax progressivity was gradually chipped away at in the following 50-60 years. The result is a much less dramatic drop in capital-income ratios during the World Wars Era in the U.S compared to Europe.
Also, the U.S.’s rapid population growth, plus its historically unconstrained supply of land, gave us a version of capitalism with a long-term B that was naturally smaller than in Europe – about 400% as opposed to 700%. Long-term numbers for Canada are slightly different, but also look far more “American” than “European.”
In my humble idea, this probably does more than any other factor to explain the phenomenon of “American Exceptionalism.” Faster growth, more land and a smaller B made American capitalism, at least in its early days, far less aristocratic and rentier-based than its European counterpart. Because capitalism worked better for the average worker in the U.S., the American working class probably developed a long-term faith in capitalism over time – a faith that unfortunately has gradually morphed into the ugly economic fundamentalism we see in modern political discourse.
And that fundamentalism persists in the United States, at precisely the time that the old realities about our form of capitalism have morphed. Population growth is much slower now than it was 50 years ago. There is less land available to work with as more is developed, so the prices of real estate have begun to balloon. And taxes are not nearly as progressive or redistributive as they were a half-century ago, either.
Meanwhile in Europe, the capital stock has returned to about 550% of annual income, with predictions it will climb to at least 700-800% by the end of the 21st century – unless something is done to reverse the trend. Piketty argues that the best solution to the problems of capitalism is a globally coordinated progressive tax on wealth, in order to stop the largest fortunes from accumulating uncontrollably.
How does this compare to Marxian theory? In his Capital Volume 1, Marx lays out the basic terms of value, commodities, labor and surplus-value. The basic idea is that capital accumulation occurs because capitalist employers extract surplus-value from their workers. (He didn’t think that surplus could come out of the machinery that workers operate, even though he acknowledges that these machines are themselves produced by other workers in other industries). This surplus-value becomes the source of profit, and any profit income not consumed by the capitalist is reinvested as new capital.
One of Marx’s most important predictions (besides steadily growing wealth and income inequality) is that the rate of profit would gradually tend to fall over the course of capitalism’s evolution, at the same time that inequality was increasing. In his views, this occurred because as production became more and more capital-intensive, then labor consisted of a smaller and smaller share of total production costs, and thus had to be exploited more ruthlessly in order to get the same amount of surplus per unit of production cost. There is, of course, a limit to how much the workers can be exploited, so that over time there would inevitably be less surplus per unit of production and hence, lower profit rates. The working class would see their incomes stagnate or decline while capitalists got richer and richer. Yet at the same time, there would be less and less return on a capital investment of a given size!
Now back to Piketty, and in particular, the equation B = a/r.
A more “capital intensive” production over time that Marx described, seems to parallel nicely to the increasing B. And Marx lived in the 19th century, at a time when B was steadily rising in Europe. So as B increases, there should be a trend toward increasing a and decreasing r. Well…the variable a represents the capital share of income, which parallels inequality. The r represents rate of return on capital, which very closely parallels Marx’s rate of profit.
So to sum up: Both Marx and Piketty suggest that over the long term, capitalism will result in tremendous economic growth. But the internal mechanisms of the system will not distribute the fruits of growth among everybody, but tend to concentrate the benefits among those who already own wealth. This drives the increasing inequality. At the same time, as the capital/labor or capital/income ratio increases, there is more capital that has to be “fed” with a rate of return or a profit, so that the rate of return or the rate of profit tends to fall.
But as to what we do about fixing this problem in capitalism? Well…that has to wait for next time.