Bill Gates and the Economist reviews Piketty

Why Inequality Matters

By Bill Gates
on October 13, 2014
http://www.gatesnotes.com/Books/Why-Inequality-Matters-Capital-in-21st-Century-Review
A 700-page treatise on economics translated from French is not exactly a light summer readeven
for someone with an admittedly high geek quotient. But this past July, I felt compelled to read
Thomas Pikettys Capital in the Twenty-First Century after reading several reviews and hearing about
it from friends.
Im glad I did. I encourage you to read it too, or at least a good summary, like this one from The
Economist. Piketty was nice enough to talk with me about his work on a Skype call last month. As I
told him, I agree with his most important conclusions, and I hope his work will draw more smart
people into the study of wealth and income inequalitybecause the more we understand about the
causes and cures, the better. I also said I have concerns about some elements of his analysis, which
Ill share below.
I very much agree with Piketty that:
High levels of inequality are a problemmessing up economic incentives, tilting
democracies in favor of powerful interests, and undercutting the ideal that all people are
created equal.
Capitalism does not self-correct toward greater equalitythat is, excess wealth
concentration can have a snowball effect if left unchecked.
Governments can play a constructive role in offsetting the snowballing tendencies if and
when they choose to do so.
To be clear, when I say that high levels of inequality are a problem, I dont want to imply that the
world is getting worse. In fact, thanks to the rise of the middle class in countries like China, Mexico,
Colombia, Brazil, and Thailand, the world as a whole is actually becoming more egalitarian, and that
positive global trend is likely to continue.
But extreme inequality should not be ignoredor worse, celebrated as a sign that we have a high-
performing economy and healthy society. Yes, some level of inequality is built in to capitalism. As
Piketty argues, it is inherent to the system. The question is, what level of inequality is acceptable?
And when does inequality start doing more harm than good? Thats something we should have a
public discussion about, and its great that Piketty helped advance that discussion in such a serious
way.
However, Pikettys book has some important flaws that I hope he and other economists will address
in the coming years.
For all of Pikettys data on historical trends, he does not give a full picture of how wealth is created
and how it decays. At the core of his book is a simple equation: r > g, where r stands for the average
rate of return on capital and g stands for the rate of growth of the economy. The idea is that when
the returns on capital outpace the returns on labor, over time the wealth gap will widen between
people who have a lot of capital and those who rely on their labor. The equation is so central to
Pikettys arguments that he says it represents the fundamental force for divergence and sums up
the overall logic of my conclusions.
Other economists have assembled large historical datasets and cast doubt on the value of r > g for
understanding whether inequality will widen or narrow. Im not an expert on that question. What I
do know is that Pikettys r > g doesnt adequately differentiate among different kinds of capital with
different social utility.
Imagine three types of wealthy people. One guy is putting his capital into building his business. Then
theres a woman whos giving most of her wealth to charity. A third person is mostly consuming,
spending a lot of money on things like a yacht and plane. While its true that the wealth of all three
people is contributing to inequality, I would argue that the first two are delivering more value to
society than the third. I wish Piketty had made this distinction, because it has important policy
implications, which Ill get to below.
More important, I believe Pikettys r > g analysis doesnt account for powerful forces that counteract
the accumulation of wealth from one generation to the next. I fully agree that we dont want to live
in an aristocratic society in which already-wealthy families get richer simply by sitting on their laurels
and collecting what Piketty calls rentier incomethat is, the returns people earn when they let
others use their money, land, or other property. But I dont think America is anything close to that.
Take a look at the Forbes 400 list of the wealthiest Americans. About half the people on the list are
entrepreneurs whose companies did very well (thanks to hard work as well as a lot of luck). Contrary
to Pikettys rentier hypothesis, I dont see anyone on the list whose ancestors bought a great parcel
of land in 1780 and have been accumulating family wealth by collecting rents ever since. In America,
that old money is long gonethrough instability, inflation, taxes, philanthropy, and spending.
You can see one wealth-decaying dynamic in the history of successful industries. In the early part of
the 20th century, Henry Ford and a small number of other entrepreneurs did very well in the
automobile industry. They owned a huge amount of the stock of car companies that achieved a scale
advantage and massive profitability. These successful entrepreneurs were the outliers. Far more
peopleincluding many rentiers who invested their family wealth in the auto industrysaw their
investments go bust in the period from 1910 to 1940, when the American auto industry shrank from
224 manufacturers down to 21. So instead of a transfer of wealth toward rentiers and other passive
investors, you often get the opposite. I have seen the same phenomenon at work in technology and
other fields.
Piketty is right that there are forces that can lead to snowballing wealth (including the fact that the
children of wealthy people often get access to networks that can help them land internships, jobs,
etc.). However, there are also forces that contribute to the decay of wealth, and Capital doesnt give
enough weight to them.
I am also disappointed that Piketty focused heavily on data on wealth and income while neglecting
consumption altogether. Consumption data represent the goods and services that people buy
including food, clothing, housing, education, and healthand can add a lot of depth to our
understanding of how people actually live. Particularly in rich societies, the income lens really
doesnt give you the sense of what needs to be fixed.
There are many reasons why income data, in particular, can be misleading. For example, a medical
student with no income and lots of student loans would look in the official statistics like shes in a
dire situation but may well have a very high income in the future. Or a more extreme example: Some
very wealthy people who are not actively working show up below the poverty line in years when
they dont sell any stock or receive other forms of income.
Its not that we should ignore the wealth and income data. But consumption data may be even more
important for understanding human welfare. At a minimum, it shows a differentand generally
rosierpicture from the one that Piketty paints. Ideally, Id like to see studies that draw from
wealth, income, and consumption data together.
Even if we dont have a perfect picture today, we certainly know enough about the challenges that
we can take action.
Pikettys favorite solution is a progressive annual tax on capital, rather than income. He argues that
this kind of tax will make it possible to avoid an endless inegalitarian spiral while preserving
competition and incentives for new instances of primitive accumulation.
I agree that taxation should shift away from taxing labor. It doesnt make any sense that labor in the
United States is taxed so heavily relative to capital. It will make even less sense in the coming years,
as robots and other forms of automation come to perform more and more of the skills that human
laborers do today.
But rather than move to a progressive tax on capital, as Piketty would like, I think wed be best off
with a progressive tax on consumption. Think about the three wealthy people I described earlier:
One investing in companies, one in philanthropy, and one in a lavish lifestyle. Theres nothing wrong
with the last guy, but I think he should pay more taxes than the others. As Piketty pointed out when
we spoke, it's hard to measure consumption (for example, should political donations count?). But
then, almost every tax systemincluding a wealth taxhas similar challenges.
Like Piketty, Im also a big believer in the estate tax. Letting inheritors consume or allocate capital
disproportionately simply based on the lottery of birth is not a smart or fair way to allocate
resources. As Warren Buffett likes to say, thats like choosing the 2020 Olympic team by picking the
eldest sons of the gold-medal winners in the 2000 Olympics. I believe we should maintain the
estate tax and invest the proceeds in education and researchthe best way to strengthen our
country for the future.
Philanthropy also can be an important part of the solution set. Its too bad that Piketty devotes so
little space to it. A century and a quarter ago, Andrew Carnegie was a lonely voice encouraging his
wealthy peers to give back substantial portions of their wealth. Today, a growing number of very
wealthy people are pledging to do just that. Philanthropy done well not only produces direct
benefits for society, it also reduces dynastic wealth. Melinda and I are strong believers that dynastic
wealth is bad for both society and the children involved. We want our children to make their own
way in the world. Theyll have all sorts of advantages, but it will be up to them to create their lives
and careers.
The debate over wealth and inequality has generated a lot of partisan heat. I dont have a magic
solution for that. But I do know that, even with its flaws, Pikettys work contributes at least as much
light as heat. And now Im eager to see research that brings more light to this important topic.
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The Economist explains
Thomas Pikettys Capital, summarised in four paragraphs
http://www.economist.com/blogs/economist-explains/2014/05/economist-explains
IT IS the economics book taking the world by storm. "Capital in the Twenty-First Century", written by
the French economist Thomas Piketty, was published in French last year and in English in March of
this year. The English version quickly became an unlikely bestseller, and it has prompted a broad and
energetic debate on the books subject: the outlook for global inequality. Some reckon it heralds or
may itself cause a pronounced shift in the focus of economic policy, toward distributional questions.
This newspaper has hailed Mr Piketty as "the modern Marx" (Karl, that is). But whats it all about?
"Capital" is built on more than a decade of research by Mr Piketty and a handful of other
economists, detailing historical changes in the concentration of income and wealth. This pile of data
allows Mr Piketty to sketch out the evolution of inequality since the beginning of the industrial
revolution. In the 18th and 19th centuries western European society was highly unequal. Private
wealth dwarfed national income and was concentrated in the hands of the rich families who sat atop
a relatively rigid class structure. This system persisted even as industrialisation slowly contributed to
rising wages for workers. Only the chaos of the first and second world wars and the Depression
disrupted this pattern. High taxes, inflation, bankruptcies, and the growth of sprawling welfare
states caused wealth to shrink dramatically, and ushered in a period in which both income and
wealth were distributed in relatively egalitarian fashion. But the shocks of the early 20th century
have faded and wealth is now reasserting itself. On many measures, Mr Piketty reckons, the
importance of wealth in modern economies is approaching levels last seen before the first world
war.
From this history, Mr Piketty derives a grand theory of capital and inequality. As a general rule
wealth grows faster than economic output, he explains, a concept he captures in the expression r > g
(where r is the rate of return to wealth and g is the economic growth rate). Other things being equal,
faster economic growth will diminish the importance of wealth in a society, whereas slower growth
will increase it (and demographic change that slows global growth will make capital more dominant).
But there are no natural forces pushing against the steady concentration of wealth. Only a burst of
rapid growth (from technological progress or rising population) or government intervention can be
counted on to keep economies from returning to the patrimonial capitalism that worried Karl
Marx. Mr Piketty closes the book by recommending that governments step in now, by adopting a
global tax on wealth, to prevent soaring inequality contributing to economic or political instability
down the road.
The book has unsurprisingly attracted plenty of criticism. Some wonder whether Mr Piketty is right
to think the future will look like the past. Theory argues that it should become ever harder to earn a
good return on wealth the more there is of it. And todays super-rich mostly come by their wealth
through work, rather than via inheritance. Others argue that Mr Pikettys policy recommendations
are more ideologically than economically driven and could do more harm than good. But many of
the sceptics nonetheless have kind words for the books contributions, in terms of data and analysis.
Whether or not Mr Piketty succeeds in changing policy, he will have influenced the way thousands of
readers and plenty of economists think about these issues.