Capital in the Twenty-First Century

Durable Goods and Valuables

Finally, I want to make it clear that private saving as defined here, and therefore private wealth, does not include household purchases of durable goods: furniture, appliances, automobiles, and so on. In this respect I am following international standards for national accounting, under which durable household goods are treated as items of immediate consumption (although the same goods, when purchased by firms, are counted as investments with a high rate of annual depreciation). This is of limited importance for my purposes, however, because durable goods have always represented a relatively small proportion of total wealth, which has not varied much over time: in all rich countries, available estimates indicate that the total value of durable household goods is generally between 30 and 50 percent of national income throughout the period 1970–2010, with no apparent trend.

In other words, everyone owns on average between a third and half a year’s income worth of furniture, refrigerators, cars, and so on, or 10,000–15,000 euros per capita for a national income on the order of 30,000 euros per capita in the early 2010s. This is not a negligible amount and accounts for most of the wealth owned by a large segment of the population. Compared, however, with overall private wealth of five to six years of national income, or 150,000–200,000 euros per person (excluding durable goods), about half of which is in the form of real estate and half in net financial assets (bank deposits, stocks, bonds, and other investments, net of debt) and business capital, this is only a small supplementary amount. Concretely, if we were to include durable goods in private wealth, the only effect would be to add 30–50 percent of national income to the curves shown in Figure 5.3 without significantly modifying the overall evolution.13

Note in passing that apart from real estate and business capital, the only nonfinancial assets included in national accounts under international standards (which I have followed scrupulously in order to ensure consistency in my comparisons of private and national wealth between countries) are “valuables,” including items such as works of art, jewelry, and precious metals such as gold and silver, which households acquire as a pure reservoir of value (or for their aesthetic value) and which in principle do not deteriorate (or deteriorate very little) over time. These valuables are worth much less than durable goods by most estimates, however (between 5 and 10 percent of national income, depending on the country, or between 1,500 and 3,000 per person for a per capita national income of 30,000 euros), hence their share of total private wealth is relatively small, even after the recent rise in the price of gold.14

It is interesting to note that according to available historical estimates, these orders of magnitude do not seem to have changed much over the long run. Estimates of the value of durable goods are generally around 30–50 percent of national income for both the nineteenth and twentieth centuries. Gregory King’s estimates of British national wealth around 1700 show the same thing: the total value of furniture, china, and so on was about 30 percent of national income. The amount of wealth represented by valuables and precious objects seems to have decreased over the long run, however, from 10–15 percent of national income in the late nineteenth and early twentieth century to 5–10 percent today. According to King, the total value of such goods (including metal coin) was as high as 25–30 percent of national income around 1700. In all cases, these are relatively limited amounts compared to total accumulated wealth in Britain of around seven years of national income, primarily in the form of farmland, dwellings, and other capital goods (shops, factories, warehouses, livestock, ships, etc.), at which King does not fail to rejoice and marvel.15

Private Capital Expressed in Years of Disposable Income

Note, moreover, that the capital/income ratio would have attained even higher levels—no doubt the highest ever recorded—in the rich countries in the 2000s and 2010s if I had expressed total private wealth in terms of years of disposable income rather than national income, as I have done thus far. This seemingly technical issue warrants further discussion.

As the name implies, disposable household income (or simply “disposable income”) measures the monetary income that households in a given country dispose of directly. To go from national income to disposable income, one must deduct all taxes, fees, and other obligatory payments and add all monetary transfers (pensions, unemployment insurance, aid to families, welfare payments, etc.). Until the turn of the twentieth century, governments played a limited role in social and economic life (total tax payments were on the order of 10 percent of national income, which went essentially to pay for traditional state functions such as police, army, courts, highways, and so on, so that disposable income was generally around 90 percent of national income). The state’s role increased considerably over the course of the twentieth century, so that disposable income today amounts to around 70–80 percent of national income in the rich countries. As a result, total private wealth expressed in years of disposable income (rather than national income) is significantly higher. For example, private capital in the 2000s represented four to seven years of national income in the rich countries, which would correspond to five to nine years of disposable income (see Figure 5.4).

FIGURE 5.4. Private capital measured in years of disposable income

Expressed in years of household disposable income (about 70–80 percent of national income), the capital/income ratio appears to be larger than when it is expressed in years of national income.

Sources and series: see piketty.pse.ens.fr/capital21c.

Both ways of measuring the capital/income ratio can be justified, depending on how one wants to approach the question. When expressed in terms of disposable income, the ratio emphasizes strictly monetary realities and shows us the magnitude of wealth in relation to the income actually available to households (to save, for instance). In a way, this reflects the concrete reality of the family bank account, and it is important to keep these orders of magnitude in mind. It is also important to note, however, that the gap between disposable income and national income measures by definition the value of public services from which households benefit, especially health and education services financed directly by the public treasury. Such “transfers in kind” are just as valuable as the monetary transfers included in disposable income: they allow the individuals concerned to avoid spending comparable (or even greater) sums on private producers of health and education services. Ignoring such transfers in kind might well distort certain evolutions or international comparisons. That is why it seemed to me preferable to express wealth in years of national income: to do so is to adopt an economic (rather than strictly monetary) view of income. In this book, whenever I refer to the capital/income ratio without further qualification, I am always referring to the ratio of the capital stock to the flow of national income.16

The Question of Foundations and Other Holders of Capital

Note also that for the sake of completeness I have included in private wealth not only the assets and liabilities of private individuals (“households” in national accounting terminology) but also assets and liabilities held by foundations and other nonprofit organizations. To be clear, this category includes only foundations and other organizations financed primarily by gifts from private individuals or income from their properties. Organizations that depend primarily on public subsidies are classified as governmental organizations, and those that depend primarily on the sale of goods are classified as corporations.

In practice, all of these distinctions are malleable and porous. It is rather arbitrary to count the wealth of foundations as part of private wealth rather than public wealth or to place it in a category of its own, since it is in fact a novel form of ownership, intermediate between purely private and strictly public ownership. In practice, when we think of the property owned by churches over the centuries, or the property owned today by organizations such as Doctors without Borders or the Bill and Melinda Gates Foundation, it is clear that we are dealing with a wide variety of moral persons pursuing a range of specific objectives.

Note, however, that the stakes are relatively limited, since the amount of wealth owned by moral persons is generally rather small compared with what physical persons retain for themselves. Available estimates for the various rich countries in the period 1970–2010 show that foundations and other nonprofit organizations always own less than 10 percent and generally less than 5 percent of total private wealth, though with interesting variations between countries: barely 1 percent in France, around 3–4 percent in Japan, and as much as 6–7 percent in the United States (with no apparent trend). Available historical sources indicate that the total value of church-owned property in eighteenth-century France amounted to about 7–8 percent of total private wealth, or approximately 50–60 percent of national income (some of this property was confiscated and sold during the French Revolution to pay off debts incurred by the government of the Ancien Régime).17 In other words, the Catholic Church owned more property in Ancien Régime France (relative to the total private wealth of the era) than prosperous US foundations own today. It is interesting to observe that the two levels are nevertheless fairly close.

These are quite substantial holdings of wealth, especially if we compare them with the meager (and sometimes negative) net wealth owned by the government at various points in time. Compared with total private wealth, however, the wealth of foundations remains fairly modest. In particular, it matters little whether or not we include foundations when considering the general evolution of the ratio of private capital to national income over the long run. Inclusion is justified, moreover, by the fact that it is never easy to define the boundary line between on the one hand various legal structures such as foundations, trust funds, and the like used by wealthy individuals to manage their assets and further their private interests (which are in principle counted in national accounts as individual holdings, assuming they are identified as such) and on the other hand foundations and nonprofits said to be in the public interest. I will come back to this delicate issue in Part Three, where I will discuss the dynamics of global inequality of wealth, and especially great wealth, in the twenty-first century.

The Privatization of Wealth in the Rich Countries

The very sharp increase in private wealth observed in the rich countries, and especially in Europe and Japan, between 1970 and 2010 thus can be explained largely by slower growth coupled with continued high savings, using the law β = s / g. I will now return to the two other complementary phenomena that amplified this mechanism, which I mentioned earlier: the privatization or gradual transfer of public wealth into private hands and the “catch-up” of asset prices over the long run.

FIGURE 5.5. Private and public capital in rich countries, 1970–2010

In Italy, private capital rose from 240 percent to 680 percent of national income between 1970 and 2010, while public capital dropped from 20 percent to −70 percent.

Sources and series: see piketty.pse.ens.fr/capital21c.

I begin with privatization. As noted, the proportion of public capital in national capital has dropped sharply in recent decades, especially in France and Germany, where net public wealth represented as much as a quarter or even a third of total national wealth in the period 1950–1970, whereas today it represents just a few percent (public assets are just enough to balance public debt). This evolution reflects a quite general phenomenon that has affected all eight leading developed economies: a gradual decrease in the ratio of public capital to national income in the period 1970–2010, accompanied by an increase in the ratio of private capital to national income (see Figure 5.5). In other words, the revival of private wealth is partly due to the privatization of national wealth. To be sure, the increase in private capital in all countries was greater than the decrease in public capital, so national capital (measured in years of national income) did indeed increase. But it increased less rapidly than private capital owing to privatization.

The case of Italy is particularly clear. Net public wealth was slightly positive in the 1970s, then turned slightly negative in the 1980s as large government deficits mounted. All told, public wealth decreased by an amount equal to nearly a year of national income over the period 1970–2010. At the same time, private wealth rose from barely two and a half years of national income in 1970 to nearly seven in 2010, an increase of roughly four and a half years. In other words, the decrease in public wealth represented between one-fifth and one-quarter of the increase in private wealth—a nonnegligible share. Italian national wealth did indeed rise significantly, from around two and a half years of national income in 1970 to about six in 2010, but this was a smaller increase than in private wealth, whose exceptional growth was to some extent misleading, since nearly a quarter of it reflected a growing debt that one portion of the Italian population owed to another. Instead of paying taxes to balance the government’s budget, the Italians—or at any rate those who had the means—lent money to the government by buying government bonds or public assets, which increased their private wealth without increasing the national wealth.

Indeed, despite a very high rate of private saving (roughly 15 percent of national income), national saving in Italy was less than 10 percent of national income in the period 1970–2010. In other words, more than a third of private saving was absorbed by government deficits. A similar pattern exists in all the rich countries, but one generally less extreme than in Italy: in most countries, public saving was negative (which means that public investment was less than the public deficit: the government invested less than it borrowed or used borrowed money to pay current expenses). In France, Britain, Germany, and the United States, government deficits exceeded public investment by 2–3 percent of national income on average over the period 1970–2010, compared with more than 6 percent in Italy (see Table 5.4).18

In all the rich countries, public dissaving and the consequent decrease in public wealth accounted for a significant portion of the increase in private wealth (between one-tenth and one-quarter, depending on the country). This was not the primary reason for the increase in private wealth, but it should not be neglected.

It is possible, moreover, that the available estimates somewhat undervalue public assets in the 1970s, especially in Britain (and perhaps Italy and France as well), which would lead us to underestimate the magnitude of the transfers of public wealth to private hands.19 If true, this would allow us to explain why British private wealth increased so much between 1970 and 2010, despite a clearly insufficient private savings rate, and in particular during the waves of privatizations of public firms in the 1980s and 1990s, privatizations that often involved notoriously low prices, which of course guaranteed that the policy would be popular with buyers.

It is important to note that these transfers of public sector wealth to the private sector were not limited to rich countries after 1970—far from it. The same general pattern exists on all continents. At the global level, the most extensive privatization in recent decades, and indeed in the entire history of capital, obviously took place in the countries of the former Soviet bloc.

The highly imperfect estimates available to us indicate that private wealth in Russia and the former Eastern bloc countries stood at about four years of national income in the late 2000s and early 2010s, and net public wealth was extremely low, just as in the rich countries. Available estimates for the 1970s and 1980s, prior to the fall of the Berlin Wall and the collapse of the Communist regimes, are even more imperfect, but all signs are that the distribution was strictly the opposite: private wealth was insignificant (limited to individual plots of land and perhaps some housing in the Communist countries least averse to private property but in all cases less than a year’s national income), and public capital represented the totality of industrial capital and the lion’s share of national capital, amounting, as a first approximation, to between three and four years of national income. In other words, at first sight, the stock of national capital did not change, but the public-private split was totally reversed.

To sum up: the very considerable growth of private wealth in Russia and Eastern Europe between the late 1980s and the present, which led in some cases to the spectacularly rapid enrichment of certain individuals (I am thinking mainly of the Russian “oligarchs”), obviously had nothing to do with saving or the dynamic law β = s / g. It was purely and simply the result of a transfer of ownership of capital from the government to private individuals. The privatization of national wealth in the developed countries since 1970 can be regarded as a very attenuated form of this extreme case.

The Historic Rebound of Asset Prices

The last factor explaining the increase in the capital/income ratio over the past few decades is the historic rebound of asset prices. In other words, no correct analysis of the period 1970–2010 is possible unless we situate this period in the longer historical context of 1910–2010. Complete historical records are not available for all developed countries, but the series I have established for Britain, France, Germany, and the United States yield consistent results, which I summarize below.

If we look at the whole period 1910–2010, or 1870–2010, we find that the global evolution of the capital/income ratio is very well explained by the dynamic law β = s / g. In particular, the fact that the capital/income ratio is structurally higher over the long run in Europe than in the United States is perfectly consistent with the differences in the saving rate and especially the growth rate over the past century.20 The decline we see in the period 1910–1950 is consistent with low national savings and wartime destruction, and the fact that the capital/income ratio rose more rapidly between 1980 and 2010 than between 1950 and 1980 is well explained by the decrease in the growth rate between these two periods.

Nevertheless, the low point of the 1950s was lower than the simple logic of accumulation summed up by the law β = s / g would have predicted. In order to understand the depth of the mid-twentieth-century low, we need to add the fact that the price of real estate and stocks fell to historically low levels in the aftermath of World War II for any number of reasons (rent control laws, financial regulation, a political climate unfavorable to private capitalism). After 1950, these asset prices gradually recovered, with an acceleration after 1980.

According to my estimates, this historical catch-up process is now complete: leaving aside erratic short-term price movements, the increase in asset prices between 1950 and 2010 seems broadly speaking to have compensated for the decline between 1910 and 1950. It would be risky to conclude from this that the phase of structural asset price increases is definitively over, however, and that asset prices will henceforth progress at exactly the same pace as consumer prices. For one thing, the historical sources are incomplete and imperfect, and price comparisons over such long periods of time are approximate at best. For another, there are many theoretical reasons why asset prices may evolve differently from other prices over the long run: for example, some types of assets, such as buildings and infrastructure, are affected by technological progress at a rate different from those of other parts of the economy. Furthermore, the fact that certain natural resources are nonrenewable can also be important.

Last but not least, it is important to stress that the price of capital, leaving aside the perennial short- and medium-term bubbles and possible long-term structural divergences, is always in part a social and political construct: it reflects each society’s notion of property and depends on the many policies and institutions that regulate relations among different social groups, and especially between those who own capital and those who do not. This is obvious, for example, in the case of real estate prices, which depend on laws regulating the relations between landlords and tenants and controlling rents. The law also affects stock market prices, as I noted when I discussed why stock prices in Germany are relatively low.

In this connection, it is interesting to analyze the ratio between the stock market value and the accounting value of firms in the period 1970–2010 in those countries for which such data are available (see Figure 5.6). (Readers who find these issues too technical can easily skip over the remainder of this section and go directly to the next.)

The market value of a company listed on the stock exchange is its stock market capitalization. For companies not so listed, either because they are too small or because they choose not to finance themselves via the stock market (perhaps in order to preserve family ownership, which can happen even in very large firms), the market value is calculated for national accounting purposes with reference to observed stock prices for listed firms as similar as possible (in terms of size, sector of activity, and so on) to the unlisted firm, while taking into account the “liquidity” of the relevant market.21 Thus far I have used market values to measure stocks of private wealth and national wealth. The accounting value of a firm, also called book value or net assets or own capital, is equal to the accumulated value of all assets—buildings, infrastructure, machinery, patents, majority or minority stakes in subsidiaries and other firms, vault cash, and so on—included in the firm’s balance sheet, less the total of all outstanding debt.

FIGURE 5.6. Market value and book value of corporations

Tobin’s Q (i.e. the ratio between market value and book value of corporations) has risen in rich countries since the 1970s–1980s.

Sources and series: see piketty.pse.ens.fr/capital21c.

In theory, in the absence of all uncertainty, the market value and book value of a firm should be the same, and the ratio of the two should therefore be equal to 1 (or 100 percent). This is normally the case when a company is created. If the shareholders subscribe to 100 million euros worth of shares, which the firm uses to buy offices and equipment worth 100 million euros, then the market value and book value will both be equal to 100 million euros. The same is true if the firm borrows 50 million euros to buy new machinery worth 50 million euros: the net asset value will still be 100 million euros (150 million in assets minus 50 million in debt), as will the stock market capitalization. The same will be true if the firm earns 50 million in profits and decides to create a reserve to finance new investments worth 50 million: the stock price will rise by the same amount (because everyone knows that the firm has new assets), so that both the market value and the book value will increase to 150 million.

The difficulty arises from the fact that anticipating the future of the firm quickly becomes more complex and uncertain. After a certain time, for example, no one is really sure whether the investment of 50 million euros several years earlier is really economically useful to the firm. The book value may then diverge from the market value. The firm will continue to list investments—in new offices, machinery, infrastructure, patents, and so on—on its balance sheet at their market value, so the book value of the firm remains unchanged.22 The market value of the firm, that is, its stock market capitalization, may be significantly lower or higher, depending on whether financial markets have suddenly become more optimistic or pessimistic about the firm’s ability to use its investments to generate new business and profits. That is why, in practice, one always observes enormous variations in the ratio of the market value to the book value of individual firms. This ratio, which is also known as “Tobin’s Q” (for the economist James Tobin, who was the first to define it), varied from barely 20 percent to more than 340 percent for French firms listed in the CAC 40 in 2012.23

It is more difficult to understand why Tobin’s Q, when measured for all firms in a given country taken together, should be systematically greater or smaller than 1. Classically, two explanations have been given.

If certain immaterial investments (such as expenditures to increase the value of a brand or for research and development) are not counted on the balance sheet, then it is logical for the market value to be structurally greater than the book value. This may explain the ratios slightly greater than 1 observed in the United States (100–120 percent) and especially Britain (120–140 percent) in the late 1990s and 2000s. But these ratios greater than 1 also reflect stock market bubbles in both countries: Tobin’s Q fell rapidly toward 1 when the Internet bubble burst in 2001–2002 and in the financial crisis of 2008–2009 (see Figure 5.6).

Conversely, if the stockholders of a company do not have full control, say, because they have to compromise in a long-term relationship with other “stakeholders” (such as worker representatives, local or national governments, consumer groups, and so on), as we saw earlier is the case in “Rhenish capitalism,” then it is logical that the market value should be structurally less than the book value. This may explain the ratios slightly below one observed in France (around 80 percent) and especially Germany and Japan (around 50–70 percent) in the 1990s and 2000s, when English and US firms were at or above 100 percent (see Figure 5.6). Note, too, that stock market capitalization is calculated on the basis of prices observed in current stock transactions, which generally correspond to buyers seeking small minority positions and not buyers seeking to take control of the firm. In the latter case, it is common to pay a price significantly higher than the current market price, typically on the order of 20 percent higher. This difference may be enough to explain a Tobin’s Q of around 80 percent, even when there are no stakeholders other than minority shareholders.

Leaving aside these interesting international variations, which reflect the fact that the price of capital always depends on national rules and institutions, one can note a general tendency for Tobin’s Q to increase in the rich countries since 1970. This is a consequence of the historic rebound of asset prices. All told, if we take account of both higher stock prices and higher real estate prices, we can say that the rebound in asset prices accounts for one-quarter to one-third of the increase in the ratio of national capital to national income in the rich countries between 1970 and 2010 (with large variations between countries).24

National Capital and Net Foreign Assets in the Rich Countries

As noted, the enormous amounts of foreign assets held by the rich countries, especially Britain and France, on the eve of World War I totally disappeared following the shocks of 1914–1945, and net foreign asset positions have never returned to their previous high levels. In fact, if we look at the levels of national capital and net foreign capital in the rich countries between 1970 and 2010, it is tempting to conclude that foreign assets were of limited importance. The net foreign asset position is sometimes slightly positive and sometimes slightly negative, depending on the country and the year, but the balance is generally fairly small compared with total national capital. In other words, the sharp increase in the level of national capital in the rich countries reflects mainly the increase of domestic capital, and to a first approximation net foreign assets would seem to have played only a relatively minor role (see Figure 5.7).

FIGURE 5.7. National capital in rich countries, 1970–2010

Net foreign assets held by Japan and Germany are worth between 0.5 and one year of national income in 2010.

Sources and series: see piketty.pse.ens.fr/capital21c.

This conclusion is not quite accurate, however. For example, Japan and Germany have accumulated quite significant quantities of net foreign assets over the past few decades, especially in the 2000s (largely as an automatic consequence of their trade surpluses). In the early 2010s, Japan’s net foreign assets totaled about 70 percent of national income, and Germany’s amounted to nearly 50 percent. To be sure, these amounts are still substantially lower than the net foreign assets of Britain and France on the eve of World War I (nearly two years of national income for Britain and more than one for France). Given the rapid pace of accumulation, however, it is natural to ask whether this will continue.25 To what extent will some countries find themselves owned by other countries over the course of the twenty-first century? Are the substantial net foreign asset positions observed in the colonial era likely to return or even to be surpassed?

To deal correctly with this question, we need to bring the petroleum exporting countries and emerging economies (starting with China) back into the analysis. Although historical data concerning these countries is limited (which is why I have not discussed them much to this point), our sources for the current period are much more satisfactory. We must also consider inequality within and not just between countries. I therefore defer this question, which concerns the dynamics of the global distribution of capital, to Part Three.

At this stage, I note simply that the logic of the law β = s / g can automatically give rise to very large international capital imbalances, as the Japanese case clearly illustrates. For a given level of development, slight differences in growth rates (particularly demographic growth rates) or savings rates can leave some countries with a much higher capital/income ratio than others, in which case it is natural to expect that the former will invest massively in the latter. This can create serious political tensions. The Japanese case also indicates a second type of risk, which can arise when the equilibrium capital/income ratio β = s / g rises to a very high level. If the residents of the country in question strongly prefer domestic assets—say, Japanese real estate—this can drive the price of those preferred assets to unprecedentedly high levels. In this respect, it is interesting to note that the Japanese record of 1990 was recently beaten by Spain, where the total amount of net private capital reached eight years of national income on the eve of the crisis of 2007–2008, which is a year more than in Japan in 1990. The Spanish bubble began to shrink quite rapidly in 2010–2011, just as the Japanese bubble did in the early 1990s.26 It is quite possible that even more spectacular bubbles will form in the future, as the potential capital/income ratio β = s / g rises to new heights. In passing, note how useful it is to represent the historical evolution of the capital/income ratio in this way and thus to exploit stocks and flows in the national accounts. Doing so might make it possible to detect obvious overvaluations in time to apply prudential policies and financial regulations designed to temper the speculative enthusiasm of financial institutions in the relevant countries.27

One should also note that small net positions may hide enormous gross positions. Indeed, one characteristic of today’s financial globalization is that every country is to a large extent owned by other countries, which not only distorts perceptions of the global distribution of wealth but also represents an important vulnerability for smaller countries as well as a source of instability in the global distribution of net positions. Broadly speaking, the 1970s and 1980s witnessed an extensive “financialization” of the global economy, which altered the structure of wealth in the sense that the total amount of financial assets and liabilities held by various sectors (households, corporations, government agencies) increased more rapidly than net wealth. In most countries, the total amount of financial assets and liabilities in the early 1970s did not exceed four to five years of national income. By 2010, this amount had increased to ten to fifteen years of national income (in the United States, Japan, Germany, and France in particular) and to twenty years of national income in Britain, which set an absolute historical record.28 This reflects the unprecedented development of cross-investments involving financial and nonfinancial corporations in the same country (and, in particular, a significant inflation of bank balance sheets, completely out of proportion with the growth of the banks’ own capital), as well as cross-investments between countries.

In this respect, note that the phenomenon of international cross-investments is much more prevalent in European countries, led by Britain, Germany, and France (where financial assets held by other countries represent between one-quarter and one-half of total domestic financial assets, which is considerable), than in larger economies such as the United States and Japan (where the proportion of foreign-held assets is not much more than one-tenth).29 This increases the feeling of dispossession, especially in Europe, in part for good reasons, though often to an exaggerated degree. (People quickly forget that while domestic companies and government debt are largely owned by the rest of the world, residents hold equivalent assets abroad through annuities and other financial products.) Indeed, balance sheets structured in this way subject small countries, especially in Europe, to an important vulnerability, in that small “errors” in the valuation of financial assets and liabilities can lead to enormous variations in the net foreign asset position.30 Furthermore, the evolution of a country’s net foreign asset position is determined not only by the accumulation of trade surpluses or deficits but also by very large variations in the return on the country’s financial assets and liabilities.31 I should also point out that these international positions are in substantial part the result of fictitious financial flows associated not with the needs of the real economy but rather with tax optimization strategies and regulatory arbitrage (using screen corporations set up in countries where the tax structure and/or regulatory environment is particularly attractive).32 I come back to these questions in Part Three, where I will examine the importance of tax havens in the global dynamics of wealth distribution.

What Will the Capital/Income Ratio Be in the Twenty-First Century?

The dynamic law β = s / g also enables us to think about what level the global capital/income ratio might attain in the twenty-first century.

First consider what we can say about the past. Concerning Europe (or at any rate the leading economies of Western Europe) and North America, we have reliable estimates for the entire period 1870–2010. For Japan, we have no comprehensive estimate of total private or national wealth prior to 1960, but the incomplete data we do have, in particular Japanese probate records going back to 1905, clearly show that Japanese wealth can be described by the same type of “U-curve” as in Europe, and that the capital/income ratio in the period 1910–1930 rose quite high, to 600–700 percent, before falling to just 200–300 percent in the 1950s and 1960s and then rebounding spectacularly to levels again close to 600–700 percent in the 1990s and 2000s.

For other countries and continents, including Asia (apart from Japan), Africa, and South America, relatively complete estimates exist from 1990 on, and these show a capital/income ratio of about four years on average. For the period 1870–1990 there are no truly reliable estimates, and I have simply assumed that the overall level was about the same. Since these countries account for just over a fifth of global output throughout this period, their impact on the global capital/income ratio is in any case fairly limited.

The results I have obtained are shown in Figure 5.8. Given the weight of the rich countries in this total, it comes as no surprise to discover that the global capital/income ratio followed the same type of “U-curve”: it seems today to be close to 500 percent, which is roughly the same level as that attained on the eve of World War I.

The most interesting question concerns the extrapolation of this curve into the future. Here I have used the demographic and economic growth predictions presented in Chapter 2, according to which global output will gradually decline from the current 3 percent a year to just 1.5 percent in the second half of the twenty-first century. I also assume that the savings rate will stabilize at about 10 percent in the long run. With these assumptions, the dynamic law β = s / g implies that the global capital/income ratio will quite logically continue to rise and could approach 700 percent before the end of the twenty-first century, or approximately the level observed in Europe from the eighteenth century to the Belle Époque. In other words, by 2100, the entire planet could look like Europe at the turn of the twentieth century, at least in terms of capital intensity. Obviously, this is just one possibility among others. As noted, these growth predictions are extremely uncertain, as is the prediction of the rate of saving. These simulations are nevertheless plausible and valuable as a way of illustrating the crucial role of slower growth in the accumulation of capital.

FIGURE 5.8. The world capital/income ratio, 1870–2100

According to simulations (central scenario), the world capital/income ratio could be close to 700 percent by the end of the twenty-first century.

Sources and series: see piketty.pse.ens.fr/capital21c.

The Mystery of Land Values

By definition, the law β = s / g applies only to those forms of capital that can be accumulated. It does not take account of the value of pure natural resources, including “pure land,” that is, land prior to any human improvements. The fact that the law β = s / g allows us to explain nearly the entirety of the observed capital stock in 2010 (between 80 and 100 percent, depending on the country) suggests that pure land constitutes only a small part of national capital. But exactly how much? The available data are insufficient to give a precise answer to this question.

Consider first the case of farmland in a traditional rural society. It is very difficult to say precisely what portion of its value represents “pure land value” prior to any human exploitation and what corresponds to the many investments in and improvements to this land over the centuries (including clearing, drainage, fencing, and so on). In the eighteenth century, the value of farmland in France and Britain attained the equivalent of four years of national income.33 According to contemporary estimates, investments and improvements represented at least three-quarters of this value and probably more. The value of pure land represented at most one year of national income, and probably less than half a year. This conclusion follows primarily from the fact that the annual value of the labor required to clear, drain, and otherwise improve the land was considerable, on the order of 3–4 percent of national income. With relatively slow growth, less than 1 percent a year, the cumulative value of such investments was undoubtedly close to the total value of the land (if not greater).34

It is interesting that Thomas Paine, in his famous “Agrarian Justice” proposal to French legislators in 1795, also concluded that “unimproved land” accounted for roughly one-tenth of national wealth, or a little more than half a year of national income.

Nevertheless, estimates of this sort are inevitably highly approximate. When the growth rate is low, small variations in the rate of investment produce enormous differences in the long-run value of the capital/income ratio β = s / g. The key point to remember is that even in a traditional society, the bulk of national capital already stemmed from accumulation and investment: nothing has really changed, except perhaps the fact that the depreciation of land was quite small compared with that of modern real estate or business capital, which has to be repaired or replaced much more frequently. This may contribute to the impression that modern capital is more “dynamic.” But since the data we have concerning investment in traditional rural societies are limited and imprecise, it is difficult to say more.

In particular, it seems impossible to compare in any precise way the value of pure land long ago with its value today. The principal issue today is urban land: farmland is worth less than 10 percent of national income in both France and Britain. But it is no easier to measure the value of pure urban land today, independent not only of buildings and construction but also of infrastructure and other improvements needed to make the land attractive, than to measure the value of pure farmland in the eighteenth century. According to my estimates, the annual flow of investment over the past few decades can account for almost all the value of wealth, including wealth in real estate, in 2010. In other words, the rise in the capital/income ratio cannot be explained in terms of an increase in the value of pure urban land, which to a first approximation seems fairly comparable to the value of pure farmland in the eighteenth century: half to one year of national income. The margin of uncertainty is nevertheless substantial.

Two further points are worth mentioning. First, the fact that total capital, especially in real estate, in the rich countries can be explained fairly well in terms of the accumulation of flows of saving and investment obviously does not preclude the existence of large local capital gains linked to the concentration of population in particular areas, such as major capitals. It would not make much sense to explain the increase in the value of buildings on the Champs-Elysées or, for that matter, anywhere in Paris exclusively in terms of investment flows. Our estimates suggest, however, that these large capital gains on real estate in certain areas were largely compensated by capital losses in other areas, which became less attractive, such as smaller cities or decaying neighborhoods.

Second, the fact that the increase in the value of pure land does not seem to explain much of the historic rebound of the capital/income ration in the rich countries in no way implies that this will continue to be true in the future. From a theoretical point of view, there is nothing that guarantees long-term stability of the value of land, much less of all natural resources. I will come back to this point when I analyze the dynamics of wealth and foreign asset holdings in the petroleum exporting countries.35

{SIX}

The Capital-Labor Split in the Twenty-First Century

We now have a fairly good understanding of the dynamics of the capital/income ratio, as described by the law β = s / g. In particular, the long-run capital/income ratio depends on the savings rate s and the growth rate g. These two macrosocial parameters themselves depend on millions of individual decisions influenced by any number of social, economic, cultural, psychological, and demographic factors and may vary considerably from period to period and country to country. Furthermore, they are largely independent of each other. These facts enable us to understand the wide historical and geographic variations in the capital/income ratio, independent of the fact that the relative price of capital can also vary widely over the long term as well as the short term, as can the relative price of natural resources.

From the Capital/Income Ratio to the Capital-Labor Split

I turn now from the analysis of the capital/income ratio to the division of national income between labor and capital. The formula α = r × β, which in Chapter 1 I called the first fundamental law of capitalism, allows us to move transparently between the two. For example, if the capital stock is equal to six years of national income (β = 6), and if the average return on capital is 5 percent a year (r = 5%), then the share of income from capital, α, in national income is 30 percent (and the share of income from labor is therefore 70 percent). Hence the central question is the following: How is the rate of return on capital determined? I shall begin by briefly examining the evolutions observed over the very long run before analyzing the theoretical mechanisms and economic and social forces that come into play.

The two countries for which we have the most complete historical data from the eighteenth century on are once again Britain and France.

FIGURE 6.1. The capital-labor split in Britain, 1770–2010

During the nineteenth century, capital income (rent, profits, dividends, interest …) absorbed about 40 percent of national income versus 60 percent for labor income (including both wage and non-wage income).

Sources and series: see piketty.pse.ens.fr/capital21c.

We find that the general evolution of capital’s share of income, α, is described by the same U-shaped curve as the capital/income ratio, β, although the depth of the U is less pronounced. In other words, the rate of return on capital, r, seems to have attenuated the evolution of the quantity of capital, β: r is higher in periods when β is lower, and vice versa, which seems natural.

More precisely: we find that capital’s share of income was on the order of 35–40 percent in both Britain and France in the late eighteenth century and throughout the nineteenth, before falling to 20–25 percent in the middle of the twentieth century and then rising again to 25–30 percent in the late twentieth and early twenty-first centuries (see Figures 6.1 and 6.2). This corresponds to an average rate of return on capital of around 5–6 percent in the eighteenth and nineteenth centuries, rising to 7–8 percent in the mid-twentieth century, and then falling to 4–5 percent in the late twentieth and early twenty-first centuries (see Figures 6.3 and 6.4).

The overall curve and the orders of magnitude described here may be taken as reliable and significant, at least to a first approximation. Nevertheless, the limitations and weaknesses of the data should be noted immediately. First, as noted, the very notion of an “average” rate of return on capital is a fairly abstract construct. In practice, the rate of return varies widely with the type of asset, as well as with the size of individual fortunes (it is generally easier to obtain a good return if one begins with a large stock of capital), and this tends to amplify inequalities. Concretely, the yield on the riskiest assets, including industrial capital (whether in the form of partnerships in family firms in the nineteenth century or shares of stock in listed corporations in the twentieth century), is often greater than 7–8 percent, whereas the yield on less risky assets is significantly lower, on the order of 4–5 percent for farmland in the eighteenth and nineteenth centuries and as low as 3–4 percent for real estate in the early twenty-first century. Small nest eggs held in checking or savings accounts often yield a real rate of return closer to 1–2 percent or even less, perhaps even negative, when the inflation rate exceeds the meager nominal interest rate on such accounts. This is a crucial issue about which I will have more to say later on.

FIGURE 6.2. The capital-labor split in France, 1820–2010

In the twenty-first century, capital income (rent, profits, dividends, interest …) absorbs about 30 percent of national income versus 70 percent for labor income (including both wage and non-wage income).

Sources and series: see piketty.pse.ens.fr/capital21c.

At this stage it is important to point out that the capital shares and average rates of return indicated in Figures 6.1–4 were calculated by adding the various amounts of income from capital included in national accounts, regardless of legal classification (rents, profits, dividends, interest, royalties, etc., excluding interest on public debt and before taxes) and then dividing this total by national income (which gives the share of capital income in national income, denoted α) or by the national capital stock (which gives the average rate of return on capital, denoted r).1 By construction, this average rate of return aggregates the returns on very different types of assets and investments: the goal is in fact to measure the average return on capital in a given society taken as a whole, ignoring differences in individual situations. Obviously some people earn more than the average return and others less. Before looking at the distribution of individual returns around the mean, it is natural to begin by analyzing the location of the mean.

FIGURE 6.3. The pure rate of return on capital in Britain, 1770–2010

The pure rate of return to capital is roughly stable around 4–5 percent in the long run.

Sources and series: see piketty.pse.ens.fr/capital21c.

FIGURE 6.4. The pure rate of return on capital in France, 1820–2010

The observed average rate of return displays larger fluctuations than the pure rate of return during the twentieth century.

Sources and series: see piketty.pse.ens.fr/capital21c.

Flows: More Difficult to Estimate Than Stocks

Another important caveat concerns the income of nonwage workers, which may include remuneration of capital that is difficult to distinguish from other income.

To be sure, this problem is less important now than in the past because most private economic activity today is organized around corporations or, more generally, joint-stock companies, so a firm’s accounts are clearly separate from the accounts of the individuals who supply the capital (who risk only the capital they have invested and not their personal fortunes, thanks to the revolutionary concept of the “limited liability corporation,” which was adopted almost everywhere in the latter half of the nineteenth century). On the books of such a corporation, there is a clear distinction between remuneration of labor (wages, salaries, bonuses, and other payments to employees, including managers, who contribute labor to the company’s activities) and remuneration of capital (dividends, interest, profits reinvested to increase the value of the firm’s capital, etc.).

Partnerships and sole proprietorships are different: the accounts of the business are sometimes mingled with the personal accounts of the firm head, who is often both the owner and operator. Today, around 10 percent of domestic production in the rich countries is due to nonwage workers in individually owned businesses, which is roughly equal to the proportion of nonwage workers in the active population. Nonwage workers are mostly found in small businesses (merchants, craftsmen, restaurant workers, etc.) and in the professions (doctors, lawyers, etc.). For a long time this category also included a large number of independent farmers, but today these have largely disappeared. On the books of these individually owned firms, it is generally impossible to distinguish the remuneration of capital: for example, the profits of a radiologist remunerate both her labor and the equipment she uses, which can be costly. The same is true of the hotel owner or small farmer. We therefore say that the income of nonwage workers is “mixed,” because it combines income from labor with income from capital. This is also referred to as “entrepreneurial income.”

To apportion mixed incomes between capital and labor, I have used the same average capital-labor split as for the rest of the economy. This is the least arbitrary choice, and it appears to yield results close to those obtained with the other two commonly used methods.2 It remains an approximation, however, since the very notion of a clear boundary between income from capital and income from labor is not clearly defined for mixed incomes. For the current period, this makes virtually no difference: because the share of mixed income in national income is small, the uncertainty about capital’s share of mixed income affects no more than 1–2 percent of national income. In earlier periods, and especially for the eighteenth and nineteenth centuries when mixed incomes may have accounted for more than half of national income, the uncertainties are potentially much greater.3 That is why available estimates of the capital share for the eighteenth and nineteenth centuries can only be counted as approximations.4

Despite these caveats, my estimates for capital’s share of national income in this period (at least 40 percent) appear to be valid: in both Britain and France, the rents paid to landlords alone accounted for 20 percent of national income in the eighteenth and early nineteenth centuries, and all signs are that the return on farmland (which accounted for about half of national capital) was slightly less than the average return on capital and significantly less than the return on industrial capital, to judge by the very high level of industrial profits, especially during the first half of the nineteenth century. Because of imperfections in the available data, however, it is better to give an interval—between 35 and 40 percent—than a single estimate.

For the eighteenth and nineteenth centuries, estimates of the value of the capital stock are probably more accurate than estimates of the flows of income from labor and capital. This remains largely true today. That is why I chose to emphasize the evolution of the capital/income ratio rather than the capital-labor split, as most economic researchers have done in the past.

The Notion of the Pure Return on Capital

The other important source of uncertainties, which leads me to think that the average rates of return indicated in Figures 6.3 and 6.4 are somewhat overestimated, so that I also indicate what might be called the “pure” rate of return on capital, is the fact that national accounts do not allow for the labor, or at any rate attention, that is required of anyone who wishes to invest. To be sure, the cost of managing capital and of “formal” financial intermediation (that is, the investment advice and portfolio management services provided by a bank or official financial institution or real estate agency or managing partner) is obviously taken into account and deducted from the income on capital in calculating the average rate of return (as presented here). But this is not the case with “informal” financial intermediation: every investor spends time—in some cases a lot of time—managing his own portfolio and affairs and determining which investments are likely to be the most profitable. This effort can in certain cases be compared to genuine entrepreneurial labor or to a form of business activity.

It is of course quite difficult—and to some extent arbitrary—to calculate the value of this informal labor in any precise way, which explains why it is omitted from national accounts. In theory, one would have to measure the time spent on investment-related activities and ascribe an hourly value to that time, based perhaps on the remuneration of equivalent labor in the formal financial or real estate sector. One might also imagine that these informal costs are greater in periods of very rapid economic growth (or high inflation), for such times are likely to require more frequent reallocation of investments and more time researching the best investment opportunities than in a quasi-stagnant economy. For example, it is difficult to believe that the average returns on capital of close to 10 percent that we observe in France (and to a lesser degree in Britain) during periods of postwar reconstruction are simply pure returns on capital. It is likely that such high returns also include a nonnegligible portion of remuneration for informal entrepreneurial labor. (Similar returns are also observed in emerging economies such as China today, where growth rates are also very rapid.)

For illustrative purposes, I have indicated in Figures 6.3 and 6.4 my estimates of the pure return on capital in Britain and France at various times. I obtained these estimates by deducting from the observed average return a plausible (although perhaps too high) estimate of the informal costs of portfolio management (that is, the value of the time spent managing one’s wealth). The pure rates of return obtained in this way are generally on the order of one or two percentage points lower than the observed returns and should probably be regarded as minimum values.5 In particular, the available data on the rates of return earned by fortunes of different sizes suggest that there are important economies of scale in the management of wealth, and that the pure returns earned by the largest fortunes are significantly higher than the levels indicated here.6

The Return on Capital in Historical Perspective

The principal conclusion that emerges from my estimates is the following. In both France and Britain, from the eighteenth century to the twenty-first, the pure return on capital has oscillated around a central value of 4–5 percent a year, or more generally in an interval from 3–6 percent a year. There has been no pronounced long-term trend either upward or downward. The pure return rose significantly above 6 percent following the massive destruction of property and numerous shocks to capital in the two world wars but subsequently returned fairly rapidly to the lower levels observed in the past. It is possible, however, that the pure return on capital has decreased slightly over the very long run: it often exceeded 4–5 percent in the eighteenth and nineteenth centuries, whereas in the early twenty-first century it seems to be approaching 3–4 percent as the capital/income ratio returns to the high levels observed in the past.

We nevertheless lack the distance needed to be certain about this last point. We cannot rule out the possibility that the pure return on capital will rise to higher levels over the next few decades, especially in view of the growing international competition for capital and the equally increasing sophistication of financial markets and institutions in generating high yields from complex, diversified portfolios.

In any case, this virtual stability of the pure return on capital over the very long run (or more likely this slight decrease of about one-quarter to one-fifth, from 4–5 percent in the eighteenth and nineteenth centuries to 3–4 percent today) is a fact of major importance for this study.

In order to put these figures in perspective, recall first of all that the traditional rate of conversion from capital to rent in the eighteenth and nineteenth centuries, for the most common and least risky forms of capital (typically land and public debt) was generally on the order of 5 percent a year: the value of a capital asset was estimated to be equal to twenty years of the annual income yielded by that asset. Sometimes this was increased to twenty-five years (corresponding to a return of 4 percent a year).7

In classic novels of the early nineteenth century, such as those of Balzac and Jane Austen, the equivalence between capital and rent at a rate of 5 percent (or more rarely 4 percent) is taken for granted. Novelists frequently failed to mention the nature of the capital and generally treated land and public debt as almost perfect substitutes, mentioning only the yield in rent. We are told, for example, that a major character has 50,000 francs or 2,000 pounds sterling of rent but not whether it comes from land or from government bonds. It made no difference, since in both cases the income was certain and steady and sufficient to finance a very definite lifestyle and to reproduce across generations a familiar and well-understood social status.

Similarly, neither Austen nor Balzac felt it necessary to specify the rate of return needed to transform a specific amount of capital into an annual rent: every reader knew full well that it took a capital on the order of 1 million francs to produce an annual rent of 50,000 francs (or a capital of 40,000 pounds to produce an income of 2,000 pounds a year), no matter whether the investment was in government bonds or land or something else entirely. For nineteenth-century novelists and their readers, the equivalence between wealth and annual rent was obvious, and there was no difficulty in moving from one measuring scale to the other, as if the two were perfectly synonymous.

It was also obvious to novelists and their readers that some kinds of investment required greater personal involvement, whether it was Père Goriot’s pasta factories or Sir Thomas’s plantations in the West Indies in Mansfield Park. What is more, the return on such investments was naturally higher, typically on the order of 7–8 percent or even more if one struck an especially good bargain, as César Birotteau hoped to do by investing in real estate in the Madeleine district of Paris after earlier successes in the perfume business. But it was also perfectly clear to everyone that when the time and energy devoted to organizing such affairs was deducted from the profits (think of the long months that Sir Thomas is forced to spend in the West Indies), the pure return obtained in the end was not always much more than the 4–5 percent earned by investments in land and government bonds. In other words, the additional yield was largely remuneration for the labor devoted to the business, and the pure return on capital, including the risk premium, was generally not much above 4–5 percent (which was not in any case a bad rate of return).

The Return on Capital in the Early Twenty-First Century

How is the pure return on capital determined (that is, what is the annual return on capital after deducting all management costs, including the value of the time spent in portfolio management)? Why did it decrease over the long run from roughly 4–5 percent in the age of Balzac and Austen to roughly 3–4 percent today?

Before attempting to answer these questions, another important issue needs to be clarified. Some readers may find the assertion that the average return on capital today is 3–4 percent quite optimistic in view of the paltry return that they obtain on their meager savings. A number of points need to be made.

First, the returns indicated in Figures 6.3 and 6.4 are pretax returns. In other words, they are the returns that capital would earn if there were no taxes on capital or income. In Part Four I will consider the role such taxes have played in the past and may play in the future as fiscal competition between states increases. At this stage, let me say simply that fiscal pressure was virtually nonexistent in the eighteenth and nineteenth centuries. It was sharply higher in the twentieth century and remains higher today, so that the average after-tax return on capital has decreased much more over the long run than the average pretax return. Today, the level of taxation of capital and its income may be fairly low if one adopts the correct strategy of fiscal optimization (and some particularly persuasive investors even manage to obtain subsidies), but in most cases the tax is substantial. In particular, it is important to remember that there are many taxes other than income tax to consider: for instance, real estate taxes cut into the return on investments in real estate, and corporate taxes do the same for the income on financial capital invested in firms. Only if all these taxes were eliminated (as may happen someday, but we are still a long way from that) that the returns on capital actually accruing to its owners would reach the levels indicated in Figures 6.3 and 6.4. When all taxes are taken into account, the average tax rate on income from capital is currently around 30 percent in most of the rich countries. This is the primary reason for the large gap between the pure economic return on capital and the return actually accruing to individual owners.

The second important point to keep in mind is that a pure return of around 3–4 percent is an average that hides enormous disparities. For individuals whose only capital is a small balance in a checking account, the return is negative, because such balances yield no interest and are eaten away by inflation. Savings accounts often yield little more than the inflation rate.8 But the important point is that even if there are many such individuals, their total wealth is relatively small. Recall that wealth in the rich countries is currently divided into two approximately equal (or comparable) parts: real estate and financial assets. Nearly all financial assets are accounted for by stocks, bonds, mutual funds, and long-term financial contracts such as annuities or pension funds. Non-interest-bearing checking accounts currently represent only about 10–20 percent of national income, or at most 3–4 percent of total wealth (which, as readers will recall, is 500–600 percent of national income). If we add savings accounts, we increase the total to just above 30 percent of national income, or barely more than 5 percent of total wealth.9 The fact that checking and savings accounts yield only very meager interest is obviously of some concern to depositors, but in terms of the average return on capital, this fact is not very important.

In regard to average return, it is far more important to observe that the annual rental value of housing, which accounts for half of total national wealth, is generally 3–4 percent of the value of the property. For example, an apartment worth 500,000 euros will yield rent of 15,000–20,000 euros per year (or about 1,500 euros per month). Those who prefer to own their property can save that amount in rent. This is also true for more modest housing: an apartment worth 100,000 euros yields 3,000–4,000 euros of rent a year (or allows the owner to avoid paying that amount). And, as noted, the rental yield on small apartments is as high as 5 percent. The returns on financial investments, which are the predominant asset in larger fortunes, are higher still. Taken together, it is these kinds of investments, in real estate and financial instruments, that account for the bulk of private wealth, and this raises the average rate of return.

Real and Nominal Assets

The third point that needs to be clarified is that the rates of return indicated in Figures 6.3 and 6.4 are real rates of return. In other words, it would be a serious mistake to try to deduce the rate of inflation (typically 1–2 percent in the rich countries today) from these yields.

The reason is simple and was touched on earlier: the lion’s share of household wealth consists of “real assets” (that is, assets directly related to a real economic activity, such as a house or shares in a corporation, the price of which therefore evolves as the related activity evolves) rather than “nominal assets” (that is, assets whose value is fixed at a nominal initial value, such as a sum of money deposited in a checking or savings account or invested in a government bond that is not indexed to inflation).

Nominal assets are subject to a substantial inflation risk: if you invest 10,000 euros in a checking or savings account or a nonindexed government or corporate bond, that investment is still worth 10,000 euros ten years later, even if consumer prices have doubled in the meantime. In that case, we say that the real value of the investment has fallen by half: you can buy only half as much in goods and services as you could have bought with the initial investment, so that your return after ten years is −50 percent, which may or may not have been compensated by the interest you earned in the interim. In periods during which prices are rising sharply, the “nominal” rate of interest, that is, the rate of interest prior to deduction of the inflation rate, will rise to a high level, usually greater than the inflation rate. But the investor’s results depend on when the investment was made, how the parties to the transaction anticipated future inflation at that point in time, and so on: the “real” interest rate, that is, the return actually obtained after inflation has been deducted, may be significantly negative or significantly positive, depending on the case.10 In any case, the inflation rate must be deducted from the interest rate if one wants to know the real return on a nominal asset.

With real assets, everything is different. The price of real estate, like the price of shares of stock or parts of a company or investments in a mutual fund, generally rises at least as rapidly as the consumer price index. In other words, not only must we not subtract inflation from the annual rents or dividends received on such assets, but we often need to add to the annual return the capital gains earned when the asset is sold (or subtract the capital loss, as the case may be). The crucial point is that real assets are far more representative than nominal assets: they generally account for more than three-quarters of total household assets and in some cases as much as nine-tenths.11

When I examined the accumulation of capital in Chapter 5, I concluded that these various effects tend to balance out over the long run. Concretely, if we look at all assets over the period 1910–2010, we find that their average price seems to have increased at about the same rate as the consumer price index, at least to a first approximation. To be sure, there may have been large capital gains or losses for a given category of assets (and nominal assets, in particular, generate capital losses, which are compensated by capital gains on real assets), which vary greatly from period to period: the relative price of capital decreased sharply in the period 1910–1950 before trending upward between 1950 and 2010. Under these conditions, the most reasonable approach is to take the view that the average returns on capital indicated in Figures 6.3 and 6.4, which I obtained by dividing the annual flow of income on capital (from rents, dividends, interest, profits, etc.) by the stock of capital, thus neglecting both capital gains and capital losses, is a good estimate of the average return on capital over the long run.12 Of course, this does not mean that when we study the yield of a particular asset we need not add any capital gain or subtract any capital loss (and, in particular, deduct inflation in the case of a nominal asset). But it would not make much sense to deduct inflation from the return on all forms of capital without adding capital gains, which on average amply make up for the effects of inflation.

Make no mistake: I am obviously not denying that inflation can in some cases have real effects on wealth, the return on wealth, and the distribution of wealth. The effect, however, is largely one of redistributing wealth among asset categories rather than a long-term structural effect. For example, I showed earlier that inflation played a central role in virtually wiping out the value of public debt in the rich countries in the wake of the two world wars. But when inflation remains high for a considerable period of time, investors will try to protect themselves by investing in real assets. There is every reason to believe that the largest fortunes are often those that are best indexed and most diversified over the long run, while smaller fortunes—typically checking or savings accounts—are the most seriously affected by inflation.

To be sure, one could argue that the transition from virtually zero inflation in the nineteenth century to 2 percent inflation in the late twentieth and early twenty-first centuries led to a slight decrease in the pure return on capital, in the sense that it is easier to be a rentier in a regime of zero inflation (where wealth accumulated in the past runs no risk of being whittled away by rising prices), whereas today’s investor must spend more time reallocating her wealth among different asset categories in order to achieve the best investment strategy. Again, however, there is no certainty that the largest fortunes are the ones most affected by inflation or that relying on inflation to reduce the influence of wealth accumulated in the past is the best way of attaining that goal. I will come back to this key question in the next Part Three, when I turn to the way the effective returns obtained by different investors vary with size of fortune, and in Part Four, when I compare the various institutions and policies that may influence the distribution of wealth, including primarily taxes and inflation. At this stage, let me note simply that inflation primarily plays a role—sometimes desirable, sometimes not—in redistributing wealth among those who have it. In any case, the potential impact of inflation on the average return on capital is fairly limited and much smaller than the apparent nominal effect.13

What Is Capital Used For?

Using the best available historical data, I have shown how the return on capital evolved over time. I will now try to explain the changes observed. How is the rate of return on capital determined in a particular society at a particular point in time? What are the main social and economic forces at work, why do these forces change over time, and what can we predict about how the rate of return on capital will evolve in the twenty-first century?

According to the simplest economic models, assuming “pure and perfect” competition in both capital and labor markets, the rate of return on capital should be exactly equal to the “marginal productivity” of capital (that is, the additional output due to one additional unit of capital). In more complex models, which are also more realistic, the rate of return on capital also depends on the relative bargaining power of the various parties involved. Depending on the situation, it may be higher or lower than the marginal productivity of capital (especially since this quantity is not always precisely measurable).

In any case, the rate of return on capital is determined by the following two forces: first, technology (what is capital used for?), and second, the abundance of the capital stock (too much capital kills the return on capital).

Technology naturally plays a key role. If capital is of no use as a factor of production, then by definition its marginal productivity is zero. In the abstract, one can easily imagine a society in which capital is of no use in the production process: no investment can increase the productivity of farmland, no tool or machine can increase output, and having a roof over one’s head adds nothing to well-being compared with sleeping outdoors. Yet capital might still play an important role in such a society as a pure store of value: for example, people might choose to accumulate piles of food (assuming that conditions allow for such storage) in anticipation of a possible future famine or perhaps for purely aesthetic reasons (adding piles of jewels and other ornaments to the food piles, perhaps). In the abstract, nothing prevents us from imagining a society in which the capital/income ratio β is quite high but the return on capital r is strictly zero. In that case, the share of capital in national income, α = r × β, would also be zero. In such a society, all of national income and output would go to labor.

Nothing prevents us from imagining such a society, but in all known human societies, including the most primitive, things have been arranged differently. In all civilizations, capital fulfills two economic functions: first, it provides housing (more precisely, capital produces “housing services,” whose value is measured by the equivalent rental value of dwellings, defined as the increment of well-being due to sleeping and living under a roof rather than outside), and second, it serves as a factor of production in producing other goods and services (in processes of production that may require land, tools, buildings, offices, machinery, infrastructure, patents, etc.). Historically, the earliest forms of capital accumulation involved both tools and improvements to land (fencing, irrigation, drainage, etc.) and rudimentary dwellings (caves, tents, huts, etc.). Increasingly sophisticated forms of industrial and business capital came later, as did constantly improved forms of housing.

The Notion of Marginal Productivity of Capital

Concretely, the marginal productivity of capital is defined by the value of the additional production due to one additional unit of capital. Suppose, for example, that in a certain agricultural society, a person with the equivalent of 100 euros’ worth of additional land or tools (given the prevailing price of land and tools) can increase food production by the equivalent of 5 euros per year (all other things being equal, in particular the quantity of labor utilized). We then say that the marginal productivity of capital is 5 euros for an investment of 100 euros, or 5 percent a year. Under conditions of pure and perfect competition, this is the annual rate of return that the owner of the capital (land or tools) should obtain from the agricultural laborer. If the owner seeks to obtain more than 5 percent, the laborer will rent land and tools from another capitalist. And if the laborer wants to pay less than 5 percent, then the land and tools will go to another laborer. Obviously, there can be situations in which the landlord is in a monopoly position when it comes to renting land and tools or purchasing labor (in the latter case one speaks of “monopsony” rather than monopoly), in which case the owner of capital can impose a rate of return greater than the marginal productivity of his capital.

In a more complex economy, where there are many more diverse uses of capital—one can invest 100 euros not only in farming but also in housing or in an industrial or service firm—the marginal productivity of capital may be difficult to determine. In theory, this is the function of the system of financial intermediation (banks and financial markets): to find the best possible uses for capital, such that each available unit of capital is invested where it is most productive (at the opposite ends of the earth, if need be) and pays the highest possible return to the investor. A capital market is said to be “perfect” if it enables each unit of capital to be invested in the most productive way possible and to earn the maximal marginal product the economy allows, if possible as part of a perfectly diversified investment portfolio in order to earn the average return risk-free while at the same time minimizing intermediation costs.

In practice, financial institutions and stock markets are generally a long way from achieving this ideal of perfection. They are often sources of chronic instability, waves of speculation, and bubbles. To be sure, it is not a simple task to find the best possible use for each unit of capital around the world, or even within the borders of a single country. What is more, “short-termism” and “creative accounting” are sometimes the shortest path to maximizing the immediate private return on capital. Whatever institutional imperfections may exist, however, it is clear that systems of financial intermediation have played a central and irreplaceable role in the history of economic development. The process has always involved a very large number of actors, not just banks and formal financial markets: for example, in the eighteenth and nineteenth centuries, notaries played a central role in bringing investors together with entrepreneurs in need of financing, such as Père Goriot with his pasta factories and César Birotteau with his desire to invest in real estate.14

It is important to state clearly that the notion of marginal productivity of capital is defined independently of the institutions and rules—or absence of rules—that define the capital-labor split in a given society. For example, if an owner of land and tools exploits his own capital, he probably does not account separately for the return on the capital that he invests in himself. Yet this capital is nevertheless useful, and his marginal productivity is the same as if the return were paid to an outside investor. The same is true if the economic system chooses to collectivize all or part of the capital stock, and in extreme cases (the Soviet Union, for example) to eliminate all private return on capital. In that case, the private return is less than the “social” return on capital, but the latter is still defined as the marginal productivity of an additional unit of capital. Is it useful and just for the owners of capital to receive this marginal product as payment for their ownership of property (whether their own past savings or that of their ancestors) even if they contribute no new work? This is clearly a crucial question, but not the one I am asking here.

Too Much Capital Kills the Return on Capital

Too much capital kills the return on capital: whatever the rules and institutions that structure the capital-labor split may be, it is natural to expect that the marginal productivity of capital decreases as the stock of capital increases. For example, if each agricultural worker already has thousands of hectares to farm, it is likely that the extra yield of an additional hectare of land will be limited. Similarly, if a country has already built a huge number of new dwellings, so that every resident enjoys hundreds of square feet of living space, then the increase to well-being of one additional building—as measured by the additional rent an individual would be prepared to pay in order to live in that building—would no doubt be very small. The same is true for machinery and equipment of any kind: marginal productivity decreases with quantity beyond a certain threshold. (Although it is possible that some minimum number of tools are needed to begin production, saturation is eventually reached.) Conversely, in a country where an enormous population must share a limited supply of land, scarce housing, and a small supply of tools, then the marginal product of an additional unit of capital will naturally be quite high, and the fortunate owners of that capital will not fail to take advantage of this.

The interesting question is therefore not whether the marginal productivity of capital decreases when the stock of capital increases (this is obvious) but rather how fast it decreases. In particular, the central question is how much the return on capital r decreases (assuming that it is equal to the marginal productivity of capital) when the capital/income ratio β increases. Two cases are possible. If the return on capital r falls more than proportionately when the capital/income ratio β increases (for example, if r decreases by more than half when β is doubled), then the share of capital income in national income α = r × β decreases when β increases. In other words, the decrease in the return on capital more than compensates for the increase in the capital/income ratio. Conversely, if the return r falls less than proportionately when β increases (for example, if r decreases by less than half when β is doubled), then capital’s share α = r × β increases when β increases. In that case, the effect of the decreased return on capital is simply to cushion and moderate the increase in the capital share compared to the increase in the capital/income ratio.

Based on historical evolutions observed in Britain and France, the second case seems more relevant over the long run: the capital share of income, α, follows the same U-shaped curve as the capital income ratio, β (with a high level in the eighteenth and nineteenth centuries, a drop in the middle of the twentieth century, and a rebound in the late twentieth and early twenty-first centuries). The evolution of the rate of return on capital, r, significantly reduces the amplitude of this U-curve, however: the return on capital was particularly high after World War II, when capital was scarce, in keeping with the principle of decreasing marginal productivity. But this effect was not strong enough to invert the U-curve of the capital/income ratio, β, and transform it into an inverted U-curve for the capital share α.

It is nevertheless important to emphasize that both cases are theoretically possible. Everything depends on the vagaries of technology, or more precisely, everything depends on the range of technologies available to combine capital and labor to produce the various types of goods and services that society wants to consume. In thinking about these questions, economists often use the concept of a “production function,” which is a mathematical formula reflecting the technological possibilities that exist in a given society. One characteristic of a production function is that it defines an elasticity of substitution between capital and labor: that is, it measures how easy it is to substitute capital for labor, or labor for capital, to produce required goods and services.

For example, if the coefficients of the production function are completely fixed, then the elasticity of substitution is zero: it takes exactly one hectare and one tool per agricultural worker (or one machine per industrial worker), neither more nor less. If each worker has as little as 1/100 hectare too much or one tool too many, the marginal productivity of the additional capital will be zero. Similarly, if the number of workers is one too many for the available capital stock, the extra worker cannot be put to work in any productive way.

Conversely, if the elasticity of substitution is infinite, the marginal productivity of capital (and labor) is totally independent of the available quantity of capital and labor. In particular, the return on capital is fixed and does not depend on the quantity of capital: it is always possible to accumulate more capital and increase production by a fixed percentage, for example, 5 or 10 percent a year per unit of additional capital. Think of an entirely robotized economy in which one can increase production at will simply by adding more capital.

Neither of these two extreme cases is really relevant: the first sins by want of imagination and the second by excess of technological optimism (or pessimism about the human race, depending on one’s point of view). The relevant question is whether the elasticity of substitution between labor and capital is greater or less than one. If the elasticity lies between zero and one, then an increase in the capital/income ratio β leads to a decrease in the marginal productivity of capital large enough that the capital share α = r × β decreases (assuming that the return on capital is determined by its marginal productivity).15 If the elasticity is greater than one, an increase in the capital/income ratio β leads instead to a drop in the marginal productivity of capital, so that the capital share α = r × β increases (again assuming that the return on capital is equal to its marginal productivity).16 If the elasticity is exactly equal to one, then the two effects cancel each other out: the return on capital decreases in exactly the same proportion as the capital/income ratio β increases, so that the product α = r × β does not change.

Beyond Cobb-Douglas: The Question of the Stability of the Capital-Labor Split

The case of an elasticity of substitution exactly equal to one corresponds to the so-called Cobb-Douglas production function, named for the economists Charles Cobb and Paul Douglas, who first proposed it in 1928. With a Cobb-Douglas production function, no matter what happens, and in particular no matter what quantities of capital and labor are available, the capital share of income is always equal to the fixed coefficient α, which can be taken as a purely technological parameter.17

For example, if α = 30 percent, then no matter what the capital/income ratio is, income from capital will account for 30 percent of national income (and income from labor for 70 percent). If the savings rate and growth rate are such that the long-term capital/income ratio β = s / g corresponds to six years of national income, then the rate of return on capital will be 5 percent, so that the capital share of income will be 30 percent. If the long-term capital stock is only three years of national income, then the return on capital will rise to 10 percent. And if the savings and growth rates are such that the capital stock represents ten years of national income, then the return on capital will fall to 3 percent. In all cases, the capital share of income will be 30 percent.

The Cobb-Douglas production function became very popular in economics textbooks after World War II (after being popularized by Paul Samuelson), in part for good reasons but also in part for bad ones, including simplicity (economists like simple stories, even when they are only approximately correct), but above all because the stability of the capital-labor split gives a fairly peaceful and harmonious view of the social order. In fact, the stability of capital’s share of income—assuming it turns out to be true—in no way guarantees harmony: it is compatible with extreme and untenable inequality of the ownership of capital and distribution of income. Contrary to a widespread idea, moreover, stability of capital’s share of national income in no way implies stability of the capital/income ratio, which can easily take on very different values at different times and in different countries, so that, in particular, there can be substantial international imbalances in the ownership of capital.

The point I want to emphasize, however, is that historical reality is more complex than the idea of a completely stable capital-labor split suggests. The Cobb-Douglas hypothesis is sometimes a good approximation for certain subperiods or sectors and, in any case, is a useful point of departure for further reflection. But this hypothesis does not satisfactorily explain the diversity of the historical patterns we observe over the long, short, or medium run, as the data I have collected show.

Furthermore, there is nothing really surprising about this, given that economists had very little historical data to go on when Cobb and Douglas first proposed their hypothesis. In their original article, published in 1928, these two American economists used data about US manufacturing in the period 1899–1922, which did indeed show a certain stability in the share of income going to profits.18 This idea appears to have been first introduced by the British economist Arthur Bowley, who in 1920 published an important book on the distribution of British national income in the period 1880–1913 whose primary conclusion was that the capital-labor split remained relatively stable during this period.19 Clearly, however, the periods analyzed by these authors were relatively short: in particular, they did not try to compare their results with estimates from the early nineteenth century (much less the eighteenth).

As noted, moreover, these questions aroused very strong political tensions in the late nineteenth and early twentieth centuries, as well as throughout the Cold War, that were not conducive to a calm consideration of the facts. Both conservative and liberal economists were keen to show that growth benefited everyone and thus were very attached to the idea that the capital-labor split was perfectly stable, even if believing this sometimes meant neglecting data or periods that suggested an increase in the share of income going to capital. By the same token, Marxist economists liked to show that capital’s share was always increasing while wages stagnated, even if believing this sometimes required twisting the data. In 1899, Eduard Bernstein, who had the temerity to argue that wages were increasing and the working class had much to gain from collaborating with the existing regime (he was even prepared to become vice president of the Reichstag), was roundly outvoted at the congress of the German Social Democratic Party in Hanover. In 1937, the young German historian and economist Jürgen Kuczynski, who later became a well-known professor of economic history at Humboldt University in East Berlin and who in 1960–1972 published a monumental thirty-eight-volume universal history of wages, attacked Bowley and other bourgeois economists. Kuczynski argued that labor’s share of national income had decreased steadily from the advent of industrial capitalism until the 1930s. This was true for the first half—indeed, the first two-thirds—of the nineteenth century but wrong for the entire period.20 In the years that followed, controversy raged in the pages of academic journals. In 1939, in Economic History Review, where calmer debates where the norm, Frederick Brown unequivocally backed Bowley, whom he characterized as a “great scholar” and “serious statistician,” whereas Kuczynski in his view was nothing more than a “manipulator,” a charge that was wide of the mark.21 Also in 1939, Keynes took the side of the bourgeois economists, calling the stability of the capital-labor split “one of the best-established regularities in all of economic science.” This assertion was hasty to say the least, since Keynes was essentially relying on data from British manufacturing industry in the 1920s, which were insufficient to establish a universal regularity.22

In textbooks published in the period 1950–1970 (and indeed as late as 1990), a stable capital-labor split is generally presented as an uncontroversial fact, but unfortunately the period to which this supposed law applies is not always clearly specified. Most authors are content to use data going back no further than 1950, avoiding comparison with the interwar period or the early twentieth century, much less with the eighteenth and nineteenth centuries. From the 1990s on, however, numerous studies mention a significant increase in the share of national income in the rich countries going to profits and capital after 1970, along with the concomitant decrease in the share going to wages and labor. The universal stability thesis thus began to be questioned, and in the 2000s several official reports published by the Organisation for Economic Cooperation and Development (OECD) and International Monetary Fund (IMF) took note of the phenomenon (a sign that the question was being taken seriously).23

The novelty of this study is that it is to my knowledge the first attempt to place the question of the capital-labor split and the recent increase of capital’s share of national income in a broader historical context by focusing on the evolution of the capital/income ratio from the eighteenth century until now. The exercise admittedly has its limits, in view of the imperfections of the available historical sources, but I believe that it gives us a better view of the major issues and puts the question in a whole new light.

Capital-Labor Substitution in the Twenty-First Century: An Elasticity Greater Than One

I begin by examining the inadequacy of the Cobb-Douglas model for studying evolutions over the very long run. Over a very long period of time, the elasticity of substitution between capital and labor seems to have been greater than one: an increase in the capital/income ratio β seems to have led to a slight increase in α, capital’s share of national income, and vice versa. Intuitively, this corresponds to a situation in which there are many different uses for capital in the long run. Indeed, the observed historical evolutions suggest that it is always possible—up to a certain point, at least—to find new and useful things to do with capital: for example, new ways of building and equipping houses (think of solar panels on rooftops or digital lighting controls), ever more sophisticated robots and other electronic devices, and medical technologies requiring larger and larger capital investments. One need not imagine a fully robotized economy in which capital would reproduce itself (corresponding to an infinite elasticity of substitution) to appreciate the many uses of capital in a diversified advanced economy in which the elasticity of substitution is greater than one.

It is obviously quite difficult to predict how much greater than one the elasticity of substitution of capital for labor will be in the twenty-first century. On the basis of historical data, one can estimate an elasticity between 1.3 and 1.6.24 But not only is this estimate uncertain and imprecise. More than that, there is no reason why the technologies of the future should exhibit the same elasticity as those of the past. The only thing that appears to be relatively well established is that the tendency for the capital/income ratio β to rise, as has been observed in the rich countries in recent decades and might spread to other countries around the world if growth (and especially demographic growth) slows in the twenty-first century, may well be accompanied by a durable increase in capital’s share of national income, α. To be sure, it is likely that the return on capital, r, will decrease as β increases. But on the basis of historical experience, the most likely outcome is that the volume effect will outweigh the price effect, which means that the accumulation effect will outweigh the decrease in the return on capital.

Indeed, the available data indicate that capital’s share of income increased in most rich countries between 1970 and 2010 to the extent that the capital/income ratio increased (see Figure 6.5). Note, however, that this upward trend is consistent not only with an elasticity of substitution greater than one but also with an increase in capital’s bargaining power vis-à-vis labor over the past few decades, which have seen 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 to be the case in 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 national income, α.

FIGURE 6.5. The capital share in rich countries, 1975–2010

Capital income absorbs between 15 percent and 25 percent of national income in rich countries in 1970, and between 25 percent and 30 percent in 2000–2010.

Sources and series: see piketty.pse.ens.fr/capital21c

Traditional Agricultural Societies: An Elasticity Less Than One

I have just shown that an important characteristic of contemporary economies is the existence of many opportunities to substitute capital for labor. It is interesting that this was not at all the case in traditional economies based on agriculture, where capital existed mainly in the form of land. The available historical data suggest very clearly that the elasticity of substitution was significantly less than one in traditional agricultural societies. In particular, this is the only way to explain why, in the eighteenth and nineteenth centuries, the value of land in the United States, as measured by the capital/income ratio and land rents, was much lower than in Europe, even though land was much more plentiful in the New World.

This is perfectly logical, moreover: if capital is to serve as a ready substitute for labor, then it must exist in different forms. For any given form of capital (such as farmland in the case in point), it is inevitable that beyond a certain point, the price effect will outweigh the volume effect. If a few hundred individuals have an entire continent at their disposal, then it stands to reason that the price of land and land rents will fall to near-zero levels. There is no better illustration of the maxim “Too much capital kills the return on capital” than the relative value of land and land rents in the New World and the Old.

Is Human Capital Illusory?

The time has come to turn to a very important question: Has the apparently growing importance of human capital over the course of history been an illusion? Let me rephrase the question in more precise terms. Many people believe that what characterizes the process of development and economic growth is the increased importance of human labor, skill, and know-how in the production process. Although this hypothesis is not always formulated in explicit terms, one reasonable interpretation would be that technology has changed in such a way that the labor factor now plays a greater role.25 Indeed, it seems plausible to interpret in this way the decrease in capital’s share of income over the very long run, from 35–40 percent in 1800–1810 to 25–30 percent in 2000–2010, with a corresponding increase in labor’s share from 60–65 percent to 70–75 percent. Labor’s share increased simply because labor became more important in the production process. Thus it was the growing power of human capital that made it possible to decrease the share of income going to land, buildings, and financial capital.

If this interpretation is correct, then the transformation to which it points was indeed quite significant. Caution is in order, however. For one thing, as noted earlier, we do not have sufficient perspective at this point in history to reach an adequate judgment about the very long-run evolution of capital’s share of income. It is quite possible that capital’s share will increase in coming decades to the level it reached at the beginning of the nineteenth century. This may happen even if the structural form of technology—and the relative importance of capital and labor—does not change (although the relative bargaining power of labor and capital may change) or if technology changes only slightly (which seems to me the more plausible alternative) yet the increase in the capital/income ratio drives capital’s share of income toward or perhaps beyond historic peaks because the long-run elasticity of substitution of capital for labor is apparently greater than one. This is perhaps the most important lesson of this study thus far: modern technology still uses a great deal of capital, and even more important, because capital has many uses, one can accumulate enormous amounts of it without reducing its return to zero. Under these conditions, there is no reason why capital’s share must decrease over the very long run, even if technology changes in a way that is relatively favorable to labor.

A second reason for caution is the following. The probable long-run decrease in capital’s share of national income from 35–40 percent to 25–30 percent is, I think, quite plausible and surely significant but does not amount to a change of civilization. Clearly, skill levels have increased markedly over the past two centuries. But the stock of industrial, financial, and real estate capital has also increased enormously. Some people think that capital has lost its importance and that we have magically gone from a civilization based on capital, inheritance, and kinship to one based on human capital and talent. Fat-cat stockholders have supposedly been replaced by talented managers thanks solely to changes in technology. I will come back to this question in Part Three when I turn to the study of individual inequalities in the distribution of income and wealth: a correct answer at this stage is impossible. But I have already shown enough to warn against such mindless optimism: capital has not disappeared for the simple reason that it is still useful—hardly less useful than in the era of Balzac and Austen, perhaps—and may well remain so in the future.

Medium-Term Changes in the Capital-Labor Split

I have just shown that the Cobb-Douglas hypothesis of a completely stable capital-labor split cannot give a totally satisfactory explanation of the long-term evolution of the capital-labor split. The same can be said, perhaps even more strongly, about short- and medium-term evolutions, which can in some cases extend over fairly long periods, particularly as seen by contemporary witnesses to these changes.

The most important case, which I discussed briefly in the Introduction, is no doubt the increase in capital’s share of income during the early phases of the Industrial Revolution, from 1800 to 1860. In Britain, for which we have the most complete data, the available historical studies, in particular those of Robert Allen (who gave the name “Engels’ pause” to the long stagnation of wages), suggest that capital’s share increased by something like 10 percent of national income, from 35–40 percent in the late eighteenth and early nineteenth centuries to around 45–50 percent in the middle of the nineteenth century, when Marx wrote The Communist Manifesto and set to work on Capital. The sources also suggest that this increase was roughly compensated by a comparable decrease in capital’s share in the period 1870–1900, followed by a slight increase between 1900 and 1910, so that in the end the capital share was probably not very different around the turn of the twentieth century from what it was during the French Revolution and Napoleonic era (see Figure 6.1). We can therefore speak of a “medium-term” movement rather than a durable long-term trend. Nevertheless, this transfer of 10 percent of national income to capital during the first half of the nineteenth century was by no means negligible: to put it in concrete terms, the lion’s share of economic growth in this period went to profits, while wages—objectively miserable—stagnated. According to Allen, the main explanation for this was the exodus of labor from the countryside and into the cities, together with technological changes that increased the productivity of capital (reflected by a structural change in the production function)—the caprices of technology, in short.26

Available historical data for France suggest a similar chronology. In particular, all the sources indicate a serious stagnation of wages in the period 1810–1850 despite robust industrial growth. The data collected by Jean Bouvier and François Furet from the books of leading French industrial firms confirm this chronology: the share of profits increased until 1860, then decreased from 1870 to 1900, and rose again between 1900 and 1910.27

The data we have for the eighteenth century and the period of the French Revolution also suggest an increase in the share of income going to land rent in the decades preceding the revolution (which seems consistent with Arthur Young’s observations about the misery of French peasants),28 and substantial wage increases between 1789 and 1815 (which can conceivably be explained by the redistribution of land and the mobilization of labor to meet the needs of military conflict).29 When the lower classes of the Restoration and July Monarchy looked back on the revolutionary period and the Napoleonic era, they accordingly remembered good times.

To remind ourselves that these short- and medium-term changes in the capital-labor split occur at many different times, I have shown the annual evolution in France from 1900 to 2010 in Figures 6.6–8, in which I distinguish the evolution of the wage-profit split in value added by firms from the evolution of the share of rent in national income.30 Note, in particular, that the wage-profit split has gone through three distinct phases since World War II, with a sharp rise in profits from 1945 to 1968 followed by a very pronounced drop in the share of profits from 1968 to 1983 and then a very rapid rise after 1983 leading to stabilization in the early 1990s. I will have more to say about this highly political chronology in subsequent chapters, where I will discuss the dynamics of income inequality. Note the steady rise of the share of national income going to rent since 1945, which implies that the share going to capital overall continued to increase between 1990 and 2010, despite the stabilization of the profit share.

FIGURE 6.6. The profit share in the value added of corporations in France, 1900–2010

The share of gross profits in gross value added of corporations rose from 25 percent in 1982 to 33 percent in 2010; the share of net profits in net value added rose from 12 percent to 20 percent.

Sources and series: see piketty.pse.ens.fr/capital21c.

FIGURE 6.7. The share of housing rent in national income in France, 1900–2010

The share of housing rent (rental value of dwellings) rose from 2 percent of national income in 1948 to 10 percent in 2010.

Sources and series: see piketty.pse.ens.fr/capital21c.

FIGURE 6.8. The capital share in national income in France, 1900–2010

The share of capital income (net profits and rents) rose from 15 percent of national income in 1982 to 27 percent in 2010.

Sources and series: see piketty.pse.ens.fr/capital21c.

Back to Marx and the Falling Rate of Profit

As I come to the end of this examination of the historical dynamics of the capital/income ratio and the capital-labor split, it is worth pointing out the relation between my conclusions and the theses of Karl Marx.

For Marx, the central mechanism by which “the bourgeoisie digs its own grave” corresponded to what I referred to in the Introduction as “the principle of infinite accumulation”: capitalists accumulate ever increasing quantities of capital, which ultimately leads inexorably to a falling rate of profit (i.e., return on capital) and eventually to their own downfall. Marx did not use mathematical models, and his prose was not always limpid, so it is difficult to be sure what he had in mind. But one logically consistent way of interpreting his thought is to consider the dynamic law β = s / g in the special case where the growth rate g is zero or very close to zero.

Recall that g measures the long-term structural growth rate, which is the sum of productivity growth and population growth. In Marx’s mind, as in the minds of all nineteenth- and early twentieth-century economists before Robert Solow did his work on growth in the 1950s, the very idea of structural growth, driven by permanent and durable growth of productivity, was not clearly identified or formulated.31 In those days, the implicit hypothesis was that growth of production, and especially of manufacturing output, was explained mainly by the accumulation of industrial capital. In other words, output increased solely because every worker was backed by more machinery and equipment and not because productivity as such (for a given quantity of labor and capital) increased. Today we know that long-term structural growth is possible only because of productivity growth. But this was not obvious in Marx’s time, owing to lack of historical perspective and good data.

Where there is no structural growth, and the productivity and population growth rate g is zero, we run up against a logical contradiction very close to what Marx described. If the savings rate s is positive, meaning the capitalists insist on accumulating more and more capital every year in order to increase their power and perpetuate their advantages or simply because their standard of living is already so high, then the capital/income ratio will increase indefinitely. More generally, if g is close to zero, the long-term capital/income ratio β = s / g tends toward infinity. And if β is extremely large, then the return on capital r must get smaller and smaller and closer and closer to zero, or else capital’s share of income, α = r × β, will ultimately devour all of national income.32

The dynamic inconsistency that Marx pointed out thus corresponds to a real difficulty, from which the only logical exit is structural growth, which is the only way of balancing the process of capital accumulation (to a certain extent). Only permanent growth of productivity and population can compensate for the permanent addition of new units of capital, as the law β = s / g makes clear. Otherwise, capitalists do indeed dig their own grave: either they tear each other apart in a desperate attempt to combat the falling rate of profit (for instance, by waging war over the best colonial investments, as Germany and France did in the Moroccan crises of 1905 and 1911), or they force labor to accept a smaller and smaller share of national income, which ultimately leads to a proletarian revolution and general expropriation. In any event, capital is undermined by its internal contradictions.

That Marx actually had a model of this kind in mind (i.e., a model based on infinite accumulation of capital) is confirmed by his use on several occasions of the account books of industrial firms with very high capital intensities. In volume 1 of Capital, for instance, he uses the books of a textile factory, which were conveyed to him, he says, “by the owner,” and seem to show an extremely high ratio of the total amount of fixed and variable capital used in the production process to the value of a year’s output—apparently greater than ten. A capital/income ratio of this level is indeed rather frightening. If the rate of return on capital is 5 percent, then more than half the value of the firm’s output goes to profits. It was natural for Marx and many other anxious contemporary observers to ask where all this might lead (especially because wages had been stagnant since the beginning of the nineteenth century) and what type of long-run socioeconomic equilibrium such hyper-capital-intensive industrial development would produce.

Marx was also an assiduous reader of British parliamentary reports from the period 1820–1860. He used these reports to document the misery of wage workers, workplace accidents, deplorable health conditions, and more generally the rapacity of the owners of industrial capital. He also used statistics derived from taxes imposed on profits from different sources, which showed a very rapid increase of industrial profits in Britain during the 1840s. Marx even tried—in a very impressionistic fashion, to be sure—to make use of probate statistics in order to show that the largest British fortunes had increased dramatically since the Napoleonic wars.33

The problem is that despite these important intuitions, Marx usually adopted a fairly anecdotal and unsystematic approach to the available statistics. In particular, he did not try to find out whether the very high capital intensity that he observed in the account books of certain factories was representative of the British economy as a whole or even of some particular sector of the economy, as he might have done by collecting just a few dozen similar accounts. The most surprising thing, given that his book was devoted largely to the question of capital accumulation, is that he makes no reference to the numerous attempts to estimate the British capital stock that had been carried out since the beginning of the eighteenth century and extended in the nineteenth century by work beginning with Patrick Colqhoun between 1800 and 1810 and continuing through Giffen in the 1870s.34 Marx seems to have missed entirely the work on national accounting that was developing around him, and this is all the more unfortunate in that it would have enabled him to some extent to confirm his intuitions concerning the vast accumulation of private capital in this period and above all to clarify his explanatory model.

Beyond the “Two Cambridges”

It is important to recognize, however, that the national accounts and other statistical data available in the late nineteenth and early twentieth centuries were wholly inadequate for a correct understanding of the dynamics of the capital/income ratio. In particular, there were many more estimates of the stock of national capital than of national income or domestic product. By the mid-twentieth century, following the shocks of 1914–1945, the reverse was true. This no doubt explains why the question of capital accumulation and a possible dynamic equilibrium continued to stir controversy and arouse a good deal of confusion for so long. A good example of this is the famous “Cambridge capital controversy” of the 1950s and 1960s (also called the “Two Cambridges Debate” because it pitted Cambridge, England, against Cambridge, Massachusetts).

To briefly recall the main points of this debate: when the formula β = s / g was explicitly introduced for the first time by the economists Roy Harrod and Evsey Domar in the late 1930s, it was common to invert it as g = s / β. Harrod, in particular, argued in 1939 that β was fixed by the available technology (as in the case of a production function with fixed coefficients and no possible substitution between labor and capital), so that the growth rate was entirely determined by the savings rate. If the savings rate is 10 percent and technology imposes a capital/income ratio of 5 (so that it takes exactly five units of capital, neither more nor less, to produce one unit of output), then the growth rate of the economy’s productive capacity is 2 percent per year. But since the growth rate must also be equal to the growth rate of the population (and of productivity, which at the time was still ill defined), it follows that growth is an intrinsically unstable process, balanced “on a razor’s edge.” There is always either too much or too little capital, which therefore gives rise either to excess capacity and speculative bubbles or else to unemployment, or perhaps both at once, depending on the sector and the year.

Harrod’s intuition was not entirely wrong, and he was writing in the midst of the Great Depression, an obvious sign of great macroeconomic instability. Indeed, the mechanism he described surely helps to explain why the growth process is always highly volatile: to bring savings into line with investment at the national level, when savings and investment decisions are generally made by different individuals for different reasons, is a structurally complex and chaotic phenomenon, especially since it is often difficult in the short run to alter the capital intensity and organization of production.35 Nevertheless, the capital/income ratio is relatively flexible in the long run, as is unambiguously demonstrated by the very large historical variations that are observed in the data, together with the fact that the elasticity of substitution of capital for labor has apparently been greater than one over a long period of time.

In 1948, Domar developed a more optimistic and flexible version of the law g = s / β than Harrod’s. Domar stressed the fact that the savings rate and capital/income ratio can to a certain extent adjust to each other. Even more important was Solow’s introduction in 1956 of a production function with substitutable factors, which made it possible to invert the formula and write β = s / g. In the long run, the capital/income ratio adjusts to the savings rate and structural growth rate of the economy rather than the other way around. Controversy continued, however, in the 1950s and 1960s between economists based primarily in Cambridge, Massachusetts (including Solow and Samuelson, who defended the production function with substitutable factors) and economists working in Cambridge, England (including Joan Robinson, Nicholas Kaldor, and Luigi Pasinetti), who (not without a certain confusion at times) saw in Solow’s model a claim that growth is always perfectly balanced, thus negating the importance Keynes had attributed to short-term fluctuations. It was not until the 1970s that Solow’s so-called neoclassical growth model definitively carried the day.

If one rereads the exchanges in this controversy with the benefit of hindsight, it is clear that the debate, which at times had a marked postcolonial dimension (as American economists sought to emancipate themselves from the historic tutelage of their British counterparts, who had reigned over the profession since the time of Adam Smith, while the British sought to defend the memory of Lord Keynes, which they thought the American economists had betrayed), did more to cloud economic thinking than to enlighten it. There was no real justification for the suspicions of the British. Solow and Samuelson were fully convinced that the growth process is unstable in the short term and that macroeconomic stabilization requires Keynesian policies, and they viewed β = s / g solely as a long-term law. Nevertheless, the American economists, some of whom (for example Franco Modigliani) were born in Europe, tended at times to exaggerate the implications of the “balanced growth path” they had discovered.36 To be sure, the law β = s / g describes a growth path in which all macroeconomic quantities—capital stock, income and output flows—progress at the same pace over the long run. Still, apart from the question of short-term volatility, such balanced growth does not guarantee a harmonious distribution of wealth and in no way implies the disappearance or even reduction of inequality in the ownership of capital. Furthermore, contrary to an idea that until recently was widespread, the law β = s / g in no way precludes very large variations in the capital/income ratio over time and between countries. Quite the contrary. In my view, the virulence—and at times sterility—of the Cambridge capital controversy was due in part to the fact that participants on both sides lacked the historical data needed to clarify the terms of the debate. It is striking to see how little use either side made of national capital estimates done prior to World War I; they probably believed them to be incompatible with the realities of the 1950s and 1960s. The two world wars created such a deep discontinuity in both conceptual and statistical analysis that for a while it seemed impossible to study the issue in a long-run perspective, especially from a European point of view.

Capital’s Comeback in a Low-Growth Regime

The truth is that only since the end of the twentieth century have we had the statistical data and above all the indispensable historical distance to correctly analyze the long-run dynamics of the capital/income ratio and the capital-labor split. Specifically, the data I have assembled and the historical distance we are fortunate enough to enjoy (still insufficient, to be sure, but by definition greater than that which previous authors had) lead to the following conclusions.

First, the return to a historic regime of low growth, and in particular zero or even negative demographic growth, leads logically to the return of capital. This tendency for low-growth societies to reconstitute very large stocks of capital is expressed by the law β = s / g and can be summarized as follows: in stagnant societies, wealth accumulated in the past naturally takes on considerable importance.

In Europe today, the capital/income ratio has already risen to around five to six years of national income, scarcely less than the level observed in the eighteenth and nineteenth centuries and up to the eve of World War I.

At the global level, it is entirely possible that the capital/income ratio will attain or even surpass this level during the twenty-first century. If the savings rate is now around 10 percent and the growth rate stabilizes at around 1.5 percent in the very long run, then the global stock of capital will logically rise to six or seven years of income. And if growth falls to 1 percent, the capital stock could rise as high as ten years of income.

As for capital’s share in national and global income, which is given by the law α = r × β, experience suggests that the predictable rise in the capital/income ratio will not necessarily lead to a significant drop in the return on capital. There are many uses for capital over the very long run, and this fact can be captured by noting that the long-run elasticity of substitution of capital for labor is probably greater than one. The most likely outcome is thus that the decrease in the rate of return will be smaller than the increase in the capital/income ratio, so that capital’s share will increase. With a capital/income ratio of seven to eight years and a rate of return on capital of 4–5 percent, capital’s share of global income could amount to 30 or 40 percent, a level close to that observed in the eighteenth and nineteenth centuries, and it might rise even higher.

As noted, it is also possible that technological changes over the very long run will slightly favor human labor over capital, thus lowering the return on capital and the capital share. But the size of this long-term effect seems limited, and it is possible that it will be more than compensated by other forces tending in the opposite direction, such as the creation of increasingly sophisticated systems of financial intermediation and international competition for capital.

The Caprices of Technology

The principal lesson of this second part of the book is surely that there is no natural force that inevitably reduces the importance of capital and of income flowing from ownership of capital over the course of history. In the decades after World War II, people began to think that the triumph of human capital over capital in the traditional sense (land, buildings, and financial capital) was a natural and irreversible process, due perhaps to technology and to purely economic forces. In fact, however, some people were already saying that political forces were central. My results fully confirm this view. Progress toward economic and technological rationality need not imply progress toward democratic and meritocratic rationality. The primary reason for this is simple: technology, like the market, has neither limits nor morality. The evolution of technology has certainly increased the need for human skills and competence. But it has also increased the need for buildings, homes, offices, equipment of all kinds, patents, and so on, so that in the end the total value of all these forms of nonhuman capital (real estate, business capital, industrial capital, financial capital) has increased almost as rapidly as total income from labor. If one truly wishes to found a more just and rational social order based on common utility, it is not enough to count on the caprices of technology.

To sum up: modern growth, which is based on the growth of productivity and the diffusion of knowledge, has made it possible to avoid the apocalypse predicted by Marx and to balance the process of capital accumulation. But it has not altered the deep structures of capital—or at any rate has not truly reduced the macroeconomic importance of capital relative to labor. I must now examine whether the same is true for inequality in the distribution of income and wealth. How much has the structure of inequality with respect to both labor and capital actually changed since the nineteenth century?

PART THREE

THE STRUCTURE OF INEQUALITY

{SEVEN}

Inequality and Concentration: Preliminary Bearings

In Part Two I examined the dynamics of both the capital/income ratio at the country level and the overall split of national income between capital and labor, but I did not look directly at income or wealth inequality at the individual level. In particular, I analyzed the importance of the shocks of 1914–1945 in order to understand changes in the capital/income ratio and the capital-labor split over the course of the twentieth century. The fact that Europe—and to some extent the entire world—have only just gotten over these shocks has given rise to the impression that patrimonial capitalism—which is flourishing in these early years of the twenty-first century—is something new, whereas it is in large part a repetition of the past and characteristic of a low-growth environment like the nineteenth century.

Here begins my examination of inequality and distribution at the individual level. In the next few chapters, I will show that the two world wars, and the public policies that followed from them, played a central role in reducing inequalities in the twentieth century. There was nothing natural or spontaneous about this process, in contrast to the optimistic predictions of Kuznets’s theory. I will also show that inequality began to rise sharply again since the 1970s and 1980s, albeit with significant variation between countries, again suggesting that institutional and political differences played a key role. I will also analyze, from both a historical and a theoretical point of view, the evolution of the relative importance of inherited wealth versus income from labor over the very long run. Many people believe that modern growth naturally favors labor over inheritance and competence over birth. What is the source of this widespread belief, and how sure can we be that it is correct? Finally, in Chapter 12, I will consider how the global distribution of wealth might evolve in the decades to come. Will the twenty-first century be even more inegalitarian than the nineteenth, if it is not already so? In what respects is the structure of inequality in the world today really different from that which existed during the Industrial Revolution or in traditional rural societies? Part Two has already suggested some interesting leads to follow in this regard, but the only way to answer this crucial question is by analyzing the structure of inequality at the individual level.

Before proceeding farther, in this chapter I must first introduce certain ideas and orders of magnitude. I begin by noting that in all societies, income inequality can be decomposed into three terms: inequality in income from labor; inequality in the ownership of capital and the income to which it gives rise; and the interaction between these two terms. Vautrin’s famous lesson to Rastignac in Balzac’s Père Goriot is perhaps the clearest introduction to these issues.

Vautrin’s Lesson

Balzac’s Père Goriot, published in 1835, could not be clearer. Père Goriot, a former spaghetti maker, has made a fortune in pasta and grain during the Revolution and Napoleonic era. A widower, he sacrifices everything he has to find husbands for his daughters Delphine and Anastasie in the best Parisian society of the 1810s. He keeps just enough to pay his room and board in a shabby boardinghouse, where he meets Eugène de Rastignac, a penniless young noble who has come up from the provinces to study law in Paris. Full of ambition and humiliated by his poverty, Eugène avails himself of the help of a distant cousin to worm his way into the luxurious salons where the aristocracy, grande bourgeoisie, and high finance of the Restoration mingle. He quickly falls in love with Delphine, who has been abandoned by her husband, Baron de Nucingen, a banker who has already used his wife’s dowry in any number of speculative ventures. Rastignac soon sheds his illusions as he discovers the cynicism of a society entirely corrupted by money. He is appalled to learn how Père Goriot has been abandoned by his daughters, who, preoccupied as they are with social success, are ashamed of their father and have seen little of him since availing themselves of his fortune. The old man dies in sordid poverty and solitude. Only Rastignac attends his burial. But no sooner has he left Père Lachaise cemetery than he is overwhelmed by the sight of Parisian wealth on display along the Seine and decides to set out in conquest of the capital: “It’s just you and me now!” he apostrophizes the city. His sentimental and social education is over. From this point on he, too, will be ruthless.

The darkest moment in the novel, when the social and moral dilemmas Rastignac faces are rawest and clearest, comes at the midpoint, when the shady character Vautrin offers him a lesson about his future prospects.1 Vautrin, who resides in the same shabby boardinghouse as Rastignac and Goriot, is a glib talker and seducer who is concealing a dark past as a convict, much like Edmond Dantès in Le Comte de Monte-Cristo or Jean Valjean in Les Misérables. In contrast to those two characters, who are on the whole worthy fellows, Vautrin is deeply wicked and cynical. He attempts to lure Rastignac into committing a murder in order to lay hands on a large legacy. Before that, Vautrin offers Rastignac an extremely lurid, detailed lesson about the different fates that might befall a young man in the French society of the day.

In substance, Vautrin explains to Rastignac that it is illusory to think that social success can be achieved through study, talent, and effort. He paints a detailed portrait of the various possible careers that await his young friend if he pursues studies in law or medicine, fields in which professional competence counts more than inherited wealth. In particular, Vautrin explains very clearly to Rastignac what yearly income he can aspire to in each of these professions. The verdict is clear: even if he ranks at the top of his class and quickly achieves a brilliant career in law, which will require many compromises, he will still have to get by on a mediocre income and give up all hope of becoming truly wealthy:

By the age of thirty, you will be a judge making 1,200 francs a year, if you haven’t yet tossed away your robes. When you reach forty, you will marry a miller’s daughter with an income of around 6,000 livres. Thank you very much. If you’re lucky enough to find a patron, you will become a royal prosecutor at thirty, with compensation of a thousand écus [5,000 francs], and you will marry the mayor’s daughter. If you’re willing to do a little political dirty work, you will be a prosecutor-general by the time you’re forty.… It is my privilege to point out to you, however, that there are only twenty prosecutors-general in France, while 20,000 of you aspire to the position, and among them are a few clowns who would sell their families to move up a rung. If this profession disgusts you, consider another. Would Baron de Rastignac like to be a lawyer? Very well then! You will need to suffer ten years of misery, spend a thousand francs a month, acquire a library and an office, frequent society, kiss the hem of a clerk to get cases, and lick the courthouse floor with your tongue. If the profession led anywhere, I wouldn’t advise you against it. But can you name five lawyers in Paris who earn more than 50,000 francs a year at the age of fifty?

2

By contrast, the strategy for social success that Vautrin proposes to Rastignac is quite a bit more efficient. By marrying Mademoiselle Victorine, a shy young woman who lives in the boardinghouse and has eyes only for the handsome Eugène, he will immediately lay hands on a fortune of a million francs. This will enable him to draw at age twenty an annual income of 50,000 francs (5 percent of the capital) and thus immediately achieve ten times the level of comfort to which he could hope to aspire only years later on a royal prosecutor’s salary (and as much as the most prosperous Parisian lawyers of the day earned at age fifty after years of effort and intrigue).

The conclusion is clear: he must lose no time in marrying young Victorine, ignoring the fact that she is neither very pretty nor very appealing. Eugène eagerly heeds Vautrin’s lesson right up to the ultimate coup de grâce: if the illegitimate child Victorine is to be recognized by her wealthy father and become the heiress of the million francs Vautrin has mentioned, her brother must first be killed. The ex-convict is ready to take on this task in exchange for a commission. This is too much for Rastignac: although he is quite amenable to Vautrin’s arguments concerning the merits of inheritance over study, he is not prepared to commit murder.

The Key Question: Work or Inheritance?

What is most frightening about Vautrin’s lecture is that his brisk portrait of Restoration society contains such precise figures. As I will soon show, the structure of the income and wealth hierarchies in nineteenth-century France was such that the standard of living the wealthiest French people could attain greatly exceeded that to which one could aspire on the basis of income from labor alone. Under such conditions, why work? And why behave morally at all? Since social inequality was in itself immoral and unjustified, why not be thoroughly immoral and appropriate capital by whatever means are available?

The detailed income figures Vautrin gives are unimportant (although quite realistic): the key fact is that in nineteenth-century France and, for that matter, into the early twentieth century, work and study alone were not enough to achieve the same level of comfort afforded by inherited wealth and the income derived from it. This was so obvious to everyone that Balzac needed no statistics to prove it, no detailed figures concerning the deciles and centiles of the income hierarchy. Conditions were similar, moreover, in eighteenth- and nineteenth-century Britain. For Jane Austen’s heroes, the question of work did not arise: all that mattered was the size of one’s fortune, whether acquired through inheritance or marriage. Indeed, the same was true almost everywhere before World War I, which marked the suicide of the patrimonial societies of the past. One of the few exceptions to this rule was the United States, or at any rate the various “pioneer” microsocieties in the northern and western states, where inherited capital had little influence in the eighteenth and nineteenth centuries—a situation that did not last long, however. In the southern states, where capital in the form of slaves and land predominated, inherited wealth mattered as much as it did in old Europe. In Gone with the Wind, Scarlett O’Hara’s suitors cannot count on their studies or talents to assure their future comfort any more than Rastignac can: the size of one’s father’s (or father-in-law’s) plantation matters far more. Vautrin, to show how little he thinks of morality, merit, or social justice, points out to young Eugène that he would be glad to end his days as a slave owner in the US South, living in opulence on what his Negroes produced.3 Clearly, the America that appeals to the French ex-convict is not the America that appealed to Tocqueville.

To be sure, income from labor is not always equitably distributed, and it would be unfair to reduce the question of social justice to the importance of income from labor versus income from inherited wealth. Nevertheless, democratic modernity is founded on the belief that inequalities based on individual talent and effort are more justified than other inequalities—or at any rate we hope to be moving in that direction. Indeed, Vautrin’s lesson to some extent ceased to be valid in twentieth-century Europe, at least for a time. During the decades that followed World War II, inherited wealth lost much of its importance, and for the first time in history, perhaps, work and study became the surest routes to the top. Today, even though all sorts of inequalities have reemerged, and many beliefs in social and democratic progress have been shaken, most people still believe that the world has changed radically since Vautrin lectured Rastignac. Who today would advise a young law student to abandon his or her studies and adopt the ex-convict’s strategy for social advancement? To be sure, there may exist rare cases where a person would be well advised to set his or her sights on inheriting a large fortune.4 In the vast majority of cases, however, it is not only more moral but also more profitable to rely on study, work, and professional success.

Vautrin’s lecture focuses our attention on two questions, which I will try to answer in the next few chapters with the imperfect data at my disposal. First, can we be sure that the relative importance of income from labor versus income from inherited wealth has been transformed since the time of Vautrin, and if so, to what extent? Second, and even more important, if we assume that such a transformation has to some degree occurred, why exactly did it happen, and can it be reversed?

Inequalities with Respect to Labor and Capital

To answer these questions, I must first introduce certain basic ideas and the fundamental patterns of income and wealth inequality in different societies at different times. I showed in Part One that income can always be expressed as the sum of income from labor and income from capital. Wages are one form of income from labor, and to simplify the exposition I will sometimes speak of wage inequality when I mean inequality of income from labor more generally. To be sure, income from labor also includes income from nonwage labor, which for a long time played a crucial role and still plays a nonnegligible role today. Income from capital can also take different forms: it includes all income derived from the ownership of capital independent of any labor and regardless of its legal classification (rents, dividends, interest, royalties, profits, capital gains, etc.).

By definition, in all societies, income inequality is the result of adding up these two components: inequality of income from labor and inequality of income from capital. The more unequally distributed each of these two components is, the greater the total inequality. In the abstract, it is perfectly possible to imagine a society in which inequality with respect to labor is high and inequality with respect to capital is low, or vice versa, as well as a society in which both components are highly unequal or highly egalitarian.

The third decisive factor is the relation between these two dimensions of inequality: to what extent do individuals with high income from labor also enjoy high income from capital? Technically speaking, this relation is a statistical correlation, and the greater the correlation, the greater the total inequality, all other things being equal. In practice, the correlation in question is often low or negative in societies in which inequality with respect to capital is so great that the owners of capital do not need to work (for example, Jane Austen’s heroes usually eschew any profession). How do things stand today, and how will they stand in the future?

Note, too, that inequality of income from capital may be greater than inequality of capital itself, if individuals with large fortunes somehow manage to obtain a higher return than those with modest to middling fortunes. This mechanism can be a powerful multiplier of inequality, and this is especially true in the century that has just begun. In the simple case where the average rate of return is the same at all levels of the wealth hierarchy, then by definition the two inequalities coincide.

When analyzing the unequal distribution of income, it is essential to carefully distinguish these various aspects and components of inequality, first for normative and moral reasons (the justification of inequality is quite different for income from labor, from inherited wealth, and from differential returns on capital), and second, because the economic, social, and political mechanisms capable of explaining the observed evolutions are totally distinct. In the case of unequal incomes from labor, these mechanisms include the supply of and demand for different skills, the state of the educational system, and the various rules and institutions that affect the operation of the labor market and the determination of wages. In the case of unequal incomes from capital, the most important processes involve savings and investment behavior, laws governing gift-giving and inheritance, and the operation of real estate and financial markets. The statistical measures of income inequality that one finds in the writings of economists as well as in public debate are all too often synthetic indices, such as the Gini coefficient, which mix very different things, such as inequality with respect to labor and capital, so that it is impossible to distinguish clearly among the multiple dimensions of inequality and the various mechanisms at work. By contrast, I will try to distinguish these things as precisely as possible.

Capital: Always More Unequally Distributed Than Labor

The first regularity we observe when we try to measure income inequality in practice is that inequality with respect to capital is always greater than inequality with respect to labor. The distribution of capital ownership (and of income from capital) is always more concentrated than the distribution of income from labor.

Two points need to be clarified at once. First, we find this regularity in all countries in all periods for which data are available, without exception, and the magnitude of the phenomenon is always quite striking. To give a preliminary idea of the order of magnitude in question, the upper 10 percent of the labor income distribution generally receives 25–30 percent of total labor income, whereas the top 10 percent of the capital income distribution always owns more than 50 percent of all wealth (and in some societies as much as 90 percent). Even more strikingly, perhaps, the bottom 50 percent of the wage distribution always receives a significant share of total labor income (generally between one-quarter and one-third, or approximately as much as the top 10 percent), whereas the bottom 50 percent of the wealth distribution owns nothing at all, or almost nothing (always less than 10 percent and generally less than 5 percent of total wealth, or one-tenth as much as the wealthiest 10 percent). 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.

Second, this regularity is by no means foreordained, and its existence tells us something important about the nature of the economic and social processes that shape the dynamics of capital accumulation and the distribution of wealth.

Indeed, it is not difficult to think of mechanisms that would lead to a distribution of wealth more egalitarian than the distribution of income from labor. For example, suppose that at a given point in time, labor incomes reflect not only permanent wage inequalities among different groups of workers (based on the skill level and hierarchical position of each group) but also short-term shocks (for instance: wages and working hours in different sectors might fluctuate considerably from year to year or over the course of an individual’s career). Labor incomes would then be highly unequal in the short run, although this inequality would diminish if measured over a long period (say ten years rather than one, or even over the lifetime of an individual, although this is rarely done because of the lack of long-term data). A longer-term perspective would be ideal for studying the true inequalities of opportunity and status that are the subject of Vautrin’s lecture but are unfortunately often quite difficult to measure.

In a world with large short-term wage fluctuations, the main reason for accumulating wealth might be precautionary (as a reserve against a possible negative shock to income), in which case inequality of wealth would be smaller than wage inequality. For example, inequality of wealth might be of the same order of magnitude as the permanent inequality of wage income (measured over the length of an individual career) and therefore significantly lower than the instantaneous wage inequality (measured at a given point in time). All of this is logically possible but clearly not very relevant to the real world, since inequality of wealth is always and everywhere much greater than inequality of income from labor. Although precautionary saving in anticipation of short-term shocks does indeed exist in the real world, it is clearly not the primary explanation for the observed accumulation and distribution of wealth.

We can also imagine mechanisms that would imply an inequality of wealth comparable in magnitude to the inequality of income from labor. Specifically, if wealth is accumulated primarily for life-cycle reasons (saving for retirement, say), as Modigliani reasoned, then everyone would be expected to accumulate a stock of capital more or less proportional to his or her wage level in order to maintain approximately the same standard of living (or the same proportion thereof) after retirement. In that case, inequality of wealth would be a simple translation in time of inequality of income from labor and would as such have only limited importance, since the only real source of social inequality would be inequality with respect to labor.

Once again, such a mechanism is theoretically plausible, and its real-world role is of some significance, especially in aging societies. In quantitative terms, however, it is not the primary mechanism at work. Life-cycle saving cannot explain the very highly concentrated ownership of capital we observe in practice, any more than precautionary saving can. To be sure, older individuals are certainly richer on average than younger ones. But the concentration of wealth is actually nearly as great within each age cohort as it is for the population as a whole. In other words, and contrary to a widespread belief, intergenerational warfare has not replaced class warfare. The very high concentration of capital is explained mainly by the importance of inherited wealth and its cumulative effects: for example, it is easier to save if you inherit an apartment and do not have to pay rent. The fact that the return on capital often takes on extreme values also plays a significant role in this dynamic process. In the remainder of Part Three, I examine these various mechanisms in greater detail and consider how their relative importance has evolved in time and space. At this stage, I note simply that the magnitude of inequality of wealth, both in absolute terms and relative to inequality of income from labor—points toward certain mechanisms rather than others.

Inequalities and Concentration: Some Orders of Magnitude

Before analyzing the historical evolutions that can be observed in different countries, it will be useful to give a more precise account of the characteristic orders of magnitude of inequality with respect to labor and capital. The goal is to familiarize the reader with numbers and notions such as deciles, centiles, and the like, which may seem somewhat technical and even distasteful to some but are actually quite useful for analyzing and understanding changes in the structure of inequality in different societies—provided we use them correctly.

To that end, I have charted in Tables 7.1–3 the distributions actually observed in various countries at various times. The figures indicated are approximate and deliberately rounded off but at least give us a preliminary idea of what the terms “low,” “medium,” and “high” inequality mean today and have meant in the past, with respect to both income from labor and ownership of capital, and finally with respect to total income (the sum of income from labor and income from capital).

For example, with respect to inequality of income from labor, we find that in the most egalitarian societies, such as the Scandinavian countries in the 1970s and 1980s (inequalities have increased in northern Europe since then, but these countries nevertheless remain the least inegalitarian), the distribution is roughly as follows. Looking at the entire adult population, we see that the 10 percent receiving the highest incomes from labor claim a little more than 20 percent of the total income from labor (and in practice this means essentially wages); the least well paid 50 percent get about 35 percent of the total; and the 40 percent in the middle therefore receive roughly 45 percent of the total (see Table 7.1).5 This is not perfect equality, for in that case each group should receive the equivalent of its share of the population (the best paid 10 percent should get exactly 10 percent of the income, and the worst paid 50 percent should get 50 percent). But the inequality we see here is not too extreme, at least in comparison to what we observe in other countries or at other times, and it is not too extreme especially when compared with what we find almost everywhere for the ownership of capital, even in the Scandinavian countries.

In order to have a clear idea of what these figures really mean, we need to relate distributions expressed as percentages of total income to the paychecks that flesh-and-blood workers actually receive as well as to the fortunes in real estate and financial assets owned by the people who actually make up these wealth hierarchies.

Concretely, if the best paid 10 percent receive 20 percent of total wages, then it follows mathematically that each person in this group earns on average twice the average pay in the country in question. Similarly, if the least well paid 50 percent receive 35 percent of total wages, it follows that each person in this group earns on average 70 percent of the average wage. And if the middle 40 percent receive 45 percent of the total wage, this means that the average wage of this group is slightly higher than the average pay for society as a whole (45/40 of the average, to be precise).

For example, if the average pay in a country is 2,000 euros per month, then this distribution implies that the top 10 percent earn 4,000 euros a month on average, the bottom 50 percent 1,400 euros a month, and the middle 40 percent 2,250 a month.6 This intermediate group may be regarded as a vast “middle class” whose standard of living is determined by the average wage of the society in question.

Lower, Middle, and Upper Classes

To be clear, the designations “lower class” (defined as the bottom 50 percent), “middle class” (the middle 40 percent), and “upper class” (top 10 percent) that I use in Tables 7.1–3 are quite obviously arbitrary and open to challenge. I introduce these terms purely for illustrative purposes, to pin down my ideas, but in fact they play virtually no role in the analysis, and I might just as well have called them “Class A,” “Class B,” and “Class C.” In political debate, however, such terminological issues are generally far from innocent. The way the population is divided up usually reflects an implicit or explicit position concerning the justice and legitimacy of the amount of income or wealth claimed by a particular group.

For example, some people use the term “middle class” very broadly to encompass individuals who clearly fall within the upper decile (that is, the top 10 percent) of the social hierarchy and who may even be quite close to the upper centile (the top 1 percent). Generally, the purpose of such a broad definition of the middle class is to insist that even though such individuals dispose of resources considerably above the average for the society in question, they nevertheless retain a certain proximity to the average: in other words, the point is to say that such individuals are not privileged and fully deserve the indulgence of the government, particularly in regard to taxes.

Other commentators reject any notion of “middle class” and prefer to describe the social structure as consisting of just two groups: “the people,” who constitute the vast minority, and a tiny “elite” or “upper class.” Such a description may be accurate for some societies, or it may be applicable to certain political or historical contexts. For example, in France in 1789, it is generally estimated that the aristocracy represented 1–2 percent of the population, the clergy less than 1 percent, and the “Third Estate,” meaning (under the political system of the Ancien Régime) all the rest, from peasantry to bourgeoisie, more than 97 percent.

It is not my purpose to police dictionaries or linguistic usage. When it comes to designating social groups, everyone is right and wrong at the same time. Everyone has good reasons for using certain terms but is wrong to denigrate the terms used by others. My definition of “middle class” (as the “middle” 40 percent) is highly contestable, since the income (or wealth) of everyone in the group is, by construction, above the median for the society in question.7 One might equally well choose to divide society into three thirds and call the middle third the “middle class.” Still, the definition I have given seems to me to correspond more closely to common usage: the expression “middle class” is generally used to refer to people who are doing distinctly better than the bulk of the population yet still a long way from the true “elite.” Yet all such designations are open to challenge, and there is no need for me to take a position on this delicate issue, which is not just linguistic but also political.

The truth is that any representation of inequality that relies on a small number of categories is doomed to be crudely schematic, since the underlying social reality is always a continuous distribution. At any given level of wealth or income there is always a certain number of flesh-and-blood individuals, and the number of such individuals varies slowly and gradually in accordance with the shape of the distribution in the society in question. There is never a discontinuous break between social classes or between “people” and “elite.” For that reason, my analysis is based entirely on statistical concepts such as deciles (top 10 percent, middle 40 percent, lower 50 percent, etc.), which are defined in exactly the same way in different societies. This allows me to make rigorous and objective comparisons across time and space without denying the intrinsic complexity of each particular society or the fundamentally continuous structure of social inequality.

Class Struggle or Centile Struggle?

My fundamental goal is to compare the structure of inequality in societies remote from one another in time and space, societies that are very different a priori, and in particular societies that use totally different words and concepts to refer to the social groups that compose them. The concepts of deciles and centiles are rather abstract and undoubtedly lack a certain poetry. It is easier for most people to identify with groups with which they are familiar: peasants or nobles, proletarians or bourgeois, office workers or top managers, waiters or traders. But the beauty of deciles and centiles is precisely that they enable us to compare inequalities that would otherwise be incomparable, using a common language that should in principle be acceptable to everyone.

When necessary, we will break down our groups even more finely, using centiles or even thousandths to register more precisely the continuous character of social inequality. Specifically, in every society, even the most egalitarian, the upper decile is truly a world unto itself. It includes some people whose income is just two or three times greater than the mean and others whose resources are ten or twenty times greater, if not more. To start with, it is always enlightening to break the top decile down into two subgroups: the upper centile (which we might call the “dominant class” for the sake of concreteness, without claiming that this term is better than any other) and the remaining nine centiles (which we might call the “wealthy class” or “well-to-do”).

For example, if we look at the case where inequality of income from labor is relatively low (think Scandinavia), represented in Table 7.1, with 20 percent of wages going to the best paid 10 percent of workers, we find that the share going to the top 1 percent is typically on the order of 5 percent of total wages. This means that the top 1 percent of earners make on average five times the mean wage, or 10,000 euros per month, in a society in which the average wage is 2,000 euros per month. In other words, the best paid 10 percent earn 4,000 euros a month on average, but within that group the top 1 percent earn an average of 10,000 euros a month (and the next 9 percent earn on average 3,330 euros a month). If we break this down even further and looked at the top thousandth (the best paid 0.1 percent) in the top centile, we find individuals earning tens of thousands of euros a month and a few earning hundreds of thousands, even in the Scandinavian countries in the 1970s and 1980s. Of course there would not be many such people, so their weight in the sum total of all wages would be relatively small.

Thus to judge the inequality of a society, it is not enough to observe that some individuals earn very high incomes. For example, to say that the “income scale goes from 1 to 10” or even “1 to 100” does not actually tell us very much. We also need to know how many people earn the incomes at each level. The share of income (or wealth) going to the top decile or centile is a useful index for judging how unequal a society is, because it reflects not just the existence of extremely high incomes or extremely large fortunes but also the number of individuals who enjoy such rewards.

The top centile is a particularly interesting group to study in the context of my historical investigation. Although it constitutes (by definition) a very small minority of the population, it is nevertheless far larger than the superelites of a few dozen or hundred individuals on whom attention is sometimes focused (such as the “200 families” of France, to use the designation widely applied in the interwar years to the 200 largest stockholders of the Banque de France, or the “400 richest Americans” or similar rankings established by magazines like Forbes). In a country of almost 65 million people such as France in 2013, of whom some 50 million are adults, the top centile comprises some 500,000 people. In a country of 320 million like the United States, of whom 260 million are adults, the top centile consists of 2.6 million individuals. These are numerically quite large groups who inevitably stand out in society, especially when the individuals included in them tend to live in the same cities and even to congregate in the same neighborhoods. In every country the upper centile occupies a prominent place in the social landscape and not just in the income distribution.

Thus in every society, whether France in 1789 (when 1–2 percent of the population belonged to the aristocracy) or the United States in 2011 (when the Occupy Wall Street movement aimed its criticism at the richest 1 percent of the population), the top centile is a large enough group to exert a significant influence on both the social landscape and the political and economic order.

This shows why deciles and centiles are so interesting to study. How could one hope to compare inequalities in societies as different as France in 1789 and the United States in 2011 other than by carefully examining deciles and centiles and estimating the shares of national wealth and income going to each? To be sure, this procedure will not allow us to eliminate every problem or settle every question, but at least it will allow us to say something—and that is far better than not being able to say anything at all. We can therefore try to determine whether “the 1 percent” had more power under Louis XVI or under George Bush and Barack Obama.

To return for a moment to the Occupy Wall Street movement, what it shows is that the use of a common terminology, and in particular the concept of the “top centile,” though it may at first glance seem somewhat abstract, can be helpful in revealing the spectacular growth of inequality and may therefore serve as a useful tool for social interpretation and criticism. Even mass social movements can avail themselves of such a tool to develop unusual mobilizing themes, such as “We are the 99 percent!” This might seem surprising at first sight, until we remember that the title of the famous pamphlet that Abbé Sieyès published in January 1789 was “What Is the Third Estate?”8

I should also make it clear that the hierarchies (and therefore centiles and deciles) of income are not the same as those of wealth. The top 10 percent or bottom 50 percent of the labor income distribution are not the same people who constitute the top 10 percent or bottom 50 percent of the wealth distribution. The “1 percent” who earn the most are not the same as the “1 percent” who own the most. Deciles and centiles are defined separately for income from labor, ownership of capital, and total income (from both labor and capital), with the third being a synthesis of the first two dimensions and thus defining a composite social hierarchy. It is always essential to be clear about which hierarchy one is referring to. In traditional societies, the correlation between the two dimensions was often negative (because people with large fortunes did not work and were therefore at the bottom of the labor income hierarchy). In modern societies, the correlation is generally positive but never perfect (the coefficient of correlation is always less than one). For example, many people belong to the upper class in terms of labor income but to the lower class in terms of wealth, and vice versa. Social inequality is multidimensional, just like political conflict.

Note, finally, that the income and wealth distributions described in Tables 7.1–3 and analyzed in this and subsequent chapters are in all cases “primary” distributions, meaning before taxes. Depending on whether the tax system (and the public services and transfer payments it finances) is “progressive” or “regressive” (meaning that it weighs more or less heavily on different groups depending on whether they stand high or low in the income or wealth hierarchy), the after-tax distribution may be more or less egalitarian than the before-tax distribution. I will come back to this in Part Four, along with many other questions related to redistribution. At this stage only the before-tax distribution requires consideration.9

Inequalities with Respect to Labor: Moderate Inequality?

To return to the question of orders of magnitude of inequality: To what extent are inequalities of income from labor moderate, reasonable, or even no longer an issue today? It is true that inequalities with respect to labor are always much smaller than inequalities with respect to capital. It would be quite wrong, however, to neglect them, first because income from labor generally accounts for two-thirds to three-quarters of national income, and second because there are quite substantial differences between countries in the distribution of income from labor, which suggests that public policies and national differences can have major consequences for these inequalities and for the living conditions of large numbers of people.

In countries where income from labor is most equally distributed, such as the Scandinavian countries between 1970 and 1990, the top 10 percent of earners receive about 20 percent of total wages and the bottom 50 percent about 35 percent. In countries where wage inequality is average, including most European countries (such as France and Germany) today, the first group claims 25–30 percent of total wages, and the second around 30 percent. And in the most inegalitarian countries, such as the United States in the early 2010s (where, as will emerge later, income from labor is about as unequally distributed as has ever been observed anywhere), the top decile gets 35 percent of the total, whereas the bottom half gets only 25 percent. In other words, the equilibrium between the two groups is almost completely reversed. In the most egalitarian countries, the bottom 50 percent receive nearly twice as much total income as the top 10 percent (which some will say is still too little, since the former group is five times as large as the latter), whereas in the most inegalitarian countries the bottom 50 percent receive one-third less than the top group. If the growing concentration of income from labor that has been observed in the United States over the last few decades were to continue, the bottom 50 percent could earn just half as much in total compensation as the top 10 percent by 2030 (see Table 7.1). Obviously there is no certainty that this evolution will in fact continue, but the point illustrates the fact that recent changes in the income distribution have by no means been painless.

In concrete terms, if the average wage is 2,000 euros a month, the egalitarian (Scandinavian) distribution corresponds to 4,000 euros a month for the top 10 percent of earners (and 10,000 for the top 1 percent), 2,250 a month for the 40 percent in the middle, and 1,400 a month for the bottom 50 percent, where the more inegalitarian (US) distribution corresponds to a markedly steeper hierarchy: 7,000 euros a month for the top 10 percent (and 24,000 for the top 1 percent), 2,000 for the middle 40 percent, and just 1,000 for the bottom 50 percent.

For the least-favored half of the population, the difference between the two income distributions is therefore far from negligible: if a person earns 1,400 euros a month instead of 1,000—40 percent additional income—even leaving taxes and transfers aside, the consequences for lifestyle choices, housing, vacation opportunities, and money to spend on projects, children, and so on are considerable. In most countries, moreover, women are in fact significantly overrepresented in the bottom 50 percent of earners, so that these large differences between countries reflect in part differences in the male-female wage gap, which is smaller in northern Europe than elsewhere.

The gap between the two distributions is also significant for the top-earning group: a person who all his or her life earns 7,000 euros a month rather than 4,000 (or, even better, 24,000 instead of 10,000), will not spend money on the same things and will have greater power not only over what he or she buys but also over other people: for instance, this person can hire less well paid individuals to serve his or her needs. If the trend observed in the United States were to continue, then by 2030 the top 10 percent of earners will be making 9,000 euros a month (and the top 1 percent, 34,000 euros), the middle 40 percent will earn 1,750, and the bottom 50 percent just 800 a month. The top 10 percent could therefore use a small portion of their incomes to hire many of the bottom 50 percent as domestic servants.10

Clearly, then, the same mean wage is compatible with very different distributions of income from labor, which can result in very disparate social and economic realities for different social groups. In some cases, these inequalities may give rise to conflict. It is therefore important to understand the economic, social, and political forces that determine the degree of labor income inequality in different societies.

Inequalities with Respect to Capital: Extreme Inequality

Although inequality with respect to income from labor is sometimes seen—incorrectly—as moderate inequality that no longer gives rise to conflict, this is largely a consequence of comparing it with the distribution of capital ownership, which is extremely inegalitarian everywhere (see Table 7.2).

In the societies where wealth is most equally distributed (once again, the Scandinavian countries in the 1970s and 1980s), the richest 10 percent own around 50 percent of national wealth or even a bit more, somewhere between 50 and 60 percent, if one properly accounts for the largest fortunes. Currently, in the early 2010s, the richest 10 percent own around 60 percent of national wealth in most European countries, and in particular in France, Germany, Britain, and Italy.

The most striking fact is no doubt that in all these societies, half of the population own virtually nothing: the poorest 50 percent invariably own less than 10 percent of national wealth, and generally less than 5 percent. In France, according to the latest available data (for 2010–2011), the richest 10 percent command 62 percent of total wealth, while the poorest 50 percent own only 4 percent. In the United States, the most recent survey by the Federal Reserve, which covers the same years, indicates that the top decile own 72 percent of America’s wealth, while the bottom half claim just 2 percent. Note, however, that this source, like most surveys in which wealth is self-reported, underestimates the largest fortunes.11 As noted, moreover, it is also important to add that we find the same concentration of wealth within each age cohort.12

Ultimately, inequalities of wealth in the countries that are most egalitarian in that regard (such as the Scandinavian countries in the 1970s and 1980s) appear to be considerably greater than wage inequalities in the countries that are most inegalitarian with respect to wages (such as the United States in the early 2010s: see Tables 7.1 and 7.2). To my knowledge, no society has ever existed in which ownership of capital can reasonably be described as “mildly” inegalitarian, by which I mean a distribution in which the poorest half of society would own a significant share (say, one-fifth to one-quarter) of total wealth.13 Optimism is not forbidden, however, so I have indicated in Table 7.2 a virtual example of a possible distribution of wealth in which inequality would be “low,” or at any rate lower than it is in Scandinavia (where it is “medium”), Europe (“medium-to-high”), or the United States (“high”). Of course, how one might go about establishing such an “ideal society”—assuming that such low inequality of wealth is indeed a desirable goal—remains to be seen (I will return to this central question in Part Four).14

As in the case of wage inequality, it is important to have a good grasp of exactly what these wealth figures mean. Imagine a society in which average net wealth is 200,000 euros per adult,15 which is roughly the case today in the richest European countries.16 As noted in Part Two, this private wealth can be divided into two roughly equal parts: real estate on the one hand and financial and business assets on the other (these include bank deposits, savings plans, portfolios of stocks and bonds, life insurance, pension funds, etc., net of debts). Of course these are average figures, and there are large variations between countries and enormous variations between individuals.

If the poorest 50 percent own 5 percent of total wealth, then by definition each member of that group owns on average the equivalent of 10 percent of the average individual wealth of society as a whole. In the example in the previous paragraph, it follows that each person among the poorest 50 percent possesses on average a net wealth of 20,000 euros. This is not nothing, but it is very little compared with the wealth of the rest of society.

Concretely, in such a society, the poorest half of the population will generally comprise a large number of people—typically a quarter of the population—with no wealth at all or perhaps a few thousand euros at most. Indeed, a nonnegligible number of people—perhaps one-twentieth to one-tenth of the population—will have slightly negative net wealth (their debts exceed their assets). Others will own small amounts of wealth up to about 60,000 or 70,000 euros or perhaps a bit more. This range of situations, including the existence of a large number of people with very close to zero absolute wealth, results in an average wealth of about 20,000 euros for the poorest half of the population. Some of these people may own real estate that remains heavily indebted, while others may possess very small nest eggs. Most, however, are renters whose only wealth consists of a few thousand euros of savings in a checking or savings account. If we included durable goods such as cars, furniture, appliances, and the like in wealth, then the average wealth of the poorest 50 percent would increase to no more than 30,000 or 40,000 euros.17

For this half of the population, the very notions of wealth and capital are relatively abstract. For millions of people, “wealth” amounts to little more than a few weeks’ wages in a checking account or low-interest savings account, a car, and a few pieces of furniture. The inescapable reality is this: wealth is so concentrated that a large segment of society is virtually unaware of its existence, so that some people imagine that it belongs to surreal or mysterious entities. That is why it is so essential to study capital and its distribution in a methodical, systematic way.

At the other end of the scale, the richest 10 percent own 60 percent of total wealth. It therefore follows that each member of this group owns on average 6 times the average wealth of the society in question. In the example, with an average wealth of 200,000 euros per adult, each of the richest 10 percent therefore owns on average the equivalent of 1.2 million euros.

The upper decile of the wealth distribution is itself extremely unequal, even more so than the upper decile of the wage distribution. When the upper decile claims about 60 percent of total wealth, as is the case in most European countries today, the share of the upper centile is generally around 25 percent and that of the next 9 percent of the population is about 35 percent. The members of the first group are therefore on average 25 times as rich as the average member of society, while the members of the second group are barely 4 times richer. Concretely, in the example, the average wealth of the top 10 percent is 1.2 million euros each, with 5 million euros each for the top 1 percent and a little less than 800,000 each for the next 9 percent.18

In addition, the composition of wealth varies widely within this group. Nearly everyone in the top decile owns his or her own home, but the importance of real estate decreases sharply as one moves higher in the wealth hierarchy. In the “9 percent” group, at around 1 million euros, real estate accounts for half of total wealth and for some individuals more than three-quarters. In the top centile, by contrast, financial and business assets clearly predominate over real estate. In particular, shares of stock or partnerships constitute nearly the totality of the largest fortunes. Between 2 and 5 million euros, the share of real estate is less than one-third; above 5 million euros, it falls below 20 percent; above 10 million euros, it is less than 10 percent and wealth consists primarily of stock. Housing is the favorite investment of the middle class and moderately well-to-do, but true wealth always consists primarily of financial and business assets.

Between the poorest 50 percent (who own 5 percent of total wealth, or an average of 20,000 euros each in the example) and the richest 10 percent (who own 60 percent of total wealth, or an average of 1.2 million euros each) lies the middle 40 percent: this “middle class of wealth” owns 35 percent of total national wealth, which means that their average net wealth is fairly close to the average for society as a whole—in the example, it comes to exactly 175,000 euros per adult. Within this vast group, where individual wealth ranges from barely 100,000 euros to more than 400,000, a key role is often played by ownership of a primary residence and the way it is acquired and paid for. Sometimes, in addition to a home, there is also a substantial amount of savings. For example, a net capital of 200,000 euros may consist of a house valued at 250,000 euros, from which an outstanding mortgage balance of 100,000 euros must be deducted, together with savings of 50,000 euros invested in a life insurance policy or retirement savings account. When the mortgage is fully paid off, net wealth in this case will rise to 300,000 euros, or even more if the savings account has grown in the meantime. This is a typical trajectory in the middle class of the wealth hierarchy, who are richer than the poorest 50 percent (who own practically nothing) but poorer than the richest 10 percent (who own much more).

A Major Innovation: The Patrimonial Middle Class

Make no mistake: the growth of a true “patrimonial (or propertied) middle class” was the principal structural transformation of the distribution of wealth in the developed countries in the twentieth century.

To go back a century in time, to the decade 1900–1910: in all the countries of Europe, the concentration of capital was then much more extreme than it is today. It is important to bear in mind the orders of magnitude indicated in Table 7.2. In this period in France, Britain, and Sweden, as well as in all other countries for which we have data, the richest 10 percent owned virtually all of the nation’s wealth: the share owned by the upper decile reached 90 percent. The wealthiest 1 percent alone owned more than 50 percent of all wealth. The upper centile exceeded 60 percent in some especially inegalitarian countries, such as Britain. On the other hand, the middle 40 percent owned just over 5 percent of national wealth (between 5 and 10 percent depending on the country), which was scarcely more than the poorest 50 percent, who then as now owned less than 5 percent.

In other words, there was no middle class in the specific sense that the middle 40 percent of the wealth distribution were almost as poor as the bottom 50 percent. The vast majority of people owned virtually nothing, while the lion’s share of society’s assets belonged to a minority. To be sure, this was not a tiny minority: the upper decile comprised an elite far larger than the upper centile, which even so included a substantial number of people. Nevertheless, it was a minority. Of course, the distribution curve was continuous, as it is in all societies, but its slope was extremely steep in the neighborhood of the top decile and centile, so that there was an abrupt transition from the world of the poorest 90 percent (whose members had at most a few tens of thousands of euros’ worth of wealth in today’s currency) to that of the richest 10 percent, whose members owned the equivalent of several million euros or even tens of millions of euros.19

The emergence of a patrimonial middle class was an important, if fragile, historical innovation, and it would be a serious mistake to underestimate it. To be sure, it is tempting to insist on the fact that wealth is still extremely concentrated today: the upper decile own 60 percent of Europe’s wealth and more than 70 percent in the United States.20 And the poorer half of the population are as poor today as they were in the past, with barely 5 percent of total wealth in 2010, just as in 1910. Basically, all the middle class managed to get its hands on was a few crumbs: scarcely more than a third of Europe’s wealth and barely a quarter in the United States. This middle group has four times as many members as the top decile yet only one-half to one-third as much wealth. It is tempting to conclude that nothing has really changed: inequalities in the ownership of capital are still extreme (see Table 7.2).

None of this is false, and it is essential to be aware of these things: the historical reduction of inequalities of wealth is less substantial than many people believe. Furthermore, there is no guarantee that the limited compression of inequality that we have seen is irreversible. Nevertheless, the crumbs that the middle class has collected are important, and it would be wrong to underestimate the historical significance of the change. A person who has a fortune of 200,000 to 300,000 euros may not be rich but is a long way from being destitute, and most of these people do not like to be treated as poor. Tens of millions of individuals—40 percent of the population represents a large group, intermediate between rich and poor—individually own property worth hundreds of thousands of euros and collectively lay claim to one-quarter to one-third of national wealth: this is a change of some moment. In historical terms, it was a major transformation, which deeply altered the social landscape and the political structure of society and helped to redefine the terms of distributive conflict. It is therefore essential to understand why it occurred.

The rise of a propertied middle class was accompanied by a very sharp decrease in the wealth share of the upper centile, which fell by more than half, going from more than 50 percent in Europe at the turn of the twentieth century to around 20–25 percent at the end of that century and beginning of the next. As we will see, this partly invalidated Vautrin’s lesson, in that the number of fortunes large enough to allow a person to live comfortably on annual rents decreased dramatically: an ambitious young Rastignac could no longer live better by marrying Mademoiselle Victorine than by studying law. This was historically important, because the extreme concentration of wealth in Europe around 1900 was in fact characteristic of the entire nineteenth century. All available sources agree that these orders of magnitude—90 percent of wealth for the top decile and at least 50 percent for the top centile—were also characteristic of traditional rural societies, whether in Ancien Régime France or eighteenth-century England. Such concentration of capital is in fact a necessary condition for societies based on accumulated and inherited wealth, such as those described in the novels of Austen and Balzac, to exist and prosper. Hence one of the main goals of this book is to understand the conditions under which such concentrated wealth can emerge, persist, vanish, and perhaps reappear.

Inequality of Total Income: Two Worlds

Finally, let us turn now to inequality of total income, that is, of income from both labor and capital (see Table 7.3). Unsurprisingly, the level of inequality of total income falls between inequality of income from labor and inequality of ownership of capital. Note, too, that inequality of total income is closer to inequality of income from labor than to inequality of capital, which comes as no surprise, since income from labor generally accounts for two-thirds to three-quarters of total national income. Concretely, the top decile of the income hierarchy received about 25 percent of national income in the egalitarian societies of Scandinavia in the 1970s and 1980s (it was 30 percent in Germany and France at that time and is more than 35 percent now). In more inegalitarian societies, the top decile claimed as much as 50 percent of national income (with about 20 percent going to the top centile). This was true in France and Britain during the Ancien Régime as well as the Belle Époque and is true in the United States today.

Is it possible to imagine societies in which the concentration of income is much greater? Probably not. If, for example, the top decile appropriates 90 percent of each year’s output (and the top centile took 50 percent just for itself, as in the case of wealth), a revolution will likely occur, unless some peculiarly effective repressive apparatus exists to keep it from happening. When it comes to the ownership of capital, such a high degree of concentration is already a source of powerful political tensions, which are often difficult to reconcile with universal suffrage. Yet such capital concentration might be tenable if the income from capital accounts for only a small part of national income: perhaps one-fourth to one-third, or sometimes a bit more, as in the Ancien Régime (which made the extreme concentration of wealth at that time particularly oppressive). But if the same level of inequality applies to the totality of national income, it is hard to imagine that those at the bottom will accept the situation permanently.

That said, there are no grounds for asserting that the upper decile can never claim more than 50 percent of national income or that a country’s economy would collapse if this symbolic threshold were crossed. In fact, the available historical data are far from perfect, and it is not out of the question that this symbolic limit has already been exceeded. In particular, it is possible that under the Ancien Régime, right up to the eve of the French Revolution, the top decile did take more than 50 percent and even as much as 60 percent or perhaps slightly more of national income. More generally, this may have been the case in other traditional rural societies. Indeed, whether such extreme inequality is or is not sustainable depends not only on the effectiveness of the repressive apparatus but also, and perhaps primarily, on the effectiveness of the apparatus of justification. If inequalities are seen as justified, say because they seem to be a consequence of a choice by the rich to work harder or more efficiently than the poor, or because preventing the rich from earning more would inevitably harm the worst-off members of society, then it is perfectly possible for the concentration of income to set new historical records. That is why I indicate in Table 7.3 that the United States may set a new record around 2030 if inequality of income from labor—and to a lesser extent inequality of ownership of capital—continue to increase as they have done in recent decades. The top decile would them claim about 60 percent of national income, while the bottom half would get barely 15 percent.

I want to insist on this point: the key issue is the justification of inequalities rather than their magnitude as such. That is why it is essential to analyze the structure of inequality. In this respect, the principal message of Tables 7.1–3 is surely that there are two different ways for a society to achieve a very unequal distribution of total income (around 50 percent for the top decile and 20 percent for the top centile).

The first of these two ways of achieving such high inequality is through a “hyperpatrimonial society” (or “society of rentiers”): a society in which inherited wealth is very important and where the concentration of wealth attains extreme levels (with the upper decile owning typically 90 percent of all wealth, with 50 percent belonging to the upper centile alone). The total income hierarchy is then dominated by very high incomes from capital, especially inherited capital. This is the pattern we see in Ancien Régime France and in Europe during the Belle Époque, with on the whole minor variations. We need to understand how such structures of ownership and inequality emerged and persisted and to what extent they belong to the past—unless of course they are also pertinent to the future.

The second way of achieving such high inequality is relatively new. It was largely created by the United States over the past few decades. Here we see that a very high level of total income inequality can be the result of a “hypermeritocratic society” (or at any rate a society that the people at the top like to describe as hypermeritocratic). One might also call this a “society of superstars” (or perhaps “supermanagers,” a somewhat different characterization). In other words, this is a very inegalitarian society, but one in which the peak of the income hierarchy is dominated by very high incomes from labor rather than by inherited wealth. I want to be clear that at this stage I am not making a judgment about whether a society of this kind really deserves to be characterized as “hypermeritocratic.” It is hardly surprising that the winners in such a society would wish to describe the social hierarchy in this way, and sometimes they succeed in convincing some of the losers. For present purposes, however, hypermeritocracy is not a hypothesis but one possible conclusion of the analysis—bearing in mind that the opposite conclusion is equally possible. I will analyze in what follows how far the rise of labor income inequality in the United States has obeyed a “meritocratic” logic (insofar as it is possible to answer such a complex normative question).

At this point it will suffice to note that the stark contrast I have drawn here between two types of hyperinegalitarian society—a society of rentiers and a society of supermanagers—is naïve and overdrawn. The two types of inequality can coexist: there is no reason why a person can’t be both a supermanager and a rentier—and the fact that the concentration of wealth is currently much higher in the United States than in Europe suggests that this may well be the case in the United States today. And of course there is nothing to prevent the children of supermanagers from becoming rentiers. In practice, we find both logics at work in every society. Nevertheless, there is more than one way of achieving the same level of inequality, and what primarily characterizes the United States at the moment is a record level of inequality of income from labor (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) together with a level of inequality of wealth less extreme than the levels observed in traditional societies or in Europe in the period 1900–1910. It is therefore essential to understand the conditions under which each of these two logics could develop, while keeping in mind that they may complement each other in the century ahead and combine their effects. If this happens, the future could hold in store a new world of inequality more extreme than any that preceded it.21