Legacy money rules, inequality’s rising — and the rich need to be taxed more
How will we know when there is true capitalism? When the capitalist figures out how to make money without employing anybody! Jokes apart, there are basically two laws of capitalism. One says the ratio of capital stock to income for any country is equal to the ratio of savings to growth in income. Intuitively, if savings are high and growth low, which is the situation in several developed countries today, then the ratio of capital to income becomes very high which is around 600 per cent in most countries.
The other law defines the share of income going to capital as the product of return on capital and capital to income ratio. With the return increasing over time with access to various assets, capital will get a larger share of income. In fact, when wealth is inherited and can be diversified the returns are higher than in case of an individual who has limited wealth and prefers safer avenues which earn lower returns.
This, according to French economist Thomas Piketty, is the crux of the problem of capitalism, which creates a crisis in the long run because when we over-invest in capital, there is little left for labour which is also what Karl Marx spoke of.
Marx spoke of a revolution, but the basic issue is that if wage earners are squeezed out, who will buy the goods that the capitalist produces? Markets are not self-correcting as is made out in textbooks and hence bourgeois economics does not quite work.
Dilemma of capital
Piketty’s Capital in the twenty first century takes us through this dilemma with a modern perspective. While Marx came to the same conclusion without using any statistics, he goes through heaps of data to draw the same conclusion.
However, economists such as Simon Kuznets and Robert Solow had shown statistically that this was not the case and that inequalities came down during the mid-fifties (1913-48), and technology and competition were the equalising factors. Piketty counters this argument and shows that it was more an aberration due to the war and that such uneven distribution of income was increased subsequently and has reached the 19th century levels today.
Piketty looks at the history of developed nations to show that all measures of inequality declined during the world war but have risen once again to the early 19th century levels with structures resembling them. This holds for the capital-income ratio too.
Inequalities can be understood in terms of the gap between labour and capital incomes. While labour income varies based on education and skill, Piketty points towards exacerbation of this inequality in the modern context where there are super managers who ensure that they earn very high incomes which may not be justified on conventional grounds considering that such labour can be easily substituted.
Therefore, the schism has widened. This, he calls, a society that is hyper-meritocratic. Typically, in such societies, managers pay themselves higher compensation (including generous stock options) and defend it on grounds of superior performance. Interestingly, this has been observed more in the English speaking developed countries.
Also, there is a strong correlation between inequalities in capital distribution with those in income distribution. So typically, while the top 10 per cent of the population has access to 20 per cent of total income, they actually have access to 50 per cent of capital or wealth.
The bottom 50 per cent would own no wealth. The question really posed is that when we look forward to the next 50 or 100 years, will these inequalities increase or move down?
His key take is that as long as the return on capital is higher than the rate of growth of the economy, there would be a natural tendency for inequalities to increase.
While such economies do bring in convergence such as knowledge and skills, it leads to divergences in social and economic order which are potentially destabilising. The processes that lead to the accumulation of wealth have forces that tend to move to divergence leading to inequality.
While land and rent dominated the pre-modern society, today it is the capitalist who dominates and reaps these benefits. Wealth is inherited or acquired and here the author feels the concept of merit does not really matter.
He is probably right because when we do look at the list of the top richest persons which are put out by various journals, there is an element of ‘rent’ which comes in where one earns money from wealth that just came down the line.
Wealth is not justified almost always by sheer enterprise. In fact, even in case of self-driven enterprise he points out that there are several elements of rent which aided innovation and hence there is need to address this issue.
What are his solutions? We can invest in knowledge, education and technology but this is inadequate to really increase growth. Only the so called poor or emerging markets can grow at high rates — which is a fact today because developed countries normally cannot go beyond say 2-3 per cent. He feels that we have to impose a tax on income and wealth. But we need to bear judgment here. Too much taxation will deter enterprise which will be detrimental. Therefore, a more calibrated approach is needed.
What he suggests is the first a progressive tax on income. By taxing the top echelons at a higher rate, and using these funds to redistribute to the poor, a semblance of equality can be pursued.
Tax them more
He suggests a progressive annual tax on capital. This will lower inequality and also prevent creation of dis-incentive for investment.
For this, politics matters and the rulers who have close links with the capitalists must be willing to tighten the laws. Often, they are responsible for the creation of private wealth and he gives privatisation as one glaring example.
The author admits, of course, that to ensure that there is no regulatory arbitrage, there is need to have a high level of cooperation between various countries. Intuitively, one can see that when companies make use of tax havens like Mauritius.
His solution is quite drastic in an age where everyone is talking of lower taxation. In fact, he also argues that governments could actually tax people, read the rich, more, instead of borrowing from them and paying them interest. This is one thought that will keep the reader thinking more.
He does make the narrative interesting when he draws stories from novels of Jane Austen to drive home his point about inequalities in various ages. The book surely adds a new dimension to capitalism and its ills which will find more takers today especially in the aftermath of the financial crisis.
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