Opinion and Economic Analysis

Hicks: Income inequality tied to capital investments

May 31, 2014

French economist Thomas Piketty’s new book “Capital in the Twenty-First Century” has taken talk shows and national columnists by storm. Much of the enthusiasm is well deserved. It is far and away one of the most important books on the economy in some time.

From a great deal of painstaking research, Piketty proposes and defends a simple thesis: The rate of return on capital investment is greater than the rate of economic growth. Thus, income inequality is destined to expand dramatically because those who own stocks, land, machinery and other types of capital earn money faster than typical workers, who are constrained by growth in their wages.

This book is not about the income inequality that animates much of today’s domestic debate for the simple reason that the book is about the role of accumulated and inherited capital, not about the incomes of rich CEOs and other big earners that anger the Occupy Wall Street crowd. Clearly, many of Piketty’s admirers haven’t read his book.

Piketty is no closet Marxist, but, like any good economist, understands what Karl Marx said about the role of capital in the world. One Marx inference that Piketty extends is that the accumulation of capital amplifies economic inequality.

Ironically, he lambasts government debt as a primary source of capital inequality. Government bonds are historically the source of vast wealth bequeathed to heirs. I don’t know how the New York Times missed that part of the book.

Indeed, while the central idea of capital accumulation is the heart of this tome, the actual policy recommendations (like a global wealth tax) are intended only to foster discussion and sell books.

There are two major problems with his thesis about capital accumulation. The first is that the United States has only three centuries of real economic growth to examine. Over much of that time, the return to capital has been below that of economic growth. The dearth and quality of data argue against grand conclusions, and Piketty’s ideas are ambitiously grand.

Second, the way capital and labor now interact to produce goods and services benefits specialized human capital. This is a very different world than the factory of 1890 where much labor was a commodity.

So, much of earnings income differences are necessarily due to the way highly skilled people use capital, not the returns to capital itself.

Piketty dislikes the term human capital, yet this is where much inequality is now rooted. That is a different issue for a different, better and ultimately more important book.•

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Hicks is director of the Center for Business and Economic Research and a professor of economics at Ball State University. His column appears weekly. He can be reached at cber@bsu.edu.

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