Living with inequality: Has Thomas Piketty really found 'the central contradiction of capitalism'?

• Author: Jones, Garett
• Position: Capital in the Twenty-First Century - Book review

Capital in the Twenty-First Century, by Thomas Piketty, Belknap /Harvard, 68$ pages, $39-95

In Capital in the Twenty-First Century, the French economist Thomas Piketty claims to have uncovered "the central contradiction of capitalism." When a major scholar like Piketty--a man who has contributed real value to empirical economics--makes such a bold claim, it deserves to be taken seriously.

So what is this flaw at the heart of the economic machine, a flaw somehow overlooked by economists for centuries? That sometimes the interest rate (which Piketty correctly uses as a stand-in for the total average return on different types of capital, including profits, interest, and capital gains) is greater than the overall economic growth rate. Piketty sums this concept up with the simple equation: r > g. If r > g for decades, he argues, capital's advantage contains the seeds of deep social conflict.

If the wealth of capitalists grows at the interest rate, and if that wealth grows faster than the overall economy, capitalists will take over more and more of the economy until something genuinely awful happens, goes the idea. Piketty is vague about what this awfulness might consist of, but the memory of the last century brings to mind quite a few unpleasant scenarios in which average citizens get mad at elites: anything from banking overregulation to a full-blown Marxist revolution, with dozens of possibilities in between. In the meantime, ultra-wealthy economic elites can buy massive political influence, prodding the government to favor well-connected insiders and thus slow down the economy.

As a matter of politics rather than economics, there's little to disagree with Piketty's prophecy. If--a big if--there's a central contradiction in capitalism that makes capitalists get richer at a faster rate than the overall economy, then the miracle of compound interest promises endless opportunities for conflict between those with compounding wealth and those with slow-growing wages.

So is this central contradiction a thing? Barely. Even capitalists consume, and they can consume quite a lot. The typical person might not be able to imagine what it's like to be worth a billion dollars and have about $40 million a year in interest and dividend income as spending money, but among private jets, new cars, the latest medical treatments, and gifts for rich friends, a billionaire can spend that much just trying to keep up with his neighbors. Saving is mostly just delayed consumption, as generations of economists have taught, and the only way for capital to grow exactly at the interest rate is for nobody to consume it. Every bit of consumption pushes down the growth rate of capital.

The entrepreneur who earns a few billion from innovation might be frugal enough to pass on a massively compounded pile of capital. But descendants have a funny way of frittering away fortunes or at least dividing it into tiny slices, causing the long-run trend of this pile of billionaire capital to grow at about the same rate as the overall economy.

Since capital helps the average worker do her job, we should hope that the world's billionaires will be frugal rather than reckless, lending their stockpile to fund innovation the world over. But we are unlikely to be so lucky. Billionaire wealth can turn into multimillionaire wealth with just a few ill-judged marriages.

There's an extra reason to think that capital isn't going to permanently grow at a faster rate than...