September 22, 2014

What if Thomas Piketty is Right about Inequality?

Peter Kennedy
Partner
Thomas Piketty’s unlikely best-seller Capital in the Twenty-First Century is widely considered one of the most influential economics books in recent memory – whether or not one agrees with the author’s conclusions. FSG believes Capital is indeed a seminal work worth discussing. With this blog we initiate an informal series of thought pieces on its implications – for the economy, business, society and for the practice of scenario planning.   
 
So, what if Piketty is right in finding that…
 
Rich countries are doomed to low growth and dangerously widening income inequality. Piketty concludes that demographics and structural impediments will limit economic growth in rich countries and widen the economic chasm that already exists between the rich and everyone else. He says that return on capital will outpace broad measures of economic and income growth, and that this dynamic will inevitably exacerbate income inequality in the future. But the much larger number of people in the middle, working and impoverished classes (who by definition lack significant capital and property) would experience income stagnation, social immobility, and enduring material uncertainty.
 
Piketty’s thesis does not necessarily mean that the twenty-first century inequality will be as grossly extreme as the nineteenth century version – but it could be. Here’s one particularly stark data set. Piketty estimates that the share of national income in the U.S. of richest decile [tenth] of households has risen from 30-35% in the 1970s to 45-50% in the 2000s. He predicts that by 2030 the upper decile will be capturing 60% of national income. Moreover, the biggest proportional gains are going to the hyper-wealthy, the top 0.01%, according to preliminary findings by Piketty collaborators Emmanuel Saez and Gabriel Zucman of UC Berkeley. It may not be the nineteenth century all over again, but Saez and Zucman say it’s starting to look a lot like the Roaring 20s.  And we know how that ended.
 
This is bleak stuff, even if we’re not necessarily headed toward Depression-like economic displacement and massive unemployment. Conditions do not have to be ruinously bad for Piketty to be right.  And it doesn’t mean that we won’t have some strong runs and some uniquely vibrant sectors along the way.  Piketty is more concerned about the long-term trajectory of economic growth versus returns to capital. He warns: “Once constituted, capital reproduces itself faster than output increases.  The past devours the future.”   
 
For business, clearly not all managers are worried about this grim outlook.  The flip side of the inequality story is that these are good times to be selling to the well-heeled. A recent Bain study estimates that the number of luxury consumers, globally, has more than tripled over the last 20 years, to 330 million people. As a result these have been boom times for brands like BMW, Hermès and Louis Vuitton, as well as for the service providers and investment managers who serve the moneyed classes.  (Meanwhile, somewhat further down on the luxury food chain, Apple reports that it had four million preorders of its iPhone 6 in the first 24 hours of the new product launch.) 
 
But what about everyone else? Here in the U.S., one of the most interesting questions that Piketty’s book raises is whether rising inequality and the disappearing middle class matter to business. Some thoughtful observers like The New Yorker’s James Surowiecki are doubtful.  He argues that business interests’ “own fortunes aren’t tied to those of the nation the way they once were.”  Surowiecki says that globalization has upset the traditional dependence of U.S. capitalism on a large, thriving middle class. The S&P 500 sells about half of their goods and services abroad. And dynamic sectors like financial services make their money largely off the rich and affluent. If all this is true, then it’s no wonder that Piketty’s book does not appear to be keeping the U.S. Chamber of Commerce awake at night.  Besides, the economy is picking up, unemployment is falling and retirement savings have recovered much of what was lost after 2008.  Consumer confidence has been rising steadily, with the Conference Board’s index hitting 92.4 in August (1985=100). 
 
That’s the short view, and that’s what drives much business sentiment. But the Piketty perspective (and many other economists’ as well) is that without aggressive reduction in economic inequality – and the attendant inequalities in education, healthcare and political capital – the rich countries of the world will grow steadily less so, especially the bottom 90%. 
 
Left unaddressed, this scenario could prove to be dangerously corrosive on many levels. Think of an exacerbation of the major negatives afflicting the U.S. over the past decade or more: government deficits, high joblessness, crumbling infrastructure, failing schools, and combustible social tensions, as witnessed most recently in Ferguson, Missouri. Such a widening in the have/have not gap would appear to have far-reaching consequences for U.S. society and politics beyond mere disparities in purchasing power.  
 
If this is frightening to ponder, it’s also, from a scenario-planning perspective, an arguably unstable state of affairs. In other words, the downward spiral would not necessarily continue unchecked. There would presumably be some kind of political push-back, accompanied by policies aimed at fixing most egregious inequalities and sources of social tension. Piketty says that in a less imperfect world, the wealth inequality problem would be most efficiently and equitably addressed by a progressive annual global tax on capital. But even he concedes that such a measure, on a global level, would never be seriously considered. It’s hard to disagree.
 
Yet it would be a mistake to leave it at that. A widening economic divide will eventually give rise to proposals – from the redistributionist left, certainly, but maybe even from the populist right – to level the economic playing field.  (Even some libertarians favor ending government subsidies that warp markets and benefit the rich.) The obvious reform targets are perceived distortions in the tax code, including the regressive 20% capital gains tax and the even more controversial carried-interest loophole, which benefits mostly elite private fund managers. Other sophisticated tax shelters and offshore tax havens are receiving increasing scrutiny.  This is apt to intensify in a prolonged period of economic stagnation, with glaring disparities in income, wealth, opportunity and political power.
 
Notwithstanding some extraordinary, groundbreaking research, Piketty may not be right. In fact, those of us in the scenario-consulting business are always uneasy about anything that comes across as an “inevitable outcome.” The world is changing at breakneck speed, and the entire concept of economic value is undergoing revolutionary change. Who knows how this is going to shake out? Piketty himself stops short of saying we’re doomed. He believes the rich countries can rebalance successfully if their leaders embrace the required policy actions.  
 
We’ll give Piketty and the inequality topic more thought in subsequent entries to this blog column. In particular, we’ll consider why our economic future may not be as bleak as Piketty projects.  Readers are encouraged to join in the discussion.  You don’t have to read all 685 pages of Thomas Piketty’s Capital in the Twenty First Century to have a point of view on the subject of inequality.  It’s too important.
 
Comments  | 

George Vecsey
I have not read the Piketty book but I have been watching the Ken Burns Roosevelt series. To me -- the son of Newspaper Guild activists -- the message is the value of self-restraint and common interest. In the Depression, FDR and Eleanor Roosevelt put many things in motion because they were the right thing to do, but also the practical thing to do. A patriot like Alf Landon agreed with some of it. Imagine him getting primaried out these days, chased by Koch Brothers & Co. The tools of selfishness are more pointed these days. Simple maintenance has become a tax/political issue. We learned nothing, apparently. George Vecsey, NY NY
Patrick Marren
Among the huge numbers of ironies is this: the man who is the patron saint of the current enemies of any sort of labor or working people's interests, Ronald Reagan, was head of a union, and also as president chastised the President of Poland in 1981 for violating "one of the most elemental human rights - the right to belong to a free trade union." (We should also recall that Solidarity, the union he was supporting, was a public sector union.) The other thing that strikes me is how we as a nation seem to be at war against everything that one might suppose would help a nation create a future. We are discouraging the next generation by loading them down with unprecedented levels of student debt. We are allowing physical infrastructure to decay at alarming rates. The tallest buildings, the newest cities, the most advanced transportation infrastructure (mag-lev trains, advanced airports) are all overseas. Hatred by a minority for the single most astoundingly successful organization of human beings in all of history, the U.S. federal government, the people who put humans on the moon, created the Internet, cured yellow fever, split the atom, and won two world wars, is forcing all of us to cede the future to nations we used to regard as backwaters. They claim to revere the Founders and to be doing their will. But what did the Founders found? Just one thing. It's not a trick question.
Peter Kennedy
George, thanks for your contribution. What has struck me about the Roosevelt series is the extent -- and nastiness -- of the opposition FDR faced on both domestic and foreign policy fronts. We tend to forget that and project back on those times a more unified and harmonious nation that maybe didn't quite exist...and maybe never really has.
Another victim of inequality: Marriage. True, marriage rates have been in decline for decades. But the worsening socio-economic divide is an increasingly significant factor, notes Clair Cain Miller in today's NYT's Upshot. http://www.nytimes.com/2014/09/24/upshot/for-the-young-money-is-increasingly-trumping-marriage.html?hp&action=click&pgtype=Homepage&version=HpSum&module=second-column-region&region=top-news&WT.nav=top-news&abt=0002&abg=1
Chris O'Keeffe
Disclosure: I'm more often a reader of reviews than books - certainly the case here. I think I get what Pinketty is talking about. I'm also struck by the optimism of people like Steven Pinker, (Better Angels of Our Nature - about the decrease in violence over the course of human history) and the remarkable progress of the Millennium Goals. I've wondered what Bill Gates' take on Piketty would be. Take a look at: http://www.gatesnotes.com/Books/Why-Inequality-Matters-Capital-in-21st-Century-Review?WT.mc_id=10_14_2014_Piketty_tw&WT.tsrc=Twitter
Thanks for the thoughts, Chris, and for the referral to the Gates piece. It's interesting, and worth unpacking in other blog entries. I think we can -- and should -- recognize all the progress of the last 20-30 years but still identify specific choke points and structural weaknesses, like inequality. Interestingly, just today, at a speech in Boston, Fed chair Janet Yellen expressed concern about inequality's negative effect on the economy. Seems kind of intuitively obvious (a consumer economy needs consumers, after all), but research has only recently begun to chart the relationship between inequality and growth. It will be very interesting to see where this all leads...

Thoughts?