Blog post assignment

Your blog post assignment is due on Friday November 4th, before 5pm (end of week 8).

Here are some tips for writing a good blog post:

  1. Be clear about what you want to say before you start.
  2. Map out the paragraph structure in your rough work.
  3. Start with a clear puzzle and question.
  4. Write a snappy imaginative title.
  5. Write a captivating introduction.
  6. Specify your core claim/argument.
  7. Marshall empirical evidence to back up this claim.
  8. Discuss this evidence in relation to the wider literature.
  9. Conclude by specifying why it is relevant.
  10. Write for a public audience.
  11. Enjoy the writing process!
The length is between 1200-1400 words. For a blog post this implies 10-13 concise paragraphs. The referencing style is Harvard. Use online link in the text to directly to direct the reader to the references. There is a blog option on Microsoft word, which is useful.

Feel free to email me with your ideas, or to discuss further. For examples of excellent academic-style blogs, see this website: http://blogs.lse.ac.uk/europpblog/

Lecture 6: Critical Political Economy

Introduction 

The study of political economy can be distinguished from the study of economics because of it’s focus on:

  • Power
  • Institutions
  • Distribution

In terms of power: whereas economists tend to analyze the market in terms of Pareto-optimality, political economists tend to analyze markets in terms of whose interests are being served by a given set of economic arrangements.

In terms of institutions: political economists tend analyze the economy as a diverse set of institutions that vary across time (history), and space (country). These institutions are the rules of the game that shape actor behaviour.

In terms of distribution: political economists study the market as a contingent human construct whose conception is not based on natural laws but the primacy of politics. They are interested in who gets what, when and how.

This tradition stems from Adam Smith but took a critical turn when Karl Marx published the first volume of Capital in 1867, fifty years after Ricardo published his Principles on Political Economy. 

  • Think about the year 1867. What was happening across Europe?

It was twenty years after the 1848 European revolutions, which swept across Italy, France, Germany, Netherlands, Poland, the Austrian Empire, and even Ireland.

What all of these nationalist revolutions shared was the attempt to overthrow feudalism and to replace it with more participatory forms of democratic government. This gave birth to the nation-state as we understand it today.

The revolutionary fervor began in Milan when 70 people were killed whilst protesting against tax increases on tobacco, imposed by their Austrian rulers. These protests spread to Sicily, where local citizens demanded a liberal constitution to replace the autocratic rule of King Ferdinand II.

Before long people were rioting in Geneva, Paris and across several cities in what we now call Germany.

Historical context

It was against this background that Marx published Volume I of Capital.

Think about the context. England had the fastest growing economy in the world. Thousands had left the ‘land’ to work in factories. All of these new labourers were living in urban slums. This is what inspired Charles Dickens to write his famous novel, Oliver Twist.

From 1840-1890 poverty was widespread, real wages were stagnant, whilst profits increased. It was not until the second half of the 19th century before real wages began to increase for the emergent industrial/working classes.

Keep in mind Adam Smith’s labour theory of value that we discussed last week.

National income (all earnings in a country) can be divided into wages, rent and profit. During this period of explosive growth the share of wages in national income did not rise.

The capital share of national income (industrial profits, land rents and building rents) increased massively in the first half of the 19th century. From 1870-1914 inequality stabilized at an extremely high level, marked by an increased concentration of wealth.

  • Hence the industrial revolution gave birth to a period of rapid economic growth, stagnant wages and a growth in extreme inequality.

This is the historical context that led Marx to write the ‘communist manifesto‘ in 1848.

The method

After this polemic Marx spent the next twenty years writing Das Kapital, which he considered the first scientific attempt to systematically analyze the internal logical contradictions of the capitalist system (based on the Hegelian dialectic).

For Marx the most important resource is not land but capital.

He takes Adam Smith’s analysis and works through the logical outcome of commercial markets. He concludes that markets lead to centralisation not competition.

Keep in mind that Capital in 1868 was primarily industrial (machines, factories) rather than landed property. Hence, contrary to Ricardo, for Marx there can be no limit to industrial capital.

This led Marx to formulate his “principle of infinite accumulation“.

Capital left its own devices will keep accumulating and become more centralized. For Marx, this principle of infinite accumulation implies that capital is doomed to perpetual crises (in the Hegelian sense).

  • For Marx, either the rate of profit will steadily decline (leading to violence amongst capitalists) or capital’s share in national income would increase indefinitely (leading to workers revolution).
  • For Marx, there is no stable equilibrium in a capitalist society, it will “build it’s own gravediggers“.

The theory (M-C-M)

Let’s unpack his theory further.

First, it is crucial to note that Marx is in dialogue with Adam Smith. In chapter 2 of volume I he accepts the Smithean argument on exchange, reciprocity and private property and then proceeds to deconstruct it entirely.

He points out that contrary to the outcomes suggested by Smith, competitive markets will lead to:

  • the centralization of capital (markets lead to corporations)
  • the concentration of capital (centralization leads to class power)

The entire book can then be read as unpacking logically the system of free competitive markets, in order to show why they can never be ‘free’.

For Marx, the capitalist starts out with a certain amount of money. He then purchases two crucial commodities:

  • Labor power and
  • Means of production (raw materials, machines)

He then puts these two to work with a given technology to produce a fresh marketable commodity. This is then sold in the market place plus a surplus value to make a profit.

But it does not stop here. The capitalists does not consume all the profit as luxury. Rather he re-invests it to produce more commodities.

To do this he must expand labour and apply new technologies to produce new and better commodities.

Why? For Marx the coercive laws of competition compels the entrepreneur to reinvest the surplus. If he does not he will be destroyed by his competitors.

The outcome is a simple formula for the circulation of capital: M-C-M. Money-commodity-Money.

The 5 crises tendencies 

For Marx the capitalist mode of production always leads to crises. It contains 5 major problems that lead to the following questions:

  • Money – where does it come from?
    • Secure the legal-state
  • Labour – how to source supply and demand?
    • Weaken unions
  • Environment – how to deal with scarcity?
    • Invest in technology
  • Technology – the falling rate of profit?
    • Source new markets
  • Debt – how to keep the system liquid?
    • Ensure aggregate demand

Keynes would later suggest that the state and fiscal policy must be used to stimulate the economy if the market is faced with a lack of effective demand.

What is important to note is that these blockage points within the capitalist mode of production need to be overcome. For Marx capital is a flow, if you stop the flow, capital gets lost. This is why Marxian economists are critical of Piketty, who thinks of capital as a stock of wealth.

For Marx, capitalist politics is a perpetual class struggle over all of these factors that keep the system intact. If there is no resolution then stagnation occurs. Crises = Revolution.

The Marxian method

Marx predictions on the inevitable demise of the capitalism turned out to be wrong. He assumed that capitalism would collapse. It didn’t.

This mistaken judgement is not sop much related to his insightful historical analysis, but more to his use of dialectical Hegelian method, which assumes, by definition, implosion.

At the end of the 19th century wages gradually began to increase, and the purchasing power of workers spread everywhere.

In Western Europe, workers and citizens explored the alternative avenue of social democracy, rather than communism.

Marx did not anticipate the emergence of a propertied middle class, nor the emergence of new technologies and a steady increase in productivity.

The balance of power among different classes associated with trade unionization complemented the emergence of a new power configuration, with a a relatively autonomous state apparatus with the capacity to tax and spend.

This gave birth to the social state as we understand it today. Or capitalist democracy.

What did he get right?

Marx’s principle of accumulation contains an important insight that contemporary economists have tended to ignore: competitive markets have a tendency toward the centralization of ownership and the concentration of wealth.

Just think about the influence of large corporations, such as Google.

The accumulation and concentration of wealth does lead to the concentration of power, which has destabilising effects in both politics and economics.

It would be naive to think that growing income and wealth inequality does not impact on equality of opportunity and democracy.

Why then have economists tended to ignore the distributional question?

Simon Kuznets 

The narrative during the 20th century shifted away from apocalyptic predictions to happy endings. It was now assumed that a rising tide lifts all boats.

Simon Kuznetsk predicted that income inequality would automatically decrease in advanced stages of capitalist development, regardless of the economic policy choices pursued by government.

This theory was based on US data from 1913-1948. It built upon Robert Solow’s (1956) theory of a “balanced growth path”.

Economists increasing assumed that all the core economic variables in society: output, incomes, profits, wages, capital, asset prices, would progress at the same pace. In the end,  everyone would benefit from strong economic growth.

This was the opposite conclusion to Ricardo and Marx’s assumption of an inegalitarian spiral built into the process of capitalist development.

Kuznet’s was the first to analyze social inequality using sophisticated statistical and mathematical tools. His data (which Piketty has since developed) was based on federal income tax returns.

This allowed him to measure top incomes, particularly the percent going to upper deciles and centiles, in the overall income distribution. What he observed was a sharp decline in income inequality between 1913-1948. In 1913, the upper decile claimed 45-50 percent of national income. By the late 1940’s this had declined to between 30-35 percent.

This decrease was equal to half the income of the poorest 50 percent of Americans. This decline in inequality shaped the debate on the politics of distribution in the USA, and various international organizations, throughout the Cold War.

Capitalism was clearly working for everyone whilst the Communist experiments were not.

Kuznets curve 

Kuznets delivered a paper titled ‘Economic Growth and Income Inequality‘ to the American Economic Association, which gave birth to a new theory: the ‘Kuznets curve’, which predicted that inequality would initially increase during industrialization and decrease at a later advanced stage of economic development.

The internal logic of capitalist development was now assumed to be one of equalization not narrow accumulation. Market competition leads to balanced growth.

As we will see in the coming weeks, it is true that wealth and income inequality decreased in the 20th century, particularly after the shocks of two world wars. But it is also true that wealth and income inequality has since increased, rapidly, everywhere since the late 1970s. This is the opposite prediction of Kuznets theory.

The income of the wealthiest have reached extraordinary levels whilst the incomes of the vast majority have stagnated.

This has led to levels of inequality not seen since the Great Depression, particularly in the USA. This table and graph illustrate the point. The question we need to ask is why this has occurred?

Conclusion 

The important question now is trying to explain the decline in inequality in the 20th century and and then it’s rapid rise during the 21st century.

What we will see over the coming weeks is that in the aftermath of WW2 various forms of progressive taxation, capital controls, collective bargaining, rents control, minimum wages and expanded social programs worked to redistribute capital across society, leading to a more equal share going to different economic interests in national income.

These were the ‘happy days‘ of a growing middle class.

There is now growing skepticism about the assumption that growth is ‘naturally’ balanced. There are clearly winners and losers. In the US the top decile receives over 52 percent of national income (a new historical record). What this suggests is that the gains of “growth” are being distributed disproportionately to the top of the income ladder.

To explain the U shaped curve of inequality from 1900-2013 we need to examine the origins of this inequality (1890-1913), which is what we will do next week.

The industrial revolution, in addition to the race to colonize the world, completely transformed the face of capital in Europe.

Furthermore, what we will also observe is that from 1890-1913 (before the outbreak of WW1), there was an extreme concentration of wealth inequality in France and Britain, which Piketty suggests can be explain by the mechanism R>G.

The shortened slides can be found here:lecture-6

Lecture 5: Classical Political Economy

Introduction 

Last week we discussed the importance of economic and population growth in measuring the wealth of nations. We observed that there was a long period of stagnant economic growth from antiquity, and a limited improvement in aggregate living standards. The period from antiquity to 1700 is often referred to as the Malthusian era.

What we observed in the data was that it was only from the late 18th century, and the subsequent period of capitalist development from the 19th century onward, when economic growth really began to take off. What explains this divergence?

This was the fundamental question of ‘classical political economy‘.

Classical political economy is a term coined by Karl Marx in the first edition of Das Kapital, to describe those British and Scottish economists that sought to explain the ‘internal framework [Zusammenhang]’ of the “bourgeoise mode of production”.

Classical political economy is a term usually associated with the normative defence of free markets (as opposed to state protectionism), and it’s origins are identified with the time period between 1750 and 1867.

Today, it is a term that primarily describes those group of political, moral and economic thinkers who drew upon and revised Adam Smith’s ‘An Inquiry Into the Nature and Causes of the Wealth of Nations‘. 

The objective of classical economic thinkers such as Thomas Malthus, David Ricardo, and John Stuart Mill was to analyze the production, distribution, and exchange of commodities in market societies.

What interested them was the development of commerce, the role of the state and the emergence of industrial capitalism.

Adam Smith (and the division of labour):

Adam Smith’s Wealth of Nationspublished in 1776, opens with a discussion on the core concept that has shaped all theories of classical political economy: the division of labour.

Smith dedicates the first book of his treatise to the question of labour.

For Smith, the division of labour explains the determinants of economic growth, as it is the key to productivity improvements in the process of capitalist development.

But what exactly does the division of labour mean?

  • It suggest that dividing the production process into different stages enables workers to focus on specialized tasks, which improves efficiency and enhances overall productivity. This, in turn, leads to technology improvements. In sociology it is a concept that is used to describe the division of tasks in any given society.

One of Smith’s most popular examples to describe the division of labour is the manufacture of a pin. He describes each stage in the production process and shows that one person doing all 18 tasks can produce 20 pins a day, whereas if the 18 different tasks are divided among 18 different people they can produce over 300 pins a day.

For Smith, the most important outcome of the division of labour is skill specialization. This is the first crucial observation, as it is the origins of human capital theories.

The outcome of skill specialization (which Smith describes as dexterity, tacit knowledge, skill and judgement) is a diversified economy, whereby each person is dependent upon the labour of another.

In this context everyone is compelled to co-operate freely in a process of exchange, as everyone is reciprocally dependent on everyone else.

This leads to his next observation:

The division of labour is wealth improving when the size of the market is bigger, and more diversified. Large markets increase the incentive to specialize.

Large markets, in turn, are made possible by “trust, reciprocity, good government, free trade and geography”.

It is often assumed that Smith was a radical advocate of individual self-interest. This assumption simplifies his work. For Smith “man has constant occasion for the help of his brethren… he will most likely prevail if he can interest their self-love in his favor….it is by barter that we obtain from one another those mutual good office that we stand in need of“.

It is through individuals pursuing their self-love, understood as the satisfaction of human needs: food, clothing, hunger, which gives rise to commercial trade in a market society.

In summary: the wealth of a nations comes from commercial expansion and productivity growth, which is dependent upon skill specialization, and the division of labour.

Adam Smith (and the division of society):

Adam Smith’s labour theory of value led him to divide society into three different “classes” of person: landlords, wage-earners and capitalists.

Those who live by rent, those who live by wages and those who live by profits.

In Smith’s commercial society the hidden hand of the market acts a horizontal mechanism to ensure a diverse economy meets supply and demand. This horizontal market supplants a hierarchical model of society governed by elites.

Only productive labour contributes to the wealth of nations. When citing unproductive labour he includes “politicians, poets, musicians, lawyers and economists”.

These are all necessary forms of labour but they are not wealth producing.

The obvious hero of Smith’s tale of wealth accumulation (told in four historical stages) is the capitalist entrepreneur. Trade is considered more profitable than agriculture, even if the agricultural laborer is the most “virtuous of all persons” in craft and skill.

At the core of the human psyche for Smith, and classical political economy more generally, is need and desire (not rational optimal utility calculation associated with the marginal utility revolution of contemporary economics).

The desire to save and the desire to consume is what drives individual effort.

Free commercial trade, the division of labour and the expansion of markets is what enables this individual effort to come to fruition.

But contrary to popular conceptions of Smith as the defender of vice and unfettered free markets he considers prudence to be a core virtue.

For it is only through hard work and saving for the future that one can ensure the respect of their peers (sociability) and generate wealth (savings) for investment.

The role of the government is to get out of the way of commerce. But government in this context means authoritarian rule.

But Smith was also quite clear on what government (the sovereign) should do: provide security, infrastructure, administer justice and public education.

Adam Smith was under no illusion about the tradeoffs associated with commercial expansion, and capitalist development.

He states that commerce renders the merchant “deceitful”, whilst the idle landlord usually ends up “stupid”. If natural man is a “merchant”, then “the virtuous man is a farmer”.

Despite his romanticism for agriculture he regularly cites that it cannot lead to aggregate wealth. A growth in national income depends on commercial expansion.

It is important to note that the Wealth of Nations is a historical and empirical text.

Smith examined both the historical predecessor to market society; feudal agrarianism, and the subsequent emergence of ‘mercantilism’.

Mercantilism was associated with state sponsored export-led growth and production (the promotion of exports over imports, and savings surpluses at expense of other nations).

Smith agreed with the French anti-mercantilist thinkers that mercantilism is consonant with absolutist rule, and a beggar thy neighbor strategy of commercial expansion.

Adam Smith (on self-love not selfishness):

For Smith, self-interest is the connecting force between ethical and economic conduct.

But self-interest is not to be confused with selfishness. It is better understood, in his words, as “self-love”, which is closely connected to reciprocity (exchange).

The term laissez-faire was never used by Smith. Further, he only ever used that famous term ‘hidden hand’, three times.

For Smith, the expansion of commercial markets would ensure greater social and economic equality, which must be primarily understood as the dissolution of feudalism.

Finally, contrary to neoclassical economics, classical economic theory was built around the theory of labour value, and it’s impact on the material production of society (and the division of social classes: rentier, wage-earner and capitalist) that it gives rise to.

Remember Piketty’s core concern is that the rentier has replaced the capitalist in modern market economies. He’s arguing that the capitalist always becomes a rentier.

David Ricardo (on rent, profit and wages):

Building on the foundations laid by Smith, the classical political economists began to focus on the specialization of the division of labor as the source of increasing national wealth.

David Ricardo became interested in economic theory after readings Smith’s Wealth of Nations. In response, he published his famous Principles of Political Economy and Taxation in 1817.

The first line of the book states that the principal problem of political economy is that of sharing national income between rent, profit and wages (therefore he was interested in the distribution of wealth and not just its creation).

For Ricardo, the societal division between rent, wages and profit is the product of the commercial economic system; the volume of production within it, and the absolute income received by each person within the system.

In the late 18th century, national income was divided up between landlords, workers and capitalists. He takes this tripartite division of society directly from Adam Smith.

But unlike Smith he is deeply concerned with the rise and fall of real wages (what we would call purchasing power today) as a percentage share in national income. He was concerned that too much of national income was being accrued in the form of rent to landowners.

As we will see Marx effectively borrowed, in total, Ricardo’s labour theory of value.

David Ricardo (and comparative advantage)

Ricardo is most famously known for his theory of comparative advantage.

This implies that a nation should specialize in the production of those industries in which it is most internationally competitive. It should then trade with other nations to import those products that it no longer specializes in at home. Swapping wine for bread.

Think about this today. What does Ireland specialize in? China? USA? France?

David Ricardo (on scarcity and rising rents)

But in his Principles (which is of most interest to us) he is primarily concerned with the long-term evolution of land prices and land rents.

His argument on scarcity and rising rents is as follows:

  • Once population and output grows, land becomes more scarce. The law of supply and demand suggests that the price of land will continuously increase (it will become scarce). This implies higher rents for landowners. Landowners will therefore claim a growing share of national income, at the expense of profit and wages.

In response to this, Ricardo called for a tax on land rents to control price increases.

His concern proved to be misplaced in the long term. Land prices increased but with the industrial revolution the value of farm land declined relative to other forms of wealth in national income.

But his ‘scarcity principle’ is an important concept for understanding why certain prices might rise to very high levels over a given period of time (and the wealth accrued to those who benefit from rising asset prices).

Rising prices

To recognize the importance of price as a coordinating mechanism, capable of destabilizing entire societies and markets (and therefore benefiting certain economic interests over others), just replace the price of farmland in Ricardo’s model with the rental price of housing in Dublin, San Francisco or London today.

Rental prices in Dublin have increased by almost 35 per cent since 2011 whilst wages have remained stagnant (or even declined), and now exceed the peak of the housing bubble.

What is a reasonable price for a basic human need like housing?

Does this need to insure a reasonable price imply that the state should introduce price (rent) controls? Or is it something that should be left to the ‘market’?

Should the state build houses, and therefore remove the profit motive for house building?

Adam Smith once wrote: “in times of necessity the people will break through all laws. In a famine they will break open the granaries and force the owners to sell at what they think is a reasonable price”.

In theory there should be a simple mechanism to avoid rent controls: the law of supply and demand. If the price of housing or rent in Dublin is too high, then demand should fall. People would rent property in those places where prices are lower. They would move to Donegal and commute.

This is obviously not realistic.

As we will see in the coming weeks, one of Piketty’s core observations is that we should be concerned about the idle use of private wealth.

Hence, an obvious solution to the housing crisis might be a public investment project to build more houses. This means using taxpayers money, or borrowing on markets.

The general point is that Ricardo was trying to demonstrate that a long lasting divergence in the distribution of wealth is intimately linked to changes in certain relative prices, such as housing or land (the scarcity principle).

Thomas Malthus (and the diabolical trade off)

Thomas Malthus was also concerned about the scarcity of resources and how this might affect the distribution of wealth.

He published his famous essay on ‘Principles of Population‘ in 1798, and argued that the primary threat to society was overpopulation.

He based his observations on what was occurring in France, the most populous country in Europe at the time (20 million compared to 8 million in the UK).

The rapid population increases contributed to the stagnation of agricultural wages (more workers than jobs) and an increase in land rents (more people than land).

All of this fed into the growing unpopularity of the landed aristocracy, and fed the conditions that gave rise to the French revolution in 1789.

Malthus was concerned that the mass poverty, associated with rapid population increases, would ultimately lead to political revolution in England, where he favored separate houses of parliament for aristocrats and commoners.

He was concerned it would up-end the rule of the elite.

For Malthus, as population increases, food per person decreases. He called this the law of diminishing returns. This meant that there is an inverse relation between wages and population growth. This is what some call the  ‘diabolical tradeoff’.

But there were natural adjustment mechanisms to deal with it: famine and war. The Black death (1348-1350) was one of the largest determinants of population decline in history. In England, the Black Death wiped out 1.5 million people out of a population of 4 million.

In the absence of such natural adjustment mechanisms, Malthus called for an end to welfare assistance to the poor and proposed other mechanisms to reduce their reproduction habits.

Charles Dickens clearly disagreed with Mathus. His ‘Christmas Carol‘, published in 1843, can be read as an allegory against Malthusians.

If you remember, Scrooge repents in the end. There is no natural diabolical tradeoff between income and living standards/population increases.

But there might be a tradeoff about the rate of growth and the cost of public services i.e. people living longer cost the state more on pensions. Demographic changes put increased demand on public services, which  raises the question: who pays?

This is a core fiscal problem that many European welfare states are struggling to deal with today. In fact, many argue that the crisis of contemporary capitalism is related to the crisis of fiscal democracy: public services require more investment, but nobody wants to pay.

Conclusion

Classical political economy is a term that is popularly used to describe a body of economic theory that advocates laissez faire, free market capitalism. But it is more nuanced than this.

It is better understood as the beginning of a scholarly attempt to systematically analyze the emergence of commercial society, and the internal conflicts of capitalist development (particularly the determinant and destabilizing effect of prices).

For the classical thinkers, the determinants of economic growth (and therefore increased living standards and the overall wealth of nations) is labour specialization, human skill, productivity improvements, trade and the expansion of markets.

All of this was based on a particular political democratic theory of economic liberalism. Private property (against the state) was assumed to be the primary source of justice.

The moral critique of an emergent group of economic socialists rejected this.

John Stuart Mill, for example, whom we have not discussed, favoured a different concept of private property. Markets provide an incentive mechanism to promote social utility.

Classical political economists assumed that greater social and economic equality would accompany the ever greater expansion of the market i.e. economic growth.

It was assumed more markets = more trade = more growth = rising tide lifts all boats. Whether this is true or not is what we will discuss on Weds.

The lecture slides can be download here. lecture-5

Lecture 4: Generating the wealth of nations; What is economic growth?

Introduction

In rich countries individuals are healthier, live longer, have better access to public services and better educated. Why are some countries rich and some countries poor? Why does this even matter? Is economic growth coming to an end? What do economists mean when they talk about secular stagnation? Is economic growth a good thing?

To explain these contemporary dynamics, and to answer some of these questions, it is worth taking a longer term perspective.

The first thing to note is that measuring “growth” requires examining both population and economic growth. It is the latter (productivity growth) that tends to improve aggregate standards of living. This data shows global economic growth since the industrial revolution.

It is important to note that a small percentage change compounded over a long period of time accumulates very quickly. A generation of economic growth can spur huge social change. Just think about what Ireland looked like in the 1950’s, compared to the 1980’s and today, in 2016.

For example, an annual growth rate of 1 per cent is equivalent to a generational growth rate (30 years) of 35 per cent. An annual growth rate of 2.5 per cent is equivalent to a generational growth rate (30 years) of 110 per cent. For purely conceptual purposes, you can think of the latter as a 100% change over a generation.

In contemporary discourse, politicians and policymakers often assume that a growth rate of 2 per cent per annum is small. But when compounded over 30 years it can lead to a lot of socio-economic change. Further, economic change can spur both positive innovation and social dislocation. It can create huge problems (i.e. housing not keeping apace with demand).

All of this compound change is called the law of cumulative growth. When thinking about it in terms of capital, it basically means that the annual rate of return compounded over several years automatically results in a very large increase. Hence, if profit/rent grows faster than wages, we see a divergence in who benefits from growth.

  • Table 2.2 captures what this means in concrete terms and can be applied to anything from the rate of return on capital, population growth, household income or economic growth.

This is crucial for understanding Piketty’s argument on the inequality R>G.

An apparently small gap between the aggregate economic growth rate (which gives a sense of wage growth) and the rate of return on capital (which gibes a sense of wealth accumulation) can accumulate over many years, creating a deep structural divergence in income distribution.

Most economists in the 20th century assumed that there would be a perpetual decline in wealth and inequality, and growth would lift all boats. Economic growth was considered something that equalised standards of living, as ultimately, in the end, everyone would benefit.

This is the normative foundation of liberal-democratic market capitalism: everyone benefits, not just the elite. Piketty is suggesting this is no longer the case. Capitalism is in crisis.

 

Population growth

Let’s look at population growth from antiquity to get a sense of just how much has changed over time.

  • Figure 2.2 depicts the growth rate of the population from year 0 to 2100. The demographic growth rate from year 0 to 1700 was less than 0.1 per cent. But in the end, much of this growth in the population was wiped out by famine and disease.

Population growth increased significantly with improvements in medical technology and sanitary conditions. Demographic growth accelerated significantly from 1700 onwards.

But there was huge variation between countries. The USA went from a population of less than 3 million in 1780 to 300 million in 2010, whereas during the same time period in France it only doubled from 30 to 60 million.

According to UN forecasts the annual population growth rate will fall to 0.4 per cent in 2030 and then 0.1 per cent in the 2070’s.

This is not a course in demography, we are not interested in demographic growth for its own sake. We are interested in population growth because it has implications for the structure of economic growth, and wealth and income distribution. As Piketty states:

Strong population growth, as in the USA, tends to play an equalizing role in wealth distribution. It decreases the importance of inherited wealth in the sense that every society must reinvent itself

What does he mean by this? Put simply: if you are one of fifteen children it is probably not a good idea to rely on inheritance from your parents to generate income and wealth. The same logic applies on a population wide aggregate basis.

Economic growth

This observation (the equalizing role played by the law of accumulated growth) makes more sense when we extend it to economic growth.

If you live in a country that is growing rapidly, such as 4 per cent per annum (with wages growing 3 percent), over a generation (30 years), you would be wise to get working, to take advantage.

Conversely, with a stagnant population and slow economic growth, with poor employment and wage prospects, inherited wealth and capital accumulated from the past (i.e. from the hard work of your grandparents) takes on much more importance in society.

This is why people emigrate to fast growing economies.

This is the crucial point for Piketty. The data suggests that western economies are slowing down rapidly but remain rich in wealth. Hence, the past impacts on the present.

Low growth economies are societies dominated by inherited wealth, and accumulated assets from the past (think Italy or France). Private capital that is owned tends to be saved and hoarded, rather than put to productive use in the real economy (i.e. investing in infrastructure). Think about an empty building in the city centre.

  • See table 2.5 for a breakdown of per capita economic output by global regional blocs.

Distribution

For Piketty, declining economic growth at the macro-level is the main factor leading to rising wealth inequality over the long-term (the inequality R>G). This is what defined the 18th and 19th century. The fast growth in the 20th century changed this. Piketty suggests it has re-emerged today in the 21st century.

It is crucial to note that it was only during the 20th century that economic growth became a tangible benefit for everyone. Access to health and education were central to this shared growth. The birth of the social state re-distributed growth to the benefit of society, at large.

In particular, the strong economic growth that swept Europe from 1945-1975 enhanced the possibility of social mobility for those whose parents did not belong to the elite of a previous generation. It also funded the emergence of the ‘social state’ in Europe.

In these rapidly changing economies, new business models were created. New skills and capabilities were developed. Capital and labour were put to work in different ways.

Economics, however, tells us very little about the political distribution of growth. This is a question of politics. Trade unions, for example, played a significant role in making sure the growth was compensated with a strong wage-productivity push, as pointed out by Larry Summers.

If societies want to ensure that the gains of growth and technological innovation are distributed fairly (i.e. not captured by the elite) then this requires an inclusive set of political institutions. Democracy enables market capitalism because it widens the opportunity space for innovation and inclusion.

Discussion

What institutions and public policies are likely to lead to inclusive economic growth? Is it better to live under a dictatorship with a home and a job, than to be unemployment in a democracy?

It is this emphasis on democratic institutions, public policy and electoral choice that defines large parts of contemporary political economy. Capitalism is viewed as variegated, and subject to radical mutations and adaptations (not a deterministic techno-economic paradigm), and primarily shaped by politics.

Conversely, Marxist economists anticipate a never ending crises of capitalism (such as the great recession) that will lead to its collapse.

But what about recent events? Does Piketty’s data suggest that perhaps Marx was right? We will discuss this next week.

Labour market

The major impact of capitalist and technological growth in the 20th century has been in the structure of employment. The structure of economic growth has a huge impact on jobs.

  • See table 2.4 on changes to the labour market.

Over 70 per cent of the population in the western world now work in services; even in countries as diverse as France and the USA. This is a broad category and includes high-skill and low-skill service jobs, traded and non-traded. But the defining characteristic in all western countries is the decline in manufacturing (and low to medium skills more broadly).

What we are witnessing is a growing divide between high and low skilled jobs, with medium skilled jobs (bank clerk, manufacturer etc) in decline. For economists, this is largely driven by the impact of globalisation, and technological change.

Think about the impact of technology on the labour market. For example, consider the impact of the Uber on taxi-drivers, or robots on car manufacturing, washing machines on cleaners etc.

Here comes the bad news, most research suggests that the structural shift from ‘manufacturing to services’ has significantly slowed down aggregate economic growth rates.

Secular stagnation 

Most forecasts suggest that the thirty post-war years of strong economic and productivity growth in Europe were the exception rather than the norm.

The implication is that liberal democracies cannot rely on economic growth to realize their democratic aspirations.

Furthermore, as we will discuss in later lectures, some economists suggest that the determinants of economic growth (technology and productivity improvements) may be in decline. This is often referred to as ‘secular stagnation‘.

Capital is running out of places to invest. It’s being hoarded.

Since the 90’s the policy response to low growth has been to remove the political constraints that inhibit free markets: liberalization, tax cuts, capital mobility, hard currency and austerity.

This is what popular commentators, such as Paul Mason, call the crisis of neoliberalism.

The golden age

  • Figures 2.3 shows the comparative evolution of economic growth rates in Europe and North America.

Per capita output surpassed 4 per cent every year in most European countries between 1950-1970. If we exclude Britain it was even higher.

Now think about this in terms of the law of cumulative growth. This was the golden age of capitalism, it’s your parent and grandparents generation.

Now, note the difference between Europe and the USA from 1940-1975. This difference might explain why Americans do not have the same nostalgia for the ‘golden age of democratic capitalism’, or socialist democracy, as many Europeans do (again, think France).

UN and OECD data now suggests that Europe and the USA look set to enter a new period of low-growth.

Inflation 

Any discussion on the history of growth must, however, include an analysis of inflation. If growth is 3% per annum and inflation is 2% then we say real growth is 1%.

Between 1913 and 1940 inflation in Germany was 17% per annum. Prices rose by a factor of 300. Inflation was widely used to reduce the public debts accumulated during the world wars.

In 1720 England the average income was 30 pounds. Fifty years later, it was barely 40 pounds. Think about the average income in France today compared to the 1950’s.

The crucial point to remember is: monetary markers are stable when economic growth is slow.

Inflation is largely a 20th century phenomenon. It can be explained by distributional politics rather than economic science. See figure 2.6. We will have more to say about this later in the course.

Conclusion

  • Figures 2.4 and 2.5 show that global growth over the past three centuries can be pictured as a bell curve with a very high peak.

Western economic growth peaked from 1940-1975 and then declined. With the ‘neoliberal’ revolution in the 1980’s growth picked up again in the 1990’s, and declined again.

But as we will see this “neoliberal period” was made possible by FIAT money; new credit formation and financialisation.

The question many scholars are asking today, in the aftermath of the international financial crisis and the great recession is whether we will see a new adaptation/mutation of capitalism?

If so, what will define the next 30 years? Will we see the emergence of a new economic paradigm? What will be the structure of economic growth? Will inequality continue to grow?

We have now mapped the history and explained the core concepts.

In the next lecture I will discuss political economy theories on the determinants of capitalist development, before trying to explain why inequality has increased so rapidly since 1970.

The shortened lecture slides can be viewed here: lecture-3-4

Lecture 3: How to Measure the Wealth of Nations

Introduction 

The field of political economy was born in the late 18th century when moral philosophers such as Adam Smith began to ask questions about how nations prosper? what kind of conditions ensure their wealth? and how should this wealth be distributed?

As argued by Prof Peter Hall it is not a coincidence that the inception of ‘political economy’ coincides with the birth of the modern state and industrial capitalism in the 19th century. This was the beginning of capitalist development.

Piketty’s contribution to political economy is to provide us with a 200 year history of ‘wealth and income distribution‘. His conclusion is that we are witnessing a level of inequality not experienced since the early 19th century.

But before we discuss the determinants of economic growth and inequality, and the different theories of political economy that explain capitalist development (Lecture 4 and 5), it is important that we clarify some important political economy concepts.

Part 1 of Piketty’s Capital in the 21st Century is titled Income and Capital. This is where the definitions are laid out.

This BBC video is a useful starting point:

Income

The first concept to understand is national income.

  • This can be defined as the sum of all income available to the residents of a country in a given year. Or more precisely, it is the total amount of money earned in a country.

Try to think about national income in real concrete terms. All production (whether it is teaching, serving coffee, providing customer support, cleaning roads  or manufacturing iPhones) must eventually be distributed as earnings i.e. income.

There are two ways these earnings will be distributed: labour and capital.  It will go to labour activity (in the form of wages, salaries, bonuses) or it will go capital activity (in the form of profit, dividends, and royalties).

As we will see, Piketty’s core critique of the 1% is that their wealth is primarily accrued not through earnings or profit (entrepreneurs) but through unearned capital income.

Unearned income is the interest/rent accrued from owning property or financial assets.

The income/rent received by virtue of owning an asset (i.e. housing) tends to yield a higher return than income earned through work/employment. (R>G). Think about that.

In light of this observation, the original title of the book was ‘The Return of Patrimonial Capitalism’. Piketty is trying to highlight that wealth and capital matter much more than human capital (skills) in the politics of distribution. We will come back to this.

  • For now, the crucial point to remember is that national income = capital income + labour income (this is the same whether we are looking at the accounts of a multinational company, a small family firm, a government or the global economy). The definition of national income (all money available) is an accounting identity.

Capital

But what exactly is capital and why does Piketty used the term wealth and capital interchangeably? Put very simply: capital is a stock. Income is a flow.

When you go to work, you earn a monthly wage. This is a flow. When you put aside some of this money into a bank account, it becomes a stock. It’s small form of wealth.

This definition of capital as a stock of wealth is important because Piketty’s conceptualization of capital has come in for a lot of criticism.

  • Capital is accumulated wealth. It is the sum total of non-human assets that can be owned and exchanged on some market. It can be either publicly or privately owned. The value of capital is decided by the price someone is willing  to pay (the market).

Or more precisely:

  • Capital is the sum total of non-financial assets (land, buildings, real estate, machinery) and financial assets (bank accounts, mutual funds, stocks, bonds, insurance and pension funds ) less debt.

Generally speaking, capital or wealth is something that is not immediately consumed.

What capital is worth is determined by market value.

If the market collapses, so does wealth. Think about the spectacular rise and fall (and rise again) of house prices in Ireland. The houses did not burn down. They remained in place. But their market value (price) fluctuated widely.

When the price of a house fell by thirty percent, the person owning that house is likely to have felt less wealthy. When the price rose by 50 percent, they felt wealthier. This observation is important because it has a big impact on electoral-political preferences.

Other examples: think about recent events in China. Stock markets declined rapidly in response to a slowdown in Chinese growth (but have since recovered). Or think about the value of a Damien Hirst painting. What determines the price of the painting?

Capital/wealth can be public or private. In theory, all capital/wealth could be owned by the state. In market economies, capital/wealth is almost entirely privately owned.

  • National capital = public wealth + private wealth. Private wealth accounts for most national capital in all of the twenty countries mentioned or studied in the book.
  • Public capital (such as UCD) constitutes a tiny portion of national wealth.

Figure 5.1 captures this disparity in private and public capital.

Note something very important in this graph: the fluctuations in the value/price of national capital tends to correspond to fluctuations in private wealth.

Given that most wealth is privately owned, and Piketty is not a communist, it is perhaps no surprise that he calls for wealth to be taxed rather than nationalised.

That is, he wants to tackle the problem of inequality using the fiscal tools of the state.

Capital/income ratios

For Piketty, the best way to analyze the importance of wealth in a society (i.e. capitalism) is to measure the amount of capital (stock) as it relates to income (flow).

Dividing the total capital stock by national income gives us the capital/income ratio (β). Imagine all the capital in Ireland (housing, land, financial assets). Imagine the value of all that in terms of a price (billions). Now divide all of that by the flow of national income.

Capital/income ratios provide us with a comparable quantitative measure to analyze capitalist development across time (history). It allows us to measure whether or not wealth has grown in importance when compared to wages and labour income.

  • If a country’s total capital stock (wealth) is equivalent to 6 years of national income we write β = 600%. β is a shorthand to say the capital/income ratio.
  • This graph shows the evolution in the capital/income ratio for Germany, Britain and France.

Back to the example of Ireland, if income per capita is 33k, and wealth per capita is 200k we simply divide the two to find the capital/income ratio.

On a macro-social level we find that average wealth is 6 times average national income. We then say that the capital/income is 6 (or 600%). But this tells us nothing about the distribution of wealth. Most people don’t own any wealth at all.

In theory, a high capital/income ratio (wealth) is a not a bad thing. We all want to live in wealthy societies. What matters is how it is distributed!!

Piketty is concerned that the rise in wealth is concentrated in fewer and fewer hands.

R>G mechanism

Piketty proposes a theoretical mechanism to analyze the evolution of capitalist development and the rise in capital/income ratios (R>G).

He suggests the following:

  • When the rate of return on capital (r) is equal to economic growth (g) then the capital/income ratio remains stable.
  • When the rate of return on capital (r) exceeds economic growth (g) then the capital/income ratio grows. Wealth accumulates.

This is precisely what we observe in the USA and Europe since 1980. R>G leads to rising capital/income ratios. For Piketty this suggests ‘private capital is back’. This is an implicit critique of the economic theory of skills-based technological change.

Piketty has come in for a lot of criticism from those who argue that the rise in capital/income is mostly accounted for by the rise of housing capital (residential).

It is a rising home-owning middle class that distinguishes the 21st century.

House prices have been rising much faster than income leading to an increase in the capital/income ratio, and housing is the asset of the middle classes.

From a political science perspective,think about the following question; What matters more in shaping electoral preferences: home ownership or labour income?

Discussion 

Lets think about these definitions in real concrete terms. How much does the average person in Europe own in terms of capital/wealth?

  • In most western European countries average private wealth is around €180,000.
  • This means that, on average, each person in Europe will own €180,000 worth of capital (think about your savings account/house).
  • This will be divided roughly into €90,000 from residential dwellings (housing) and €90,000 in stocks, bonds, savings and investments.

Remember, these are averages!

In reality, more than half the population own nothing at all. As we will see, in the US, the top 1% own 80% of all wealth. 50% of the population own nothing.

If the remaining 40% do own any wealth, it is usually nothing more than some savings in a local bank account, which they may have inherited, or received as a gift.

Most wealth/capital is highly concentrated at the very top of the income ladder. As we will see, and which is completely intuitive, wealth is far more unequally distributed than labour income. Most people work. Most people don’t own capital.

In terms of income:

In France, Germany, Italy, Britain (reflecting an average for Europe) and the USA, national income per capita (per person) is around €30-35,000.

Again, this is an average and hides enormous disparities amongst the population.

Most people earn significantly less than €2,500 a month from their labour income.

Income and capital

  • Take the average Irish person.
  • If per capita national income is €30,000 per annum (it’s actually higher). According to Piketty this mean that €21,000 will come from labour income (70%) whilst €9,000 will come from capital income (30%).
  • If each citizen owns €180,000 in capital this figure of €9,000 equals a rate of return of 5%.

Most people obviously don’t earn €9,000 in capital income because they don’t own any wealth. These are averages.

On the contrary, most people will pay their landlord rent and/or pay interest to their creditors for borrowing i.e. to pay their mortgage debt.

Summary

To recap. The most important concepts for analysing capitalist development for Piketty are:

  • the capital/income ratio
  • capital income
  • national income
  • the rate of return on capital

How do we calculate the rate of return on capital?

  • On the basis of his historical analysis Piketty finds that on average, in the long-run, economic growth averages 1-2%, whereas the rate of return on capital is 4-5%.

Piketty doesn’t really explain why the average rate of return on capital is 5 percent.

But one way to think about this is in terms of how much interest one can generate from owning a capital asset. Lets go back to the example of owning residential housing.

Owning real estate or property can generate a return of between 3-4 per cent interest. Owning stocks in a firm can generate between 7-8 per cent. Owning German issued government bonds can yield around 1-2 per cent interest. The yield varies!!

Conclusion

To understand these concepts Piketty suggests that we think about a 19th century Jane Austen novel, such as Pride and Prejudice. Who has seen the film with Keira Knightley?

The aristocratic characters in these stories, centered around the landed gentry in 19th century England, constantly remark that the rate of return on land in their rural societies is around 4-5 per cent. They also observe that owning government bonds yield around 5 per cent. They are perfectly aware how much land they need to live well (or marry into).

How much does one need to live well today?

How would you generate that income: from work or owning capital?

Next week will talk about the evolution of economic growth. This is crucial for Piketty because the slow down in economic growth is considered the most important determinant of the the re-emergence of a rentier society. Why?

  • Slow-growth economies are wealth-dominated societies. Think Italy.

This is why Piketty argues that inherited wealth has become more important than hard work, much like the 19th century societies of patrimonial capitalism in Jane Austen.

In our democratic market societies this is difficult to justify, as it undermines a culture of meritocracy, which is the normative justification for capitalism.

The lecture notes can be found here: lecture-2-3

Lecture 1/2: the Global Political Economy of Capitalism

Introduction

One core question permeates political economy scholarship: how is it possible to combine capitalism with democracy? One produces stark inequalities in the distribution of income and property, whilst the latter, in principle, is based on egalitarianism (one person, one vote).

So why don’t the poor soak the rich? As we will see throughout this course distributive economics under democratic rules is anything but straightforward – a sizable middle class acts as a buffer against radical demands for redistribution.

For the moment it is sufficient to acknowledge that the distribution of wealth and income is a primary concern in the study of global and comparative political economy.

But what do we really know about how these have evolved over time?

  • Do capitalist market economies inevitably lead to the concentration of wealth in fewer and fewer hands as Marx thought in the 19th century?
  • Or do the balancing forces of growth and market competition equalize distribution as Kuznets thought in the 20th century?

Thomas Piketty’s main contribution to the study of global political economy – in his book ‘Capital in the 21st Century‘ – is to provide 200 years of data to answer these questions.

His conclusion is that economic inequality was exceptionally high in the 19th century, declined in the 20th century, and increased again in the 21st century.

Over time, the income of the wealthiest (those who own capital-assets, such as large property portfolios) has increased whilst the income of the majority has stagnated. But this was not the case in the 20th century, primarily because of the birth of the social state.

From a broader academic perspective, his core contribution is to put the question of distribution and inequality back into economics. This is what’s called political economy.

Core theory: R>G

The data in the book covers three centuries and twenty countries. This data has been carefully sourced from historical tax records, and is primarily concerned with measuring incomes of the top 1%, and which cannot be captured accurately in survey data.

Central to the book is the development of a new theory to explain economic inequality.

  • His core theory is that when the rate of return on capital (think about any asset that yields an income such as housing) exceeds economic growth, inequality grows (R>G).
  • The R>G inequality is not a market imperfectION, rather it is built into the structure of market economies and requires democratic intervention if it is to be avoided.
  • Basically, what it implies is that when left to it’s own devices, the free market will always end up being dominated by corporate capital.

We will analyse the pattern of income and wealth over time. What we will observe is that there is nothing inevitable about inequality (it declined in the 20th century). Rather the pattern reflects the changing relationship between the state and market.

This is what I refer to as the history of democratic capitalism, or capitalist democracy.

Class discussion 

Most people are implicitly interested in the question of distribution and usually have an preferences toward how much tax they should pay; how much inflation is tolerable; how much the state should spend on eduction; rising rental costs and the minimum wage.

For example, just think about the following questions:

  • How much monthly income does a student need to live well in Dublin?
  • Should the government regulate the price of housing rent?

Global

Now think about these questions from a global perspective. Average per capita monthly income in Europe is just over €2,000, whereas it is just €150 in sub-saharan Africa.

If all global income was equally distributed, how much would each person in the world get? How much does this vary by regional bloc (Africa, Asia, Europe and the USA)?

  • Take a guess. The answers are here.

Most people would not accept a world whereby 100 percent of all wealth (land, housing, finance, industry) was owned by 1 percent of the population. In all likelihood,  this would be not possible in a democratic society, with free and fair elections.

But what if 1 percent own 50 percent of wealth, or 60 percent, or 70 percent? Is there such thing as an optimal distribution of wealth and income? How much is tolerable?

We observe inequalities (good and bad) all around us, and these observations inevitably lead to political judgement. Normative interpretations cannot be avoided.

The barista who served you coffee this morning and the Wall Street banker experience the world in very different ways. Given their vastly different income they are likely to have very different political preferences toward taxation and government expenditure.

Put simply: electoral preferences are heavily influenced by social class and income level. However, electoral theories that narrowly based on the ‘median voter’  tend not very good at explaining aggregate distributional outcomes (and policy choices). Why?

  • Later in the course I will suggest that policy choices shaping distributional politics is better analyzed as a form of organized combat between different interest groups.

Purpose of the course

The distribution of income and wealth inequality varies significantly across time (history) and space (country). A core objective of this course is to provide you with the tools, and critical thinking skills, to study the politics of inequality systematically.

Patiently looking for facts and historical patterns can inform democratic debate.

  • But perhaps more importantly, they enable us to ask the right questions.

The classical political economists of the 18th and 19th century (such as Adam Smith, David Ricardo, Thomas Malthus and Karl Marx) were deeply concerned with the question of distribution, and the societal effects of capitalism.

They were experiencing the radical transformation of society brought about by increased demographic growth, the industrial revolution, poverty, and mass migration out of rural communities into city-towns.

To give a historical example of these debates think about the abolition of the Corn Laws in England, in 1846. This was a dispute about the price of grain, and reflected a political struggle between aristocratic landlords and an emergent manufacturing class in Britain.

The repeal of the Corn laws reflected an ideological debate on how to manage the changing relationship between the state and private markets – and how this would affect the political equilibrium of European society.

  • It was against this political and ideological background that over 1 million people starved in the Irish famine.

Relevance

As we will see over the duration of the course, few doubt that wealth and income inequality has increased in rich countries from the 1980’s, particularly in the USA.

  • The empirical dispute centers on how to explain this change.

In the study of economics the rise in inequality is usually explained by changes in technology (skills-based technological change).

In political science it is usually attributed to institutional changes in the bargaining power among social classes; weaker trade unions and a rise in corporate power.

But before discussing the politics of inequality, and the politics of advanced capitalism, we first need an agreed quantifiable measure of things. A large part of the debate on inequality centres of different ways to measure similar phenomenon.

This is the part of the course you will probably find most difficult. Be patient.

Measuring capital and income

Piketty uses two sources of data in his book: the distribution of income (I) and the distribution of wealth/capital(w). Wealth and income are not the same.

He then analyses the relationship between these two (capital/income ratios).

It is important to note that he uses the terms wealth and capital interchangeably in this books: a problem we will discuss later.

At the most basic level, there are two ways to earn an income: selling your labour (earning a wage) or owning capital that yields an income (renting out a house).

The data on top incomes (the 1%) is gathered from historical tax records whereas the data on national/average incomes is taken from national government accounts.

The total stock of wealth (capital) in a country equals all the land, real estate, financial and industrial capital that can be traded on an open market.

The richest in society tend to earn their income from owning capital not from working.

All of this income data is then collated into the World Top Incomes Database (WTID).

Main findings:

  1. We should be wary of economic determinism. The historical distribution of wealth and income is a deeply political process.
  2. The shocks of WW1 and WW2 reduced the inequalities of the 19th century.
  3. The subsequent post-war period of strong economic growth and the emergence of the welfare state in Europe was a very temporary period in the history of capitalism.
  4. The long term dynamics of capitalist development reveal powerful mechanisms of convergence (a decline in inequality) and divergence (growth in inequality).
  5. The forces that lead to convergence are investment in education and training; the expansion of public goods; and tax regimes aimed at redistributing market income.
  6. The forces that lead to divergence in income inequality are associated with the capacity of top earners to increase their incomes through lobbying and tax cuts. This means that the growth in inequality is not associated with having better skills.
  7. The dominant force that leads to a divergence in wealth and capital inequalities is R>G (where the rate of return on capital exceeds economic growth).
  8. R>G means that when the economy is growing slowly, inheritance and wealth accumulated in the past becomes a powerful force of inequality. T
  9. The implication is that inherited wealth grows in importance relative to merit.

Think about the following question: if inequality keeps rising, as Piketty suggests it will, what are the likely political consequences? Will democratic market societies accept a level of inequality that undermines a culture of meritocracy? What will the electorate vote for?

Main findings

Piketty’s main findings on the politics of ‘divergence’ are represented in the two most important graphs of the book:

  • Figure 1.1 shows the rise in income inequality in the US. The top decile claimed 45-50 percent of national income in 1910 before dropping to 30-35 percent at the end of 1940. By 2014 it had risen to a historical high of 52 percent.
  • Figure 1.2 shows the rise in capital/income ratios in Europe. This is more difficult to understand and I will explain it in more detail next week.

Both graphs depict a U-shaped curve, which illustrates that income and wealth inequality decreased in the 20th century and then increased in the 21st century.

A core part of this course is to try and explain this change over time.

Let me explain two things about figure 1.2.

  • First, it shows the total market value of aggregate private capital/wealth (primarily real estate and financial assets) net of debt, expressed in years of national income from 1870-2010.
  • Second, capital income = all income generated from profits, dividends, interest, and rents. The growth of an economy (G) = growth in national income or output.

In a capitalist society where R is greater than G, inherited wealth grows faster than income from labour. For Piketty, when this occurs, the entrepreneur becomes a rentier i.e. wealth is primarily accumulated through the ownership of assets rather than work.

  • The growth in capital/income ratios are important because they illustrate the structural influence of capital in society. Think about this in terms of housing

For Piketty the increase in the inequality associated with R>G has nothing to do with market imperfection. It is the logical outcome of a free market.

Conclusion

All of these technical terms will become familiar to you as the course unfolds. Don’t give up at first sight. Every discipline has its own language and it takes time to learn this.

  • Understanding statistics on income, wages, inflation, prices, expenditure, revenue and wealth is essential in a democratic society. Study hard and be patient.

The PPT slides to the lecture can be viewed here: lecture-1-2