Lecture 12: Inequality and the 1% in Europe and the USA


The increase in income inequality since 1970 has not been the same everywhere. Why?

Political and institutional factors play a key role in shaping cross-national variation between countries. Explaining this difference is a core part of the study of comparative political economy.

To illustrate this, let’s examine the evolution of top incomes in France and the USA.

Starting with France, Figures 8.1 and 8.2 depicts the share of the upper decile (and centile) in national income (the trend in France is broadly similar for most continental European countries).

The reduction of inequality in France

Four observations stand out from this data:

  1. Income inequality has greatly diminished in France since the Belle Époque. The share of the top decile in national income declined from 45-50% on the eve of WW1 to 30-35% today. This does not mean France is an equal society but it shows that the society of the 19th century was deeply inegalitarian.
  2. The compression of income inequality was entirely due to diminished top incomes from capital. If we only look at wage inequality we’ll see that this has remained stable over time. The least well paid have always received around 25-30 percent of total wages. This has not changed that much over time.
  3. In particular, the share of the top centile (the 1%) in national income has greatly declined over the 20th century. If top incomes from capital (the 19th century rentier class) had not diminished, income inequality would not have declined the 20th century. Hence, it’s the fall in capital income that explains the fall in inequality.
  4. There is no natural equilibrium in the shape of the income distribution. It is shaped by politics and institutions.

The reduction in inequality in France during the 20th century can be explained by what Piketty calls “the fall of the rentier” and the collapse of very high incomes from capital. No generalized structural process of wage inequality compression has occurred.

Piketty suggests that war rather than democratic rationality erased the past and allowed European countries to begin anew.

The different worlds of the top decile

Figures 8.3 and 8.4 depicts the composition of incomes for the top decile in France in 1932 and 2005.

We can see that a significant change has occurred. Today, one has to climb much higher up the social hierarchy before before income from capital outweighs income from labour.

Income from capital only assumes decisive importance in the top one thousandth or 0.1%. The top decile has changed from one occupied by land owners to those employed as ‘super managers’.

In the top 9 percent in France you will mainly find individuals who earn 2-3 times the average monthly wage ($2,000). In other words, this group earns, on average between $4-6,000 a month.

These are mainly private sector managers, doctors, lawyers, senior officials and university professors.

  • Remember it is pre-tax!

To make it into the top half of the 9 percent requires attaining an income 4-5 times the average monthly wage ($8-10,000 a month).  This includes a lot of senior business-finance managers and corporate lawyers.

To make it into the top 1 percent it is necessary to earn an income that is 7-10 times larger than the average monthly wage ($15-20,000 a month). But to make it into the top one thousandth, only those who substantial amounts of financial capital assets are only like to reach this level of income.

Labour market changes

Sometimes the quantitative must become qualitative to understand the social world we live.

Previously the lowest  wage earners were farm laborers and domestic servants. Today the lowest-paid jobs are in the service sector: retail, catering, hotels, security and cleaners.

The labour market has been fundamentally transformed but the structure of wage inequality has barely changed at all. The bottom 50 percent still take the same share of national income.

The 1 Percent

The top decile always composes two different worlds: the 9% in which income from labour dominates and the 1% in which income from capital becomes progressively more important.

This is not to say that someone in the 9% earns nothing from capital.

A manager on an income of $5,000 per month might rent out an apartment at $1,000 per month, and/or hold shares in his/her firm. This is a monthly income of $6,000. 80% of his/her income will come from labour and 20% from capital.

Most capital-income that supplements labour-income among the 99 percent comes from real estate. In the top 1% it is primarily business and financial: dividends and interest from mobile capital. In the top one thousandth it is almost entirely a return financial dividends.

Large fortunes primarily consist of financial assets (stocks and shares in partnerships).

Tax evasion

It is important to note that figures 8.3 and 8.4 are pre-tax returns and therefore the estimates are based solely on income from capital that is reported in national tax returns accounts.

Actual capital income is, therefore, probably completed under-estimated, owing to large scale tax evasion (it is much easier to hide investment income than it is is to hide wage income).

This can be achieved by using foreign bank accounts in countries that do not cooperate with the country in which the taxpayer resides and using quasi-legal tax-exemption strategies on whole categories of capital income.

It is extremely difficult to measure capital income. Very large capital income fortunes are almost always inherited.

France since 1980

The long-term stability in wage inequality should not mask short-term fluctuations.

For example, after May 1968′ Charles De Gaulle’s government increased the minimum wage by 20%. It was then indexed to the average wage such that the purchasing power of the low paid increased by more than 130 percent between 1968′ and 1983′.

Figure 9.1 shows the evolution of the minimum wage in France and the USA.

This political effect this had on the labour market led to a significant compression of wage inequalities.

The turn toward fiscal austerity and wage competitiveness from the 1980’s, particularly under Mitterand, meant that this compression was reversed. Wages were frozen and profits increased.

From the late 1990’s when the purchasing power of the bottom 50 percent stagnated it increased for the top decile, primarily because of a new phenomena: super salaries at the very top (where purchasing power increased by 50 percent).

Inequality in the USA


Figures 8.5 and 8.6 represent the share of the top decile (and centile) in national income in the USA.

The most striking fact is that the USA has become much more inegalitarian than France (and Europe). It is quantitatively as extreme as Old Europe in the first decade of the 20th century.

Inequality was at it’s lowest from 1950-1980 in the USA where the top decile took 30-35 percent of national income (the same as most of Europe today).

This is what Paul Krugman describes as “the America we love”, the period of the TV series Mad Men.

The explosion since 1980

Since 1980 income inequality has exploded. The shape of the curve is impressively steep (from 35 percent to 52 percent today). If it continues it will go beyond 60 percent in 2030.

Remember, this most likely under-estimates the returns to capital income because of tax evasion strategies.

The financial crisis did not impact on the structural increase in inequality at all.

Figure 8.6 shows that the bulk of the increase in inequality came from the 1% whose share in national income rose from 9 percent in the 1970’s to a staggering 20 percent today.

The top 1 percent include those making $352,00 a year. The 4 percent earn between $150-350k, and the 5 percent between $108-150k. The top 0.1 percent earn $1.5 million a year (US academic economists are usually in the top 4 percent). Hence, the largest fortunes are in the top 0.01 percent.

Cause of the financial crisis?

Given that US income inequality peaked at extremely high levels in both 1929 and 2007 it seems reasonable to ask whether it was a causal factor behind the financial crisis of 2008?

This is a tough question to answer. But it is not unreasonable to assume that it contributed to financial instability. Inequality meant a virtual stagnation of the purchasing power of low to middle income earners. The implication is hat low income earners had to substitute their declining wages with rising credit-card debt.

This debt was repackaged and recycled into complex and increasingly uncertain financial markets.

Larger share of the pie

From 1977-2007 (the eve of the crisis) the richest 10 percent appropriated three quarters of all economic growth.

The top 1 percent absorbed a staggering 60 percent of the total increase of US national income during this period.

For the bottom 90 percent the rate of income growth was less than 0.5 percent per annum. Is it possible to imagine a democratic society accepting such divergences between social groups for long period of time?

To get a sense of how this compares to Europe, see Figure 9.8.

The rise of the super-manager

What caused this rapid rise in inequality in the USA?

It was largely a result of rising wage inequalities and the rise of top salaries for super managers in large US firms (something we will discuss more next week). This accounts for two thirds of the increase. One third is associated with capital income.

Is this skills-based remuneration (and therefore based on merit) or favorable tax treatment for the rich (i.e. based politics)?

Figure 8.9 and 8.10 depicts the precise composition of top income in the upper centile.

In 1929 income from capital was the primary source of income for the top 1%. In 2007 one had to climb into the top 0.1% for this to be true. Qualitatively, who are all these people?

60 to 70 percent of the top 0.1 percent ($1.5m per annum) consisted of top managers. Athletes, actors, and celebrities make up less than 5 percent. It is more about super managers, and corporate executives, than it is about super stars.

Who are these super managers in the 0.1 percent? 20 percent work for banks and financial institutions whilst approximately 80 percent work in the non-financial sector.


The debate that tends to dominate from a macroeconomic point of view (regardless of whether you think rising inequality is justified or not) is the stagnation of wages for the majority, rather than the exponential increase at the top.

Top incomes might be able to purchase luxury items but market economies require mass consumption. There are only two ways this can happen: wage growth or private debt (credit cards).

Next week we will examine the role of politics and institutions in explaining the cross-national variation in different worlds of capitalism in Europe and the USA.

The slides can be found here: lecture-12

Lecture 11: Income Inequality in Europe and the USA


In all societies income inequality can be unpacked into three interactive terms:

  • inequality in income from labour
  • inequality in income arising from the ownership of capital
  • and the interaction between these two terms

The causal mechanism, and normative justification, underpinning each of these is different.

What is Vautrin’s social lesson to Rastignac in Balzac’s Père Goriot? Why does Piketty use this story to explain the difference between work, merit and inheritance?

Vautrin explains to Rastignac that it is illusory to think that social success can be achieved through study, talent and effort.

He explains to Rastignac what income he can expect to earn, and what career paths he can expect to pursue in the various professions in France at the time, such as medicine or law, where learned competences/skills are more necessary than inherited wealth.

Vautrin claims that even if Rastingnac is talented and learns brilliant skills, he will never become wealthy. By contrast, the best strategy for social success is inheritance. On this basis he encourage Rastignac to marry Mademoiselle Victorine.

But to do this he must first murder her brother, to ensure that she gets the inheritance. Rastingnac is prepared to marry without love but not quite prepared to commit murder.

The key question being proposed by this moral dilemma is whether it pays to work if dishonesty, petty crime, inheritance and corruption matter much more for success. If such deep social inequalities exist, why should anyone bother to follow societal norms and market rules?

The structure of wealth and income hierarchies in 19th century Europe meant that the standard of living of the wealthiest greatly exceeded that of those who earned their income from labour.

Under such conditions why not be immoral and appropriate capital by whatever means?

The key question: work or inheritance? 

In these societies (which existed in all European countries until World War 1) the question of work/labour/skill did not arise. All that mattered was the size of one’s wealth and the size of one’s fortune, whether acquired through inheritance or marriage.

The shock of WW1 brought these patrimonial societies to an end. But Piketty suggests that rising wealth inequalities today mean they are making a comeback.

Democratic capitalism is founded on the normative belief that those inequalities that are based on merit, talent and hard work are more justified than other inequalities, such as inheritance.

For example, it is probably safe to assume that those who work the hardest in this class will most likely get the best grades. Everyone would rightly abhor a situation whereby grades were distributed on the basis of favour or social class.

Inequalities need normative justification. Liberal capitalism is justified on the basis that free markets encourage fair and open competition, and that rewards are distributed on the basis of hard work, not corporate influence and power.

The core question to ask yourself over the coming weeks is whether we live in a society where social class matters more than hard work and merit? Do we live in a meritocracy? Does this vary by country, region and city? For example, ask yourself which countries have the highest levels and lowest levels of social mobility.

Inequalities with respect to labor and capital

To answer these questions we need to distinguish between those inequalities that arise from selling labour and owning capital. Lets remind ourselves of some basic trends and concepts.

  • Income can be expressed as the sum total of all income from labor (usually wages and salaries) and capital (usually rent, interest, capital gains).
  • Total income inequality is the result of adding up these two components: inequality of income from labour and inequality of income from capital.

The more unequally distributed both of these are, the greater the total level of income inequality.

It is not always true that individuals with high income from labour/wages have a high income from capital, and vice versa. Jane Austen’s heroes owned so much capital (land) that they did not have to work. They had no labour income. They didn’t need a wage.

The difference 

There are two reasons why we need to understand these differences.

  • First, for normative reasons, the justification of inequality arising from labour effort is totally different from inequalities associated with inherited wealth and owning capital. There is probably only one Messi in the world. We tend to accept that it is justifiable that he earns a huge labour income from his very particular footballing skills (but not his tax avoidance).
  • Second, the causal mechanism that explains how rising wealth and wage inequalities, and how they change, are totally different.
    • In the case of wages/labour, what matters most is the supply and demand for different skills within a given labour market; the quality and type of the educational system in place; the rules and institutions of the labour market; the strength of trade unions and the structure of collective bargaining.
    • Note: in the study of economics these institutions are considered a rigidity that block the presence of competitive labor market forces. What policy implications emerge from this?
  • In the case of the inequality that arises from income from capital, what matters most are cross-national differences in the organisation of capital/finance markets; savings and investment behaviour;  laws on inheritance; and the operation of rental and housing/land markets.

Inequality has multiple dimensions and different mechanisms and cannot be adequately captured in unidimensional indicators.

Synthetic indices such as the Gini coefficient (ranging from 0-1) tend to lump all of these different things together. We are going to use distribution tables, which express inequalities in terms of social class. To quote Piketty directly:

distribution tables allow us to have a more concrete and visceral understanding of social inequality. They emphasize the shares of national wealth and income held by different groups, as well as an appreciation of the data to study these issues…the Gini coefficient gives a sterile and atemporal view of inequality.

Inequalities: some orders of magnitude 

There are two regularities/trends in the study of income inequality.

First, capital income is allays more unequally distributed than labour income. This is the case in all time periods and all countries, without exception. The ownership of capital is significantly more concentrated than labour. Therefore, by definition, it is more unequally distributed.

Second, the concentration of capital ownership is explained mainly by inherited wealth and its cumulative effects (it is easier to save if you inherit an apartment and don’t have to pay rent).

inequalities with respect to labour income (wages) always seem moderate whereas inequalities with respect to capital always seem more extreme.

In public discourse we tend to think and talk more about wage inequality, primarily because most of us don’t experience capital inequality in the same way. Just think of the media coverage given to the Dublin Bus drivers wage demand, and the coverage given to massive increases in asset/capital prices.

Inequality of income distribution 

Tables 7.1, 7.2, and 7.3 chart the distribution of inequality from labour income, capital income, and total income.

They give an indicative picture of low, medium and highly unequal countries. Note: they are before taxes.

The top 10% of the labour income distribution usually receive 25-35% of total labour income, whereas the top 10% of capital owners usually receive 50% of all wealth (and in some societies as much as 90%).

Lets examine each of these distribution tables in turn (inequalities of labour income, capital income and the sum total).

Table 7.1 illustrates that in societies where labour income inequality is low (Scandinavia in the 1970’s), the top 10% received 20% of labour income, the middle 40% took 45% of labour income, and the bottom 50% took 35%.

In real terms: if average pay is €2,000 per month, the top 10% would take €4,000 (the top 1% would take €6,000) the bottom 50% would take €1,400 and the middle 40% would take €2,250.

Labour income is almost entirely earned wages and constitutes around three quarters of all national income. Most people live off their wages, not income earned from owning capital.

Piketty uses deciles (10 percent) and centiles (1 percent) to discuss distribution and inequality. These may lack the poetry of peasants, nobles, elites, workers and bourgeoise. But they enable us to make clear statistical comparisons across time and space.

Top decile/centile 

When discussing the top decile it is essential that we distinguish between the top 9 and 1 percent.

This was one of the major innovations of Piketty. He demonstrates that it is the top 1 percent, or more precisely the top one thousandth, where most of the change (inequality) has taken place, over the past 30 years.

Remember the top centile is the top 1 percent. This means that in the USA, with a population of 320 million, the top centile is 2.6 million individuals (adults). This is a numerically large group of people, capable of significant political influence.


The one country that stands out from table 7.1 is the USA,  where the inequality of labour income has broken historical records.

In real terms, what this means is that in the USA if average pay is $2,000 per month:

  • The top 10% would take $7,000 ($24,000 for the top 1 percent),
  • The middle 40% would take $2,000
  • The bottom 50% would take $1,000.
    • If these trends continue the top 1 percent could effectively employ the bottom 50 percent as domestic servants.

Think about these magnitudes. In Sweden the bottom half of the population earn $1,400 whereas in the USA it is $1,000.

This is a 40 percent difference, which is a significant amount. If we take into consideration the difference in the price of third level education, and the cost of public services, this income difference is likely to have a significant impact on equality of opportunity (and social mobility).

Women are significantly over-represented in the bottom 50 percent. What this suggests is that class-based inequalities are also gender-based income inequalities.

Looking at table 7.1 we can probably conclude that it is better to be a low wage earner in western Europe than to be a low wage earner in the the USA.

Why do different countries have different attitudes toward social inequalities?

Inequality of capital ownership

Table 7.2 shows that inequalities with respect to wealth and capital ownership are even more extreme.

In Europe the top decile typical own 60% of wealth, the middle class own 35%, whereas the bottom 50 percent own 5% of wealth.

In the US, the top decile typically owns 70% of wealth, the middle class own 25%, whereas the bottom 50 percent also own little more than 5% of wealth.

It is important to ask whether an optimal distribution of capital ownership can exist? Can normative political theories inform these debates (on preferences toward efficiency and equity). This about John Rawls.

In real terms, if average net wealth is $200k (divided into real estate and financial assets) this would imply that in the US:

  • The top decile would own capital worth $1.2 million
  • the top centile would own capital worth $5 million.
  • The poorest 50 percent would have net wealth of less than $20,000.

The importance of housing as a form of wealth decreases the further one goes up the income distribution. Housing is the asset of the middle class, whereas true wealth/fortune almost always consists of financial and business assets.

The growth of a propertied middle class was the principle structural transformation of the distribution of wealth (and politics) in the 20th century.

In the 19th century, and right up to WW1, there was no middle class. Almost 90 percent of national wealth was owned by the top 10 percent. The vast majority of a society’s assets were owned by an elite minority.

Nevertheless, despite the emergence of a middle class, table 7.2 shows that inequality in the ownership of capital remains extreme (the top decile own 60 percent of national wealth in Europe and 70 percent in the USA).

Inequality of total income

Table 7.3 shows inequality of total income (and the one that you will most often hear in public debate) with corresponding Gini coefficients.

Is it possible to imagine a society where the concentration of income is much greater than this? Could we imagine a democracy where the top decile appropriates 90 percent of all national income?

Democratic societies are clearly capable of accepting high levels of wealth inequality, probably because capital-income only constitutes one quarter to one third of national income.

But if the same level of inequality (top decile owning 90 percent of all output) applied to total income then surely a democratic revolution would occur? Or would it?

Table 7.3 shows that the USA may set a new record on income inequality in 2030. The top decile may take 60 percent whereas the bottom half of the population would barely get 15 percent.


Lets return to our opening question on merit versus inheritance. How are each of these inequalities justified? It is the justification of inequality that matters most in a democratic society.

One way to think about this is to compare high-inequality societies, such as the US today, with Europe in the 19th century.

19th century Europe was a hyper-patrimonial society where high incomes from capital (and inherited wealth) dominated.

The new high levels of inequality in the USA  emerge from high incomes from labour (super-managers).

If these co-evolve, as Piketty suggests they will, the 21st century will reach levels of inequality not seen since the 19th century. This is why the original title of the book was “the return of patrimonial capitalism”.

Growing inequalities in labour income are assumed to be justified on the basis of merit (better skills and new technologies). But is this true?

Next week we look at the composition of top incomes in Europe and the USA.

Lecture slides: Lecture 11

Lecture 10: The growth of capital income.


In this lecture we bring to an end our analysis of the capital/income ratio and turn our attention to the division of national income between labor and capital income.

Let’s remind ourselves of some important concepts:

  • Income can be broken down into two sources: income from labor (wages, salaries, bonuses) and income from capital (rent, dividend, interest, profit).
  • Income from capital is any income earned from the mere fact of owning capital, regardless of whether it is land, a government bond, a stock, a firm or real estate.

All capital assets will yield an income, although at very different rates. If you retire and own $1 million in assets (government bonds and real estate) and the rate of return on these assets is 3%, you will earn a capital income of $30,000.

Capital and income are very different things although they are related.

If you graduate and have a debt of $80,000 (US tuition fees) you will have negative wealth but you might get a job earning $85,000. So you will have a good flow of labour income. But from this you will have to use a significant percentage to pay off your student loan.

For Piketty the best way to analyze the importance of capital/wealth in society is to measure the amount of capital/wealth as it relates to income. This is what he calls the capital-income ratio (β). On Monday we concluded that the long-run capital/income ratio (β) depends on the savings rate (s) and the economic growth rate (g).

Rate of return on capital income

Piketty is arguing that when the rate of return on capital exceeds the rate of return of economic growth, wealth inequality grows (captured by increased β).

But what determines the rate of return on capital?

Different types of capital-assets yield different rates of return. The yield on the riskiest assets (for example, shares in an emergent high-tech firm) might yield 6-7+%. Real estate can be as low as 3-4%, whereas your savings accounts can yield less than 0.1%.

Figures 6.3 and 6.4 illustrate the pure annual rate of return on capital from 1770-2010 in France and Britain. You’ll see that the long-term average is between 4-5 percent.

Pre-tax returns!

There are three important observations to remember about this long-run trend on the pure rate of return to capital (which went from 6-7% in the 19th century to 4-5% today).

  1. They are pre-tax returns. The average tax rate on capital-income, in most rich countries, is around 30 percent. Companies adopt a whole variety of tax strategies to reduce this.
  2. They hide enormous disparities between capital-assets. The average pure rate of return is found by dividing the total capital stock by the annual flow of income from capital. But not all capital-assets are the same. Savings accounts are a form of ‘wealth’ but they yield very little. If the interest rate today is 0.05% it make more sense to spend.
  3. These are ‘real’ rates of return and do not deduct inflation. Nominal assets such as buying a government bond or your savings account (non-indexed) are subject to real inflation risk. This is not the case with real estate for example, given that house and rental prices generally rise with (or faster) than the consumer price index (CPI).

What factors lead to changes in the rate of return to capital?

In general we can say that there are two driving forces:

  1. Technology (what is capital used for?)
  2. Capital stock (too much capital kills the return on capital)

The capital stock

The stock of national capital in a nation-state usually fulfills two dominant functions: it provides housing services (the rate of return can be measured by the rental-value of dwellings) and it serves as a factor of production in producing goods and services (tools, machinery, equipment, land, computers etc).

If you have a farm and you want to produce food you need land, tools, machinery, workers. Combined they produce your product. The logic is the same if you are producing an iPhone.

In theory, the purpose of the financial and banking system is to find the best possible use of capital (national savings), such that each unit of capital is invested where it is most productive (or where it is most profitable).

This is the ideal of a perfectly efficient capital market.

In reality we know that financial capital markets are far from ideal (and it’s bizarre that they still teach it as such). They are ridden with waves of speculation, instability and bubbles. Most banks don’t lend for investment in business; rather than lend to buy and sell existing assets (such as housing).

In the Anglo-Saxon world most high risk capital investment is carried out by venture capital funds, not banks.

Technology and innovation 

The second driving force is that too much capital kills the return on capital. What does this mean?

It can be captured by thinking about the value of land and land rents in the USA during the 19th century. There was so much land that it did not yield much of a return. It was cheap and plentiful. There was simply too much landed capital to make a return. The same would apply to housing.

Why then does an increase in β (capital/income ratio) not lead to a decrease in R (rate of return on capital)?

Everything depends on technology and the extent to which society can substitute capital for labour, and labour for capital in the production process. There are always new ways to find new uses for capital (i.e. solar panels as a replacement for oil). This is called innovation.

But profits, rents and capital-income accumulate (and it is accumulating fast). Therefore, for Piketty, the volume effect outweighs the price effect.

The labour-capital split

This brings us to the division of national income between labour income and capital income

Figures 6.1 and 6.2 present the long-term trend in Britain and France.

Capital income absorbed around 35-40 percent of national income in the late 19th century before falling to 20-25 percent in the mid-20th century, and then increasing to 25-30 percent in the 21st century.

Note: this corresponds to an average rate of return to capital of 5-6 percent.

In basic terms, if you invest $1 million and earn $50,000 per annum, your rate of return is 5%. How is all this calculated?

Remember Pikettys first law of capitalism α = r X β. This is an accounting identity to determine the ratio of capital income in overall national income.

  • a = capital income,
  • r = rate of return on capital
  • β = capital/income ratio.

The percent of capital income in national income can be found if we multiply the rate of return on capital (r =5)  by the capital/income (β = 6). The outcome is 30. What remains is labour income, which equals 70 percent.

Figure 6.5 shows the increase in the share of capital income in national income from 1970. This has increased even faster since 2010. Why?

Because wages/salaries have been declining whilst the rate of return on capital-assets has been increasing. As the pie of national income grows, the gains are absorbed by capital-asset holders.

The stability of the capital-labour split

The stability of the 70-30 split, however, doesn’t really tell us anything about how capital or labour income is distributed. Very few people earn an income from owning capital assets because capital-wealth is significantly more concentrated than labour.

As we will see next week, the top 10 percent of the US population own 70 percent of wealth (capital), whereas the top 1 percent own 52 percent of wealth (capital). They control a large part of economic resources in society.

It is this 1 percent of the population that tends to gain when the share of capital income in national income grows. Hence, if the shape of capital income in national output increases, it’s likely to only benefit a very small percentage of the population (those who own financial assets).

Hence capital income in overall national income is concentrated in a much smaller segment of the population.

The stability of the labour-capital income split is usually attributed to the increased importance of human skills, with the implication that many economists think that capital doesn’t really matter anymore. It is all about human capital (i.e. high-tech skills). It’s not about capital rents.

Explaining the rise in capital income

The increase in capital income (in national income ) that we observe since 1970 is related to shifts in economic bargaining power between societal interest groups and changes to capital-tax laws.

It is more about politics than markets. This is something we will discuss in later weeks.

Further, the stability of capital’s share in national income in no way implies a stability in the capital-income ratio. This is what we have been analyzing over the past two weeks.

The big contribution of Piketty is to shift our attention toward the evolution of the capital-income ratio rather than the capital-labour split. Why is this shift so important? It allows us to assess the overall structural influence of wealth in a society.


Looking to the future: a capital/income ratio equal to 7-8 years of national income and a rate of return to capital of 4-5 percent means that capital’s share of global income could grow to 30-40 percent by 2050.

Free-market optimists suggest that technological change will favor a shift to labour-income (human capital and work) rather than capital-income (to the owners of assets/rent/interest). This is certainly plausible. Just think about Silicon Valley.

Piketty suggests otherwise.

If the rate of return on capital (5 percent) grows faster than economic growth (2 percent) then wealth from the past will accumulate in importance. Inheritance will matter more than entrepreneurship and work.

Ultimately, what Piketty is saying is that progress toward economic and technological rationality (more efficient and more competitive markets) does not imply progress toward democratic and meritocratic rationality. There is a clash between capitalist-markets and social-democratic rights.

Think back to week 2, advances in productivity and technological growth, and the rise of a middle class, have meant that we have avoided the Marxian apocalypse.  But has technology changed the deep structural influence of capital over society? Economic resources continue to be unequally distributed. How does this concentration of power and wealth impact upon politics?

From next week we analyze the distribution of income and wealth at the individual and household level.

The slides can be found here. Lecture 10

Lecture 9: The Return of Capital in the 21st Century


In this lecture we will seek to answer three questions:

  • why the capital-income ratio has returned to historically high levels?
  • why it is structurally higher in Europe than the USA?
  • what does this suggest about the future of wealth accumulation in the western world?

The determinant of capital/income ratios

To answer these questions we have to identify the determinants of the capital/income ratio over the long-term.

Piketty’s core claim is that the capital/income ratio is related to the savings rate and growth rate.  The relationship is so strong that he calls it the second ‘law’ of capitalism,  β = s / g .

β = s / g means that the capital/income ratio is equal to the savings rate divided by the economic growth rate.

  • β = capital/income ratio
  • S = savings rate
  • G = growth rate

If a country saves 12 percent of its national income every year and it’s economy grows by 2 percent, the long-run capital income ratio = 600% (12 divided by 2).

Basically a country that saves a lot, and grows slowly, will accumulate a large stock of capital relative to income. In turn, this will have a significant effect on the structure of society and the distribution of wealth. It’s a neoclassical perspective.

For Piketty, low growth (especially slow demographic growth) and a higher-savings rate (by households and corporates) is responsible for the variation in the capital/income ratio between Europe and the USA, and the main explanation for rising capital/income ratios since WW2 (in the long run).

If the economic growth rate falls to 1 percent and the savings rate remains 12 percent, β will equal 12 years national income or 1200% (12 divided by 1). But if the rate growth increases to 3 percent then β will equal 4 years income 0r 400% (12 divided by 4).

For Piketty, this is the long term driver of the capital/income ratio.

Note: I tend to disagree. Institutions and politics are arguably more important for explaining growth, whilst asset price fluctuations (price effect) are just as important as the volume effect (savings rate). But it all depends on the time period. Asset prices matter more in the short run (30 years), but maybe less so over the long run (100 years).

The case of Ireland

But what does all of this really mean for the political economy ?

Surely a high capital/income ratio benefits society? Does it not imply that there will be more investment and more jobs?

Not necessarily. It all depends on the distribution of capital.

For example, a country will not gain from a high capital/income ratio if it is all tied in up in housing capital (i.e. rising house prices are not necessarily a sign of a rich country).

From a political perspective, if wealth is concentrated in a few hands, then the economic resources of a society are not efficiently distributed. It is not likely to be put to productive/efficient use. It might be used to consume luxury goods.

Think about it another way, how much of Ireland’s capital from 1998-2008 was invested in productive investment?

Between 2000-2008 the total capital stock in Ireland increased from  €228 to €477 billion. According to Davy Stockbrokers only €50 billion was spent productively.

72 percent of the increase (or  €188 billion) went into housing.

Of the €50 billion that went into productive investment, two thirds of it (€33bn), was driven by the state: roads, education, energy, water-waste management.

Productive private sector investment (those investments that contribute to long-term productivity gains, and hence long-term improvements in living standards) made up a meagre €17n of the total capital stock.

Davy Stockbrokers conclude that the Irish private sector wasted the money. Today, the capital stock is rising, but it is almost entirely driven by the rise in house prices.

The two ‘laws’ of capital

β = s / g provides a logical historical account of the structural evolution of capital.

The US has a higher demographic growth rate and lower savings rate than Europe, leading to a lower capital-income ratio.

It is important to note that this is only valid in the very long-run. The real accumulation of wealth takes time, particularly at the country-level. History will matter a lot.

Further, it is only valid if asset prices evolve in tandem with consumer prices. It is also dependent on certain assumptions about the savings rate (s).

Furthermore, it does not explain the short-term shocks to capital (which are political!).

But what about the amount of capital income as a percent of national income (i.e. the amount of income that comes from the ownership of property as opposed to wages)?

Piketty proposes another “law” to explain this.

He says that the ratio of capital income in national income (a) is equal to the average rate of return of capital (r) times the capital/income ratio.

A = 30 percent when r=5 and β=6

We can write this as follows: α = r X β  Note: it is a pure accounting identity.

Capital since 1970

Figure 5.3 indicates the annual change to private capital in the eight richest countries from 1970-2010.

For Piketty this data suggests that β varies constantly in the short-run but tends toward an equilibrium in the long run.

Capital asset prices (stocks, finance and housing) are notoriously volatile. They can make a country look wealthy. But over the long-run, for Piketty, these balance out.

But the price of capital is not a ‘natural’ phenomena. It is a human construct.

Therefore the fluctuation in boom-bust cycles of wealth are consubstantial with the history of capitalism itself. Just think about the impact of quantitative easing (QE) on the price of assets since 2008.

Think about the Japanese speculative bubble in the 1990s and the bursting of the dot-com bubble in the US in the early 2000’s.

Is Piketty right to assume there is a long-term trend toward an equilibrium in the capital/income ratio?

Some would suggest that the speculative boom and bust in prices are the norm in capital.

What the data clearly reveals, however, is that since 1970 private capital has returned. Piketty calls it the re-emergence of patrimonial capitalism (the original title of the book).

Keep in mind Piketty’s critique: he is suggesting that wealth matters more than hard work in shaping the politics of distribution today.

There are three reasons for this return of capital (measured in terms of higher capital/income ratios):

  1. Slower economic growth and higher savings (primarily retained corporate earnings) – long-term
  2. The privatisation of public wealth since the 1970’s – short-term
  3. The acceleration of real estate and stock market prices since the 1990’s – short-term

Savings since 1970

Table 5.1 indicates the average value of growth rates and savings rates in the eight richest countries from 1970-2010.

The lower population growth and the higher savings rate in Europe and Japan explains why capital-income ratios are higher in these regions of the world when compared to the USA.

Over a period of 40 years these savings and growth differentials will accumulate and create structural differences (remember the importance of the compound rate of growth-interest). This is an automatic consequence of β = s / g 

It is crucial to note that that there are two components to private savings: corporate (retained earnings) and households.

See table 5.2 for the percentage difference in these savings rates within national income. Note the big differences between the UK/USA and Germany.

Retained earnings are profits of a company that are not distributed to shareholders. They allow companies to reinvest in themselves; rather than pay out profits as dividends to their shareholders, which are usually more heavily taxed.


The second complementary factor that explains the comeback of capital is privatization. 

Figure 5.5 shows the ratio of public and private capital to national income in the eight richest countries of the world. The data suggests that the revival of private wealth is partially due to the privatization of public wealth.

  • The decrease in public wealth equals an increase of around one fifth or one quarter the increase in private wealth.

The case of Italy is particularly clear.

This reflects an increase in the debt owned by one portion of the Italian population on another portion of the population. Instead of the wealthy paying taxes to fund the deficit they lent government money at interest – increasing their own private wealth.

At a global level the most extensive privatization’s took place in the former Soviet Bloc.

The stock of capital in these countries was the same in the 1970’s and 2000’s (3-4 times national income) but the public-private split was completely reversed.

The rise of Russian Oligarchs obviously had nothing to do with the β = s / g  but was purely driven by privatization (and asset stripping), and close state-business ties.

The rebound of asset prices

The third complementary factor that explains the comeback of capital  is the historic rebound of asset prices.

The increase in asset prices from 1950-2010 largely compensated for the decline from 1910-1950.

The price of capital-assets is shaped by politics and institutions, such as rental control laws (real estate) and corporate governance laws (corporations). Remember our discussion about Germany last week. There is no such thing as a natural price. It’s a human construct.

Multinationals are political actors that actively shape the market.

We don’t know where capital prices are headed in the future. For example, we don’t know if house prices will tumble. But we do know that they cannot increase indefinitely.

This is why many critics of Piketty argue that he is overly reliant on the concept of “equilibrium” and does not appreciate the boom-bust nature of the capitalist cycle. That is, he is overly reliant on neoclassical assumptions of growth.

Prices as a human construct 

The market value of a firm is its stock market capitalization.

The accounting value of a firm is equal to assets (such as buildings) minus liabilities, net of debt. These are usually the same when a company is created. But they diverge over time.

The divergence is largely dependent upon whether financial markets are pessimistic or optimistic about the profitability of the company.

The ratio between market and book value is known as Tobin’s Q. This has tended to increase in all rich countries.

The main point to remember is that:

  • The rebound in capital-asset prices (stocks and real estate) accounts for between one third and one quarter of the increase in the capital/income ratio (but with significant variations between countries).

In terms of the capital/income ratio, Japan set the record set in 1990, but was recently beaten by Spain, where private capital equalled 8 times national income. In both case the rapid rise was can be explained by the emergence of a property bubble. Ireland was similar.


Hence, for Piketty the comeback of capital can be explained primarily by (1) and complemented by (2) and (3).

  1. Slower growth, higher savings (primarily retained corporate earnings) – long-term
  2. Privatisation of public wealth since the 1970’s – short-term
  3. Acceleration of real estate and stock market prices since the 1990’s – short-term

The imbalance of capitalisms in Europe

Finally, it is important to note that the sharp increase in national capital is primarily an increase in domestic capital.

Figure 5.7 shows that it is only really Germany and Japan that have accumulated net foreign assets. This accounts for between 50-70 percent of their national income (and an automatic consequence of their large trade surpluses).

International cross-national investments are particularly important in Europe. If we look at capital flows within the Eurozone, post-2000, we get a pretty disturbing picture.

In a global world of financialisation and cross-border capital movements every country is owned by another country to some extent.  Net international investment positions reflect this.

In the 1970s the total amount of financial assets and liabilities owned by households and firms barely exceeded four times national income. By 2010 this had increase to a staggering 15-20 times national income.

Within Europe this inevitably leads to perceptions that countries are owned by other countries such as ‘German banks’.

Ireland’s net international investment position is staggering. This is primarily because of the impact of the IFSC. These debts-liabilities are in part related to fictious financial flows associated with corporate tax-strategies.


What Piketty does not discuss is that from 1970 to the present there has been a fundamental political change in public policy. This is often referred to as “neoliberalism”. How important are economic ideas in explaining this change?

To conclude, what about the future?

What will the global capital-income ratio be in 2050? The law β = s / g implies that it will logically rise and could reach 19th century levels by the end of the 21st century.

See figure 5.8.

The lecture slides can be downloaded here. Lecture 9

Lecture 8: The Shock to Capital in the 20th Century


Lets remind ourselves of Piketty’s core argument. He suggests that wealth inequality is growing because capital is accumulating much faster than income in Europe and the USA.

This can be measured by the rise in capital-income ratios, which we looked at on Monday.

Capital is equal to 5-6 years national income in most European countries (national income is around $2.5 trillion in France, hence multiply it by 6 to get a sense of the total capital stock).

What we observed in the last lecture, however, is that the ratio of capital to income over the long-run has remained remarkably stable in Europe since 1800, with the exception of the period 1950-1980.This is where we observe a decline in capital-income ratios, or a shock to capital.

But despite the stability in capital-income ratios, the composition of capital (and wealth) has fundamentally changed. Housing-real estate and domestic/finance capital have replaced agricultural land. Capital has been transformed.


In this lecture we will look at:

  • the shocks to capital in Europe from 1950-1980
  • the evolution of the capital-income ratio in the USA
  • the importance of slavery in the origins of US capitalism

Figure 4.5 depicts national capital in Europe from 1870-2010. This long term trend is useful as it captures the two waves of globalization that have shaped capitalist development (1870-1910 and 1980-present).

Germany, France and the UK are only three countries but they can be considered representative of Western Europe, given that they constitute more than two-thirds of national income in Western Europe.

All the available estimates reveal a similar capital/income ratio for Spain, Italy, Austria and the Netherlands (Spain experienced a more rapid rise due in their capital/income ratios, much like Ireland, due to it’s housing bubble in the 2000’s).

The shock to wealth

What caused the shock to capital in Europe during the 20th century, which can be observed in the decline in capital-income ratios?

One obvious answer is the physical destruction of buildings, factories and infrastructure during the two world wars.

In France, physical destruction was equal to one year of national income. In Germany it was one and a half years national income. In Britain it was less than one years national income. Hence, physical destruction only explains part of the decline.

The budgetary and political shocks of the two world wars proved far more destructive to capital than combat itself.

The loss of foreign capital-assets, the low savings rate and physical destruction explain two thirds of the loss of wealth, whereas the new forms of capital ownership, and new forms of capital rental-regulation, associated with the post-war ‘mixed market economy’, explain the final third.

  • Capital regulations, decline in real estate and stock market prices = 25-33% of decline
  • Low national savings, loss of foreign assets and physical destruction = 66-70% of decline

It is very important to remember this as it will help us to explain the rebound of capital-income ratios from the 1970’s, especially in the 1990’s and 2000’s. The rise in capital-income ratios in the 21st century, I will suggest, can largely be explained by rising commercial and real estate prices. It is a price effect.

Public policies

The period 1914-1945 was a dark period for the wealthy in Europe; The Bolsheviks defaulted on French loans, Nasser nationalized the Suez canal, and wealthy individuals across Britain were forced to sell their foreign colonial assets to make up for lost savings.

Those owning stocks and bonds lost a fortune when Wall Street crashed before the great depression.

But from the 1950 onwards it was not the external shocks that shaped the nature of capitalist development rather it was government fiscal and socio-economic policies, which reduced the market value and economic power of those who owned capital-assets.

Post war Europe was a form of state-directed capitalism, which gave birth to different national models of capitalism across North, West, East and Southern Europe.

In he West, real estate prices fell relative to the price of goods and services. House prices stood at historically low levels, owing primarily to rent control policies, which not only meant that housing became significantly less expensive, but that landlords earned less on their properties.

The stock value of corporations and firms also fell to historically low levels. The state nationalised industries, across various sectors of the economy, all over the continent. Dividends and profits were heavily taxed, whilst shareholders were weakened vis-a-vis other stakeholders.

It was the period of Keynesian demand management or “mixed market” economies, where the state took responsibility for guaranteeing employment. This radical new role for the state can be observed directly in rising tax revenues (measured as a per cent of national income).

Post war Europe gave birth to the social state.

The USA 

But what about the evolution of capital/income ratios in the USA? Figure 4.6 shows that “wealth” mattered less in the New World  (USA) than the Old World (Europe).

National capital was worth less than 3 times national income from 1770-1810 whereas it was worth 7 times in Britain and France. What explains this divergence?

It can primarily be explained by the price of agricultural land. There was so much land in the US that its market value was worth very little. The volume effect outweighed the price effect (remember Ricardo’s scarcity principle).

Domestic capital was also worth much less. This is because the US population were predominately immigrants. They arrived without houses, businesses, machinery, tools or factories. It takes years to accumulate this type of capital.

Hence, from the beginning, the influence of accumulated (inherited) wealth was less important in America when compared to Europe. Land cost little and anyone could become a landowner.

All of this has probably contributed to the Jeffersonian ideal of the ‘small landowner, riding out west, free and equal’. The American dream was born.

But by 1910 national capital had begun to accumulate rapidly, particularly in real estate and industrial capital, such that it amounted to 5 times national income.

The US had become capitalist, and industrial, but inherited wealth still had much less influence over the economy than in “old” Europe.

The shocks of the 20th century also struck America with far less violence.

Capital shocks in the US

Capital-income ratios were far more stable, fluctuating between 4-5 times national income from 1910 to 2010.

It was only after the Great Depression and World War II did the structure of capital change. This was primarily because Franklin D Roosevelt specifically adopted policies to reduce the influence of private capital, such as introducing rent controls.

But unlike in Europe, the US did not adopt policies of nationalisation. It was not the same type of “state directed capitalism” that occurred in Europe.

Rather, from the 1940s onwards, a series of public investment programs were launched, in addition to sweeping changes in progressive taxation. Public debt increased to fund the war effort but this eventually returned to a modest level in 1970.

Figure 4.7 shows that America continues to have net public wealth i.e. its assets exceed public debt.

Overall, the capital-income ratio in the US is far more stable than in Europe. This might explain why Americans tend to have a far more benign view of capitalist development than Europeans.

In 2010, capital in the USA was worth around 4.5 times national income. National income in the US is around $17 trillion, whilst in the EU it is around $18 trillion. Hence, multiply 17 trillion by 4.5 to get a sense of what the overall value of national capital/wealth is (measured in terms of market prices).


It would be a mistake to conclude our analysis on the structural transformation of capital in the USA and Europe without discussing slavery.

Thomas Jefferson didn’t just own land in Virginia, he owned 600 slaves and these obviously didn’t form part of his ideal of the land of the free. Slavery was eventually abolished in 1865.

In 1800 slaves represented 20 percent of the US population: roughly 1 million slaves out of a total population of 5 million. In the South, slaves represented 40 percent of the population: roughly 1 million slaves out of a population of 2.5 million.

By 1860 the slave population had fallen to 15 percent or 4 million slaves in a population of 30 million. This can be explained primarily by population growth in the north and west. In the south it remained above 40 percent.

What was the price of a slave?

Figure 4.10 shows that the total market value of slaves represented 1.5 years of national income in the early 19th century (this is equal to the total value of farmland).

Remarkably, this implies that slave-owners in southern US states controlled more wealth than the aristocratic landlords in old Europe.

Black slaves and the land they worked equalled 4 times national income in southern states. The northern (land capital) and southern states (slave capital) is the USA during their period were completely different worlds.

Remember southern blacks were deprived of civil rights until the 1960’s. Racial tensions in the US, arguably, goes a long way to explaining the peculiar development of the US welfare state, and the type of inequality that the US experiences today.

Further, it’s important to acknowledge that slavery was a significant factor that led to the particular trajectory of capitalist development in the US, as suggested by this research.

Next week we will analyze the comeback of capital and wealth inequality since 1970. Lecture 8

Lecture 7: The Structural Transformation of Capital in Europe Since the 19th Century


Over the last few weeks we discussed the main stages of income and economic growth since the industrial revolution. We also discussed the history of ideas underpinning classical and critical political economy.

We found that, on average, the economy has grown by 1-2 percent per annum whereas the rate of return on capital is 4-5 percent. This means that in the long-term the importance of capital (wealth) will increase relative to income (real economy).

This is not a market failure.

What it suggests is that when markets are left to their own devices they will produce the inequality R>G. The more ‘perfect’ the capital market the greater the R>G inequality.

This week we are going to analyze the structural transformation of capital (public and private) in Britain, France and Germany, from 1870-2010.

To do this we also need to analyze the importance of public debt and inflation. Public debt is private wealth.


For Piketty, the best way to analyze the importance of capital (wealth) within a society is to measure the total amount of capital stock as it relates to national income. This is expressed as the total amount of capital owned at a given point in time divided by total yearly income. This calculation gives us the capital/income ratio, denoted by the greek symbol β.

If a country’s total capital stock is equal to six years of national income we write β = 6 (or 600 percent). If the stock grows, wealth grows. This in-itself is not a problem. It becomes a problem when all the wealth is owned by a small group of people.

In Piketty’s theory, when the rate of return on capital exceeds the rate of return to national income, the capital/income ratio β grows. Note that the capital-income ratio in most western capitalist democracies, today, is between 500-600 percent (or 5-6 times national income).

In concrete term, that means, for example, in the UK, national wealth/capital equals 5-6 times 2.4 trillion dollars.

In fictious novels of the 19th century the rate of return to capital (wealth) was widely discussed. Wealth was a stable monetary marker. In Jane Austen’s novels it usually takes two forms: land and/or government bonds. This form of wealth may seem old fashioned in a period of ‘dynamic financial capitalism’.

But have things really changed that much?

Private/public wealth

Owning a capital asset has one purpose, and this hasn’t changed at all. The purpose is to produce a reliable steady income.

That’s exactly what land and government bonds provided in the low growth, zero-inflation economies of the 18th and 19th century. Hence these countries had high and stable capital-income ratios.

For Piketty, the implication of this, particularly during the 19th century, is that low growth economies are capital dominated societies. Capital income from wealth accumulates faster than labour income.

But what exactly is a government bond that made these Jane Austen characters so wealthy?

It is a claim of one portion of the population (those who lend to government and receive an interest) from another portion of the population (those who pay taxes to the government).

Government debt is always another person’s private wealth.

In the aftermath of the international financial crisis, taxpayers are regularly reminded that their state is in ‘debt’. But to whom exactly do taxpayers owe this money?

Ask yourself the following question: Has the structure of capital from the 19th century become more dynamic and less rent-seeking?

For Piketty, capital at its inception is always risky and entrepreneurial but evolves into rent when it accumulates into larger amounts. To make this point he uses the character of Père Goriot (a classic Balzac novel). Goriot gets rich as a pasta manufacturer and then invests his wealth in government bonds, only to be deceived and abandoned by his daughters.

Capital in Britain and France

Figures 3.1 and 3.2 illustrate the capital/income ratio in Britain and France from 1700-2010, and demonstrate three important social facts about the economic structure of British and French society from the 18th – 20th century (the countries for which we have the longest data).

  • First, the capital/income ratio followed a similar u-shaped curve.

The total market value of national capital fluctuated between 6 and 7 times national income between 1800-1914.

After WW1, and up until 1970, it collapsed to 2 and 3 times national income. It has since climbed back up to 6 times national income in 2010.

These are very large swings and reflect the serious distributional conflicts during the 20th century, when the ownership of wealth and capital was highly contested, politically.

For Piketty, the rise in capital/income ratios suggests ‘wealth is back’ and flourishing. But the overall value of capital (wealth), measured in terms of national income, has not changed that much.

  • Second, despite the stability of capital/income ratios, the composition of capital has totally changed over time.

Capital-assets are no longer agricultural. They have been replaced by buildings, business, financial and real estate.

Remember national capital = farmland + housing + other domestic capital + net foreign capital.

What figures 3.1 and 3.2 demonstrate, most clearly, is the collapse in the value of farmland. But ask yourself what has replace this?

It was counterbalanced by a rise in the value of housing and domestic capital (the industrial/financial assets of private firms and government). As I will suggest later in the course, I think Piketty under-estimates the significance of housing capital as a determinant for rising capital/income ratios. This is important, because it heavily impacts political preference formation.

  • Third, net foreign capital was highly significant in the 19th century but not anymore.

British and French citizens could yield a significant income through colonial ownership.That is, rich citizens of these imperial countries could increase their wealth through colonial power.

The advantage of owning another country’s resources is that you can consume and accumulate without having to work. The colonies produced and the colonizers consumed.

With decolonization these foreign assets evaporated: this role for imperialism in capitalist accumulation, throughout the 20th century, is a core factor in explaining western European wealth.


The core inference from all of this is that national capital has preserved its value in terms of annual income but it’s composition has totally changed (from land to real estate and finance).

But does this structural transformation of capital imply that wealth has become more dynamic and more entrepreneurial? This is an important question to ask yourself.

Before we explain the revival of capital since WW2 we need to analyse the politics of public debt. To do this, we need to examine whether national capital (wealth) is publicly or privately owned.

Government debt

The division of property rights between government and private individuals (states and markets) is a very important political question. We usually only ever hear about government liabilities or government debt. But what about government/public assets?

Public assets (wealth) can be financial (think about the oil-producing sovereign wealth funds underpinning the Middle Eastern monarchies) or non-financial (think about public hospitals or universities). But for the most part, states have more public debt than public wealth.

Britain and France offer two very different case studies on the relationship between public debt and private capital.

  • In Britain, at the end of WW2 (and after the Napoleonic wars) public debt was over 200 percent, but Britain never defaulted.

The British monarchy never collected enough taxes to pay for their wars. Rather they raised revenue by borrowing from private individuals (thereby increasing the private wealth of their richer residents and in turn: rising capital/income ratios) rather than taxing them. Taxation was a 20th century phenomenon.

Britain’s economy grew at a steady rate of 2-3 percent from 1815-1914, so after a century, they eventually reduced their debt-GDP ratio, which was accumulated in the 19th century. In the 20th century they primarily got rid of public debt through inflation. But they never defaulted.

  • In France, at the end of WW2 (and after 1798) the French government defaulted and cancelled all of its public debt. They choose to create a large public sector instead.

This meant that they took capital away from the private sector and placed it in the public sector.

Think about the recent financial crash, and the post-crisis policy response, and the relationship between private wealth and public debt.

The Irish bank bailout cost 64 billion (40 percent of GDP), and was designed to cover the private liabilities of six financial institutions: AIB, Bank of Ireland, EBS Building Society, Irish Life & Permanent, Anglo-Irish Bank and Irish Nationwide. The cost of the bank bailout was approximately €8,956 per person.

How does the Irish government (taxpayer) repay this debt? Or more precisely, who pays it?

From a private financial market perspective it is obviously far more advantageous to lend to governments and receive an interest/payment than to pay higher taxes without compensation.


Investing in public debt (buying government bonds) at 4-5 percent interest in a context of slow growth and zero inflation is a pretty good investment.

In the 20th century many governments, particularly those in France, borrowed from private investors to fund public services and therefore rising public debt was specifically aimed at redistributing resources to lower-income households. But this debt was evaporated (paid off) by inflation.

From 1914-1950 French inflation was approximately 13 percent per annum. This means that a government bond bought in 1913 was worthless twenty years later. Inflation enabled the French government to ‘inflate it’s debt away’, whilst simultaneously re-building their social state.

Germany did the same.

None of this is meant to suggest that redistribution by inflation is a good idea, or an optimal strategy to manage the public-private wealth dynamic. It cannot work indefinitely. But it is important to note that public debt is a vehicle of redistribution whether it is repaid or not. It’s a strategy to mobilise private wealth for public gain.

Public assets

Enough about public debt, what about the evolution of public wealth/assets?

Figures 3.3 and 3.4 reflect a steady expansion, albeit modest, of the economic role of the state in France and Britain.

The total value of public assets (primarily public buildings, national industry and infrastructure) rose from 50 percent of national income in the 19th century to approximately 100 percent in the early 21st century.

These public assets peaked during the interventionist years, from 1950-1980, and were then followed by major waves of privatization after 1980.

Figure 3.6 is indicative of the interventionist years in France.

It is important to keep in mind the changed ideational climate after WW2. The period of laissez-faire during what is often described as the first era of globalisation, (1870-1913), was widely considered a policy failure that contributed to war and recession.

The French nationalized many parts of their banking and automobile sectors (the owner of Renault was arrested as a Nazi collaborator in 1944) after the war, giving rise to an economic system of ‘dirigisme‘. From an economic ideas perspective, France considered the weakness of their state a causal factor behind German invasion, therefore they wanted to strengthen the state.

By 1950 public wealth in France was worth one year of national income whereas private wealth was worth two years of national income. The government owned 30 percent of the nation’s wealth. This is not a communist regime, but it’s certainly a state-led variant of capitalism.

France had a mixed economy, or capitalism without capitalists. The biggest firms were public not private. This all changed from the late 1980’s and 1990’s when the new era of Europeanization, liberalization and privatization was instituted.


How does all of this compare with Europe’s other ‘great nation’, Germany?

Figure 4.1 shows that the evolution is very similar.

  • First, agricultural land gave way to residential and commercial real estate.
  • Second, the capital/income ratio has grown steadily since 1950.

But note one important difference. Germany never had a net foreign asset position during the 19th century (it was not a colonial power), but it has amassed substantial foreign assets over the past few decades, primarily because of it’s large trade surpluses.

Germany’s net foreign asset position is equal to 50 percent of national income, a significant amount, and over half of this has been accumulated since 2000.

  • Germany, like France, got rid of its public debt throughout the 20th century via inflation, which averaged 17 percent between 1930 and 1950.

The hyper inflationary strategy during the 1930’s destabilized German society. This arguably underpins the paradoxical situation in Europe today. Germany is absolutely opposed to any price increase that exceeds 2 percent per annum, despite being the country that resolved its public debt in the past via the inflation mechanism.

Britain, on the other hand, always repaid it’s debt, and today it does not have the same fear of politically induced inflation. For example, the UK is happy to allow its central bank to buy a substantial portion of its public debt (monetary policy), regardless of the asset-price inflation effect.

Germany also engaged in large asset purchases of its banking and automobile sectors during the interventionist years of 1950-1980. The government owned almost 30 percent of national wealth during the decades of postwar reconstruction.

The state of Lower-Saxony still owns 15 percent of Volkswagen shares today (and therefore 20 percent of voting rights, given corporate governance and co-determination laws in Germany).


Figure 4.4 compares Britain, France and Germany. National wealth is equivalent to 4 times national income in Germany, compared to 5 and 6 in France and the UK.

But national savings are higher in Germany. What explains this paradox? How can a country with high-savings have a lower capital/income ratio?

It can be largely explained by two factors. First, the very low price of real estate in Germany, which is kept in check by strict rental control regulations. Second, German firms have a lower stock market valuation, which is lower because workers have a stronger claim on the ownership of German firms.

This reflects the German ‘Rhenish’ or ‘Stakeholder’ variety of capitalism, whereby firms are owned not just made up of private shareholders (the Anglo-Saxon model) but stakeholders such as trade unions, consumer associations and regional governments.

Lower stock market valuation does not imply lower social valuation, nor does it imply less economically efficient firms. Rather it reflects a politically different way to organise the market.

We will examine this in more detail during the second half of the course, when we analyze the importance of ‘different varieties of capitalism’, a debate that has become more important in the aftermath of the great recession in Europe.

The PPT slides can be found here: Lecture 7

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


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?


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


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.


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