Lecture 20. Summary: The Political Economy of Inequality


In the rich market economies of the world, the incomes of the wealthiest are rising, whilst the incomes of the majority are stagnating. The outcome is growing wealth and income inequality.

None of this is in empirical dispute. What is in dispute is trying to explain why (i.e. the causal mechanism) and whether it is justified or not (normative legitimacy)?

Economic history

Piketty, and political economists more broadly, wants to put the issue of inequality into a broader historical context.

To do this, he traces the evolution of capital from the agrarian societies in the 18th century, through to the industrial revolutions of the 19th century, the inter war years, and into the second half of the 20th century.

There are three conclusions from this comparative historical analysis on the political economy of distribution:

  • Inequalities of wealth and income are influenced by a whole host of institutions; political, economic, cultural and normative factors (be sure to read the notes from lecture 19, which we did not have time to cover).
    • Piketty does not discuss the underlying determinants of national models of capitalism. This is where a comparative politics perspective becomes useful.
  • Markets when left to their own devices produce a high degree of inequality because the rate of return on capital always exceeds economic and income growth (R>G).
    • But not all markets are the same. There are multiple paths to economic and employment growth. The USA is, in many respects, an outlier.
  • On the basis of the inequality R>G, wealth tends to accumulate and concentrate at the very top of the income distribution.
    • This is a story about the rich , and the extent to which the top 1% of wealth owners have pulled away from the rest of society.

His core conclusion is that to tame the worst effects of market inequalities requires active fiscal intervention by the state, through a wealth tax.


It is important to note that democracies throughout the 20th century have pursued various public policy interventions to tame market inequalities: minimum wages, progressive taxation, capital controls, social security programs, collective bargaining rights, trade unions, rent controls and financial/banking regulations.

A central finding in the study of comparative political economy is that institutions – and their underlying political coalitions – actively shape market outcomes, and these institutions vary significantly between nation-states.

These institutions are usually associated with the functions of the labour market and/or the social state. But since the 1980’s, the political institutions that tended to create more egalitarian market outcomes have been gradually eroding (for a whole variety of reasons associated globalisation), with the implication that market inequalities within countries are increasing.


The benefits of globalisation have been defended for years by large parts of the economic profession and policymaking community.

Policymakers have tended to support and implement those policies that enable markets to get back to their competitive “natural tendencies”.

For critics, these natural competitive market tendencies logically lead to the inequality R>G, and undermine the meritocratic principles of democratic societies.

When competitive markets are left to their own devices, wealth accumulates and concentrates, with the implication that inheritance matters more than hard work.

This is the core normative critique underpinning Piketty.

It suggests that markets when left to their own devices leads to a “rentier” society not a meritocratic society. It suggests that a rising tide does not lift all votes (trickle down economics), and that the explicit hand of politics is needed to steer economies toward socially beneficial outcomes.


Lets unpack the concept of wealth, which is used interchangeably with the concept of “capital” in the book.

The first question to ask is where does capital-wealth come from? There are two sources: inheritance and income (theft also matters).

Income can be broken down into two sources: income from labour (wages, bonuses and salaries) and income arising from owning capital (rent, assets, interest, bonds, stocks, dividends).

Wealth that accrues from either of these forms of income can be consumed, saved or invested. Most people barely earn enough income to cover their living expenses. They have no wealth.

Capital only becomes true wealth when it is not immediately consumed i.e. when it accumulates in a savings account, re-invested in financial stocks and bonds, owned in real and/or commercial estate, machinery, buildings or land.

Most capital-wealth is held in either housing or financial assets. The purpose of owning capital is to yield an income. This has not changed since the 19th century.

Capital/income ratio

Capital/wealth can be public and/or private.

In any given society, total wealth equals public+private capital (minus debt). In all market democracies today, capital is almost entirely privately owned.

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

Dividing the total capital stock by national income gives us the capital/income ratio (β).

Capital/income ratios are important because they provide us with a comparable quantitative measure to analyze capitalist development across time.

In most countries we find that, on average, national wealth is 6-7 times national income. The capital/income is 600-700%. We live in wealthy societies!

But capital/income ratios tell us very little about the actual distribution of capital in a society i.e. who owns the wealth at an individual or household level.

Most people own nothing at all. In the US and Europe, 50% of the population own less than 5% of the wealth. Wealth is more unequally distributed than labour-income.

The R>G inequality

Before Piketty analyses the precise distribution of income and wealth in Europe and the USA, he proposes a theoretical mechanism to analyze the evolution of capitalism:

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

This is precisely what we observe in the USA and Europe since 1980. R>G leads to rising capital/income ratios. For Piketty, this suggests ‘private capital is back’.

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

R>G is the logical outcome of what happens when markets are left to their own devices.

It was only during the fiscal revolutions associated with the birth of the social state in the 20th century did the inequality R>G go into reverse.

This was the period of an emergent property owning middle class, which was central to the politics of democratisation.


Theoretically, a high capital/income ratio does not imply a high degree of inequality.

All capital-wealth, in theory, could be distributed equally or held publicly. But this is not the case in a private market economy.

As we have seen throughout this course, in the USA the top decile own 72% of all wealth, whereas the bottom 50% own nothing.

Why does R>G lead to inequality?

But why does the mechanism R>G lead to increased concentration of wealth at the top of the income distribution? There are two reasons.

  • First, wage inequality. Most people only earn enough to cover their living costs. They cannot save or invest. The higher your wage-income the more more you can consume whilst investing and saving. The wealthiest (0.1%) tend to invest in financial assets. The capital-income from these assets tends to accumulate and reap a high yield/interest rate.
  • Second, inheritance. The largest fortunes in market economies are usually inherited not earned. Bill Gates is a very very rare phenomenon, and not representative of a general trend.

Why did inequality decline in the 20th century?

Capitalist markets generate high levels of inequality. This is not in dispute. But why then did we witness a rapid decline in wealth and income inequality from 1950 to the 1980’s?

  • In the 18th century most capital-wealth was agrarian. Large landowners owned 90% of all wealth in European societies. There was no such thing as progressive taxation. Most fortunes were associated with inherited land or government bonds. In this period, capital/income ratios were rising because of the inequality R>G.
  • In the 19th century capital was increasingly invested into industry not land. In Europe, most private capital was bound up with industrial assets and those foreign assets accrued through colonisation.
    • This was not the case in the USA. In this period, although the composition of capital change dramatically, the capital/income ratios continue to rise because of the inequality R>G. A rising tide did not lift all boats.
  • From 1914 through to the interwar years, private capital experienced massive external shocks. Capital/income ratios declined because of physical destruction, government debt, inflation, the introduction of top income taxes, rent control and a whole raft of capital regulations.
    • Post-war societies, in turn, gave birth to social democratic capitalism.
  • From WW2 until the 1980’s there was a balance between private and public capital (mixed market economies), which gave birth to qualitatively distinct national varieties of capitalism. This was the birth of the democratic state, where revenue and expenditure shifted toward providing income transfers (pensions and unemployment protection) and public services (healthcare and education) to all citizens. Labour and wages became more important than inheritance.
    • Trade unions and collective bargaining were strong, and reflected the structure of employment, and mass manufacturing.
  • In the 20th century economic growth exceeded or balanced capital-income growth. This was the period of a “rising tide lifting all boats”, associated with the Kuznets curve. Strong growth in a democracy gave rise to pressures for redistribution.

In summary, the decline in inequality took the shock of two world wars, followed by a revolution in the fiscal policies associated with the democratic state. In turn, this gave rise to national models of capitalism, based on distinct electoral politics.

There was nothing “natural” about this process of capitalist development and democratisation. It was the outcome of distributional “class” politics.

The rise of ‘neoliberalism’.

With rising economic and income growth, associated with the period of mass manufacturing/productivity growth, which made possible strong wage growth (and taxes), democratically elected governments could fund an expansion of social services, whilst implementing public policies aimed at re-shaping market inequalities.

These, in addition to macroeconomic polices aimed at full employment, meant that the quality of life for those lower down the income distribution rapidly improved.

  • From the 1980’s most countries were exposed to international financial globalization. There was a shift back to private capital, particularly financial capital. In response to the oil crisis, stagflation and overburdened welfare states, in a period of declining economic growth, the Keynesian demand management ‘consensus’ came to and end.
  • Public policies and institutions shifted toward “the market”, particularly in international capital markets. The middle classes, particularly in the US, did not continue to experience rising income. Economic growth slowed down, the structure of the labour market rapidly changed, whilst the capital incomes of those owning financial assets soared i.e. R>G.
  • The accumulation of capital-income ratios has meant inheritance has re-emerged as an important factor in determining who owns wealth, and who does not. Further, public opinion and has become much more tolerant of inequalities (probably because they are perceived as a just outcome of individual merit and talent).
    • It is also important to note what we covered in lectures 17-19, where we discussed the impact of globalisation on voter preferences, and the increase in electoral and parliamentary volatility. All of this has meant that it is much more difficult to build stable redistributive electoral coalitions.

This graph from Branko Milanovic is a useful summary of the story of financial globalisation over the past two decades:


Distribution tables

Piketty uses distribution tables to track this historical change in wealth and income distribution from the 18th-21st century.

These are distinct measures from the Gini coefficient. T7.3

What these social tables suggest is that it is increasingly important to observe those changes in the top decile and top centile of the income distribution, as this is where most of the radical changes in the politics of distribution have taken place.

Most of the income and wealth gains since 1980 have accrued to the top 0.1 percent of the population. This trend has increased, not decreased, in the aftermath of the crisis!

Why does this matter?

Piketty does not get into a normative discussion on questions of fairness or social justice. This is perhaps a major problem of the book. Why should policymakers car?

He basically argues that even if you think extreme inequalities are justified, it is hard to legitimate a situation where inheritance matters more than merit.

He also warns us about the dangers to democracy in a society completely dominated by private capital, particularly when the top 1 percent.

He also highlights the distributive implications (and irony) of austerity and public debt in European societies rich in private wealth.

His solution to stem the rise of economic inequality, and to avoid the worst effects of R>G, is to impose a coordinated and progressive global wealth tax (including corporate profit).


The conditions under which a coordinated wealth-capital tax is possible is a question for political science. It requires international cooperation to overcome collective action problems.

The most likely place it could occur is in the EU. But such cooperation is undermined by growing tax competition between nation-states.

This capital tax should be used, according to Piketty, to pay off the public debt of those sovereign states who stepped in to save the financial sector from collapse.

He also argues that it should be used to raise revenue to invest in education and public infrastructure.

In the absence of international cooperation to regulate global capital in the 21st century Piketty anticipates a rise in support for nationalist, right wing, and anti-european political parties.

This brings us to the end of our lecture series. Best of luck in the exams, and the rest of your studies. At least in university, the price of success is hard work!

Slides: Lecture 20


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