No economics book published in recent years has had as much impact as Thomas Piketty's "Capital in the 21st Century." The book is a masterpiece with over 600 pages, which discuss how globalization and economic development impact our lives, the economy, and the contemporary world. Piketty, after years of research, brings us a major essay on how capitalism generates inequality for society, increasing the concentration of wealth. In his work, he traces a history of how the economic regime has reached its present state and assesses a future prognosis for the world economy.
The work is a benchmark for economic studies, but the 12min team knows that not everyone has the time to devour this bible. That's why we synthesized the book and created a micro-book so you can learn its key ideas in no time. Shall we go?
Capitalism is a powerful force in economics, with a long history of entrepreneurs who have worked hard creating companies, making money, and returning it to the economy in the form of investments. With its roots in the fourteenth century, this economic system has been central to the construction and development of many markets in the world. Economists have argued and defended capitalism over the centuries, and the system shows no signs that it will move in another direction.
However, while it is clear that the system is both fascinating and successful, it also faces an imminent and growing threat of unequal wealth. Capital in the Twenty-First Century, by Thomas Piketty, takes a deep look at the issues capitalism raises. It describes the foundations of capitalism, showing how an uncontrolled capitalist economy can lead to a great and dangerous chasm between the middle and upper classes. Each statement is supported by extensive data and research, as evidence of past trends as well as actual statistics. Once the problem has been established and exploited, Piketty then proposes a revolutionary solution that if put into practice could change the face of capitalism and economies around the globe.
To understand the problem with capitalism, you must first understand how capitalism works. Capitalism, in essence, concerns the production of goods and services with the primary purpose of making money, instead of exchanging it for other goods, food and clothing, as was done in the past. A simple illustration of this is that a farmer cultivating seeds for the sole purpose of selling them on the market for profit. In time, the farmer decides to invest part of his profit in seeds and equipment to produce more. What it reinvests is known as the "capital", which are essentially the tools or money used to generate more money. When he sells his crop to the market, the money he earns back is called "return".
A portion of the return will be reinvested as capital again, while a portion will be used to pay those doing the work (in this case, the farmer himself) - and the cycle continues. Over time, the farmer may begin to think about his rate of return, which is the profit he recovers from his investments, expressed as a percentage. When the farmer's operation begins to become more profitable, he may choose to hire more workers to increase his workforce and thus his productivity. It means that he will have to spend more money on labor, but now his returns must also be much higher. However, if the farmer's profits begin to grow faster than his operation, his capital will not be needed. As an alternative, the excess of money will go directly into his pocket, and the inequality of wealth begins to develop.
The same principles that apply to the farmer apply to the rest of the economy. If the rate of return continues to grow, but the economy does not grow with it, owners and organizations end up generating a disproportionate amount of wealth to save capital. While it is true that this wealth can often be transferred to capital and used to create new jobs, the result is that, ultimately, a very small percentage of people hold a very large percentage of the wealth of an economy. Also, being the main force behind capital gives owners great power over job creation. When it comes to planning the future of our economy, placing a significant amount of power in the hands of such a small group of people can be considered dangerous.
Unless changes are made, power imbalance only worsens over time. A constantly growing global economy is healthy, but the rate at which the world's markets grow needs to remain similar to the rate at which its capital return increases. We call these rates "growth rate" and "rate of return on capital", respectively. If the rate of return is off the scale of the rate of growth, there is a financial imbalance, followed by social inequality. That is a problem that needs an immediate solution since even the smallest gap can grow over time to dangerous proportions. Itis best viewed by comparing market growth to population growth.
If the world's population grew at a rate of about 1 percent each year, the number of humans on this planet would grow from just over half a billion in the 1700s to over 7 billion in 2012. Although a rate of 1 % does not look like much at first, it grows exponentially, reaching large numbers over time. The same principle applies directly to capitalism and demonstrates the great problem of the way in which it currently works. If there is a small but steady difference between the rate of return on capital and the rate of growth, the imbalance will lean heavily in favor of the currently wealthy. Although it takes a long time, the results are inevitable. In the end, allowing unequal growth creates a dangerous social imbalance that only worsens over time.
Simply put, the national capital is the sum of a country's domestic capital - assets they own in their own land - and their international capital - assets that they own in other countries. Capital has increased and diminished over the decades, but possibly the most notable change has been in its nature. In the past, the land was the most important type of capital, but it gave way to industrial and housing assets. Historically, France and the United Kingdom found great value in international assets, but major global events such as world wars and the Great Depression began to exhaust the value of these assets. By 2010, foreign holdings of these two countries were almost worthless.
Domestic capital can also be divided into public and private assets. These two share an inversely proportional relationship: losses on public assets often mean gains on private assets and vice versa. It means that changes in public and private capital often do not mean changes in domestic capital, but understanding the difference between the two is important. The public assets of a government are always nonfinancial, as in the case of buildings and government structures, or financial, cash in the state. Private assets are simply assets that are not publicly traded. But capital was not the only thing which changed. The way governments deal with their debts has also changed throughout history, but some of the old methods have had unintended effects on the market.
Inflation (where the prices of goods rise) and private lending (where the government borrows from rich private citizens) are both common methods of dealing with public debt, and both present effective solutions. Unfortunately, these methods are quite brutal for the working classes, with the former reducing purchasing power and the latter by giving back power to the already wealthy. Although both methods are declining in Europe, their impacts can already be felt: as markets recover, the unbalanced distribution of wealth is still a real and present factor.
To truly understand the complexities of global capitalism, one must understand its history, theory and carefully examine current trends. The first and second fundamental laws of capitalism are formulas that go a long way in explaining market behavior over time and do a great job of simplifying history and making real problems clearer. The first fundamental law of capitalism says that national income (α) is equal to the rate of return on capital (r) multiplied by the rate of capital/income (β). Simply put, the formula looks like this: α = r × β This small formula is powerful, making it incredibly simple to calculate national income, which is the total income received by everyone in a country.
As an example, if you know that the capital/income ratio (the rate that demonstrates how much capital can be received with a year's income) is 5: 1 with a 4% rate of return on capital, the national income is 20 %. This law is very useful for finding national income, but it is also incredibly versatile and can be used to find its variables as well. For example, if you are looking for the current rate of return and you know the national income and the capital/income ratio, finding your answer is as simple as replacing the numbers in your formula. Because the rate of return is the measure of the amount of return received from investments, it is a very important statistic. The calculation of the rate of return is a simple formula making capitalism's first fundamental law a powerful tool.
The second fundamental law of capitalism says that the rate of capital/income (β) is equal to the rate of saving (s) divided by the rate of economic growth (g). For example, if an economy saves 20% of its income and has a growth rate of 4%, the capital-income ratio will be 5: 1 or 500% for the value of income of each year. This well illustrates the main problem: if a country saves a lot but does not grow at a rate high enough to keep the economy running, then the result will be an excess of capital, which is then distributed, to those who already have wealth. You can see how important growth is to the economy by simply increasing the growth rate by 1% in the example above.
The capital/income ratio falls to 4: 1, a significant drop. Simply put, this means that if in our example the economy grows only 1% more, the increase would be only 400% instead of 500%. That extra money could be distributed elsewhere, most notably to the middle and lower class families who need it. Capital is a potentially wonderful collection of resources used to create jobs and opportunities for those who do not have capital. But giving the largest share of a country's economy to a very small percentage of the population is dangerous. These formulas allow us to see how critical the imbalance of wealth can be.
We have seen that inequalities can get out of control relatively quickly when not monitored. However, even with catastrophic problems affecting markets on a global scale, capitalism advances over time. In France and the United Kingdom of the nineteenth and twentieth centuries, a working-class, middle-class citizen was rewarded with a good life, food on the table, and money in their pockets. But it also allowed others no realistic chance of getting close to the extravagant wealth of those who inherited fortunes. That was a trend that dominated these centuries. But the world and the economy has changed, and with this, the richest soon found themselves losing more than they expected.
The period between 1914 and 1945 was full of events in the worst possible way. World War I struck hard, shaking the world both economically and politically. Just 11 years later, markets around the world plummeted in the widespread economic recession known as the Great Depression. The event began in 1929, and its effects were postponed until 1939 when combat shook the world again in World War II. These events hit the most prosperous members of society incredibly hard. In 1914, before the start of events, the top 1% of the income hierarchy in France controlled 20% of income. Between 1914 and 1945, that number plummeted to 7%. The top 10% lost control of 45% to 30% of the country's income, bringing the lifestyle of the highest class very close to the middle class. With so many impacts on the top 10% wealth, one might think that the chasm between the upper and middle classes would be lower, but this is not the case.
Between 1945 and 2010, the top 10% recovered three percentage points, reacquiring 33% of the country's wealth, and there is still a growing trend. Given the habit of capitalism to grow the percentage wealth at the top exponentially, this inequality is a concern for the future. Capitalism has had some setbacks impeding its efficiency and remains a powerful force that leads to wealth inequality. Research shows that citizens in the top 10% of Europe's wealthiest countries in 2010 controlled 35% of the continent's capital and labor. While in the United States, the top 10 percent controlled a huge 60 percent. These numbers serve only to illustrate the dynamics of capitalism: even with a world crisis spanning 31 years and markets breaking in several countries, time is all it takes to recover.
Capitalism’s dynamics are powerful, able to take advantage of small growth rates to put excessive capital in the pocket of the already wealthy. The system as such only aggravates the inequality of wealth over time and shows no signs of improvement on its own. Some schools of economic thought advocate an approach without interference, believing that the economy will naturally regulate itself. However, as we have seen, even the 31 years of the economic crisis were not enough to permanently regulate the problem. What the economy needs is something unnatural. Here 'unnatural' simply means something that is directly created to regulate the inequality of wealth, opposing an external occurrence that unintentionally affects it. World wars are prime examples of natural interference, while progressive taxes (which are probably the best solution to regulate inequality) are unnatural interferences.
A 'progressive tax' is a tax that increases according to the income of who is taxed. This kind of tax would force the wealthiest and the savers to pay a higher rate than the others. Different forms of progressive tax have been and are being applied around the world. But in the United States and the UK, they are decreasing, reducing their effects and, in some cases, reversing them. For example, in 2010, the poorest 50% in France paid taxes at rates of 40-45% and the next 40% paid slightly higher rates of 45-50%. That sounds ideal until it is revealed that the rates paid by those at the top actually fell, with the top 0.1% paying only 35% and paying virtually no capital wealth tax such as land, factories, and machinery. Progressive taxes are the step in the right direction, but for there to be some permanent and real change, the capital problem needs to be pointed out.
With capital goods commonly free of taxes, something entirely new must be created to counter the problems generated by capitalism. A new and progressive global tax on capital solves these problems by inhibiting the power of capitalism over inequality and allowing for greater balance. Doing so would be a long and severe process, including elaborating a tax plan satisfactory to the whole world, but the efforts involved in creating a tool made specifically to regulate the inequality of wealth would be worth it. To achieve this, a high level of financial transparency would be required, allowing the general banking information of countries and individuals to be monitored. That would include assets held overseas.
In today's modern society, it would be easier to achieve this, thanks to electronic transfer records. This type of tax would be a perfect tool: in fact, too perfect to be true. It is almost impossible to get all the nations of the world to embark on this idea, as well as finding the perfect planning and support from rich countries. In fact, planning would take a long and impractical time, and the richest members of society would lose so much that they would never agree with this idea. A progressive global capital tax is a utopian concept, but that does not mean that it is not worth considering as a goal. Having an idea of perfection allows economists and governments around the world to see how a world with drastically less inequality would be and then becomes a strong reference for future policies.
What started as a system that helped managers put their money back into the economy has grown almost overwhelmingly. Now, dreams of riches and fortune are virtually impossible for low and middle-class citizens in many countries around the globe. Wealth inequality is astonishingly high, and something needs to be done. These are not just theories. Careful history studies reveal the power of capitalism dynamics, even in the face of the worst financial catastrophes in history and two of the greatest wars the world has ever seen. The facts shown point to one conclusion: wealth inequality is not a problem that will solve itself. We need policy changes that focus squarely on the main issues to end the chasm and level the playing field again.
When we look at the problems of capitalism, it becomes clear that a progressive tax is the best solution. But in many countries, this type of tax does not affect capital, which is often exempt. Therefore, Thomas Piketty suggests that a progressive tax should be applied directly to capital globally. That would be accompanied by new transparency laws. Although this model is unrealistic, it demonstrates an idea for a perfect economy: an economy in which wealth inequality is minimal and the working classes have a chance to become wealthy through hard work.
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