21st Century Capitalism, Inequality, and and the Policy Toolkit

Capitalism qua capitalism is a topic of serious discussion for the first time in the U.S. in a very long time, at least among the NY Times/Atlantic/New Yorker reading demographic. It has been spurred by post-2008 real world conditions and channeled through Thomas Piketty's new book Capital in the Twenty-First Century. A surprisingly weighty tome to top the Amazon non-fiction list, Piketty's book marshals a massive amount of data to show the recent rise in inequality to new gilded age heights. In itself that is not a revelation, but Piketty observes that it is not driven by high incomes (the executive salaries that routinely make headlines) but rather by returns on capital.  He illustrates the growth of the economy versus returns on capital (figure taken from Kruger review of Piketty):


The first amazing fact captured in this diagram is the dramatic drop in the rate of return from capital during the 19th century--the shift away from feudalistic rent-taking to competitive capitalist production. And now the troublesome divergence that emerged in the 1990s and 2000s.

There is good evidence to suggest that a certain degree of inequality is correlated with economic growth.  Too much inequality, however, disarticulates the production and consumption sides of the economy, constricts the opportunities open to the majority of people, a poses serious ethical dilemmas over what is acceptable. Where to draw the line is a technical and moral question, one that we tend to avoid.

Still, there is hope and even some practical solutions. Piketty calls for a 15% tax on capital and an 80% tax on incomes over $500,000.

Piketty's work reminds me of Jon Shayne's interview of Andrew Smithers (previously blogged here) in which Smithers shows the divergence of earning shares going to labor and going to profit:

Smithers argues that executive compensation has introduced a number of incentives that encourage managers to maximize short term profits at the expense of long-term investment in labor and productivity. This is troubling, and unhealthy for the economy in the long haul, as future collective prosperity is foregone for immediate rewards.

In terms of speculation that produces little social benefit, Jon points out that one alternative would be for the capital gains tax rate to become progressively lower over time (i.e. rewarding holding and long-term investment). Economist Bob Frank promotes a steeply progressive consumption tax that would discourage the arms race of conspicuous consumption of positional goods.

From nudges to smart regulation, there now exists a policy toolkit to fix our economic, political, and social woes. If only we would use it.