ECN105 Contemporary Economic Issues

Lecture 6

Inequality: Income and Wealth Distribution

Lecture plan

A brief summary and discussion of

n. 1 on Amazon’s bestseller book list in 2014

First a brief recap of the module so far….
 The module so
far
Automation and
Robotization
In the first half of
the semester we
have focused our Universal Basic
attention on topical Income
(contemporary)
issues related to Productivity (UK
Income Distribution productivity puzzle)

Minimum Wage
So, it makes sense to conclude this part of the module with a ‘Grand
Theory’ of Inequality…

http://piketty.pse.ens.fr/en/capital21c2
• Piketty’s main contribution is in the provision of new, very accurate,
forensic, long-run data on income and wealth inequality drawn from
various sources including, in particular, tax records

• This new evidence enables:

• An investigation of the evolution of income and wealth inequality over time;
• The creation of projections about future patterns of inequality
Let’s start with some data/evidence
https://wid.world/
Sh a r e o f to p d e cile in to ta l in c

Income inequality: Europe vs. the United States, 1900-2010

0.48
0.47
0.46 0.46
0.45
0.45

0.42

0.41
0.41 0.4
0.39

0.37
0.36

0.35
0.34 0.34
0.34 0.34 0.33
0.32
0.32 0.32

0.3 0.29

U.S. Europe

1900 1903 1906 1909 1912 1915 1918 1921 1924 1927 1930 1933 1936 1939 1942 1945 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008

The top decile income share was higher in Europe than in the U.S. in 1900-1910; it is a lot higher in the U.S. in 2000-2010. Sources and series: see piketty.pse.ens.fr/capital21c.
S h a r e o f to p d e c ile in n a ti o n a l

Top decile share in national income in Europe and the USA, 1900-2010 (decennial averages)

U.S. U.K. Germany France

0.48
0.47 0.47
0.47 0.47

0.46
0.45 0.45
0.45
0.44
0.43
0.42
0.42 0.42
0.41 0.42
0.41
0.41 0.4
0.39
0.39
0.38
0.37
0.36
0.36 0.36
0.36

0.34 0.34
0.34 0.34 0.34
0.33 0.33 0.33
0.33 0.33 0.33
0.33 0.32
0.31 0.32
0.31 0.31
0.3
0.29
0.28

1900 1903 1906 1909 1912 1915 1918 1921 1924 1927 1930 1933 1936 1939 1942 1945 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008

In the1950s-1970s, the top decile share was around 30%-35% of national income in Europe as in the USA
Sources and series: see piketty.pse.ens.fr/capital21c.
S h are o f to p d ecile in n ati on al in c

Income inequality: Europe vs. USA, 1900-2010

(Annual series)
50%

45%

40%

35%

30%

U.S. Europe

25%
1900 1903 1906 1909 1912 1915 1918 1921 1924 1927 1930 1933 1936 1939 1942 1945 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008

The top decile share in national income was bigger in Europe in 1900-1910; it was far bigger in the USA in 2000-2010. Sources and series: see piketty.pse.ens.fr/capital21c.
 The Evidence

Fact n°1

• In 1900-1910, income inequality was higher in Europe than in the United States; in
2000-2010, it is a lot higher in the United States

• This is due to a mixture of reasons:

• changing supply and demand for skills;
• race between education and technology;
• globalization;
• more unequal access to skills in the US;
• unprecedented rise of top managerial compensation in the US
S h a r e o f t o p d e c ie o r t o p p e r c e n ti le in

Wealth inequality in Britain, 1810-2010

0.92
0.89
0.87
0.85
0.83

0.76

0.72 0.71
0.69 0.69
0.64 0.64
0.63
0.61 0.61

0.55 0.55

0.47

0.34

0.27 0.28
0.24
0.23 0.23

Top 10% wealth share Top 1% wealth share

1810 1820 1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

The top decile owns 80-90% of total wealth in 1810-1910, and 70% today.
Sources and series: see piketty.pse.ens.fr/capital21c.
Share of top decile or percentile in total wealth

Wealth inequality in France, 1810-2010

88.5%
87.3%
83.7% 84.6% 84.7%
83.2% 82.4%
81.8% 81.8% 81.7%
79.9% 80.4% 80.0%
75.8%
72.8%
69.9%

62.0% 61.8% 62.1% 62.4%

60.5% 61.0%
58.7%

52.0% 51.1%
50.3% 50.4% 49.5% 49.2%
46.7% 47.5% 47.4%
45.6% 46.0%

36.3%
33.4%
31.9%

23.5% 24.4%
22.0% 22.0% 21.7%

Top 10% wealth share Top 1% wealth share

1810 1820 1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

The top decile (the top 10% highest wealth holders) owns 80-90% of total wealth in 1810-1910, and 60-65% today.
Sources and series: see piketty.pse.ens.fr/capital21c.
S h a re o f to p d e c ile o r p e rc e n ti le in to

Wealth inequality in the U.S., 1810-2010

0.81
0.8

0.73
0.71 0.72
0.69 0.7
0.66 0.67 0.67
0.66
0.64

0.58

0.45
0.44

0.37
0.33 0.33 0.34
0.32 0.31
0.3 0.3 0.3
0.28
0.25

Top 10% wealth chare Top 1% wealth share

1810 1820 1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

The top 10% wealth holders own about 80% of total wealth in 1910, and 75% today.
Sources and series: see piketty.pse.ens.fr/capital21c.
S h a r e o f t o p d e c ile o r p e r c e n ti le in t o t

Wealth inequality: Europe and the U.S., 1810-2010

0.9
0.85 0.86
0.82 0.83
0.81
0.8
0.75
0.73
0.71 0.72
0.69 0.7
0.68 0.67
0.66 0.67
0.66
0.64 0.64 0.64
0.63
0.6 0.61
0.59
0.58
0.56
0.55
0.52
0.48
0.45
0.44

0.37 0.38

0.33 0.33 0.34

0.32 0.31
0.3 0.3 0.3 0.3
0.28
0.25 0.24
0.24
0.21 0.22
0.2

Top 10% wealth share: Europe Top 10% wealth share: U.S. Top 1% wealth share: Europe Top 1% wealth share: U.S.

1810 1820 1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Until the mid 20th century, wealth inequality was higher in Europe than in the United States.
Sources and series: see piketty.pse.ens.fr/capital21c.
M arket value of private capital (% national incom e)

Figure I.2. The capital/income ratio in Europe, 1870-2010

800%
Germany France United Kingdom

700%

600%

500%

400%

300%

200%

100%
1870 1890 1910 1930 1950 1970 1990 2010

Aggregate private wealth was worth about 6-7 years of national income in Europe in 1910, between 2 and 3 years in 1950, and between 4 and 6 years in 2010. Sources
and series: see piketty.pse.ens.fr/capital21c.
Va lue of priva te ca pita l (% na ti ona l incom

Figure 5.8. The world capital/income ratio, 1870-2100

800%

Projections
700% (central
scenario)

600% Observed
series

500%

400%

300%

200%

100%
1870 1890 1910 1930 1950 1970 1990 2010 2030 2050 2070 2090

According to simulations (central scenario), the world capital/income ratio could be near to 700% by the end of the 21st century. Sources and series: see
piketty.pse.ens.fr/capital21c.
Lab o r an d cap ital in co m e (% n ati o n al in c

Figure 6.1. The capital-labor split in the Britain, 1770-2010

Labor income Capital income

80%
79% 79%
75% 76% 76%
74% 73%
72% 72%

66% 67%
64% 65% 65% 65% 64%
62% 63%
60% 59% 59%
58% 57% 57%

42% 43% 43%

40% 41% 41%
38% 37%
36% 35% 35% 35% 36%
34% 33%

28% 28% 27%

25% 26%
24% 24%
21% 21%
20%

1770 1780 1790 1800 1810 1820 1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

During the 19th century, capital income (rent, profits, dividends, interest,..) absorbed about 40% of national income, vs. 60% for labor income (salaried and non salaried). Sources and series: see piketty.pse.ens.fr/capital21c.
 The Evidence

Fact n°2
• Wealth inequality is always a lot higher than income inequality

Fact n°3
• Wealth inequality is less extreme today than a century ago, although the total quantity of
wealth relative to income has now recovered from the 1914-1945 shocks
 The model
How can we explain why wealth is so much more concentrated than income?

• We can think of two main models of accumulation

• Life-cycle models: people plan their labour supply, consumption, saving over their
finite life horizon;
• Individuals die with zero wealth (no inheritance), wealth accumulation is entirely
driven by life-cycle motives (i.e. savings for retirement);
• Such a model cannot help to explain wealth accumulation.

• Best model to explain wealth accumulation is

• Pure dynastic model (with cumulative shocks e.g. number of children, inheritance)
• Individuals maximize dynastic utility functions, as if they were infinitely lived;
• Death is irrelevant in their wealth trajectory, so that they die with positive wealth,
unlike in the lifecycle model
 The model
• In such a dynastic view of household behaviour, for a given variance of shocks, the
equilibrium level of wealth inequality is a steeply increasing function of

r-g
r = rate of return on capital
Capital: stands for “wealth” in all its various forms: stocks, real estate, gold, etc.

Wealth inequality
g = growth rate of output (GDP)

r–g
 Why is wealth inequality an increasing function of r-g?

• Intuition
• with high r – g, initial wealth inequalities get amplified at a faster pace
• For example with r = 5%, g = 1%, wealth holders only need to reinvest
1/5th of their capital income so as to ensure that their wealth rises as
fast as national income; this makes it easier to build and perpetuate
large fortunes
What does the evidence say about the relationship between r and g?
A nn u al rate o f re t u rn o r rate o f gro

Return to capital and growth: France 1820-1913

6.5%

6.0%
5.7% 5.8%

5.2%

4.8%
4.6%

4.0%
3.7%
3.6%

1.8% 1.8%

1.4%
1.2% 1.1%
1.0% 0.9%

0.6%

0.2% 0.1%
1820 1830 1840 1850 1860 1870 1880 1890 1900 1910
The rate of return on capital is a lot higher than the growth rate in France between 1820 and 1913.
Sources and series: see piketty.pse.ens.fr/capital21c.

Pure rate of return to capital r Growth rate of national income g

A nnual rate of re turn or rate of g

Rate of return vs. growth rate at the world level,

from Antiquity until 2100

5.3%
5.1% 5.1%
5.0%

4.5% 4.5% 4.5%

4.3% 4.3%

3.8%

3.3%

1.8%

1.5% 1.5%

0.5%

0.1% 0.2%
0.0%
0-1000 1000-1500 1500-1700 1700-1820 1820-1913 1913-1950 1950-2012 2012-2050 2050-2100

The rate of return to capital (pre-tax) has always been higher than the world growth rate, but the gap was reduced during the 20th century, and might widen again in the 21st century.
Sources and series: see piketty.pse.ens.fr/capital21c

Pure rate of return to capital r (pre-tax) Growth rate of world output g

A nnual rate of re turn or rate of g

After tax rate of return vs. growth rate at the world level, from Antiquity until 2100
Pure rate of return to capital (after tax and capital losses) Growth rate of world output g

5.1%
5.0%

4.5% 4.5% 4.5%

4.3%

3.9%
3.8%

3.2% 3.3%

1.8%

1.5% 1.5%

1.1%

0.5%

0.1% 0.2%
0.0%
0-1000 1000-1500 1500-1700 1700-1820 1820-1913 1913-1950 1950-2012 2012-2050 2050-2100

The rate of return to capital (after tax and capital losses) fell below the growth rate during the 20th century, and may again surpass it in the 21st century. Sources and series : see piketty.pse.ens.fr/capital21c
 So, the evidence suggests that historically:

r>g

A capitalist economy has an inherent tendency to accumulate wealth and

increase wealth inequality….
 Historical evolution of r and g

• During most of the history of mankind, r > g was obvious: g was close to 0%, and r was
generally around 5%
• Typically, annual rental income = 5% of land values in traditional agrarian societies (to
get an annual income of £1,000, one needs a capital of £20,000)
• Modern industrial growth did not change this basic fact as much as one might have
expected: g rose from 0% to 1-2%; r rose also
• During the 20th century, very unusual combination of events: low r due to 1914-1945
shocks + unusually high g during postwar period (reconstruction + demographic
transition: g = 3-4%)
• But the long run g seems to be closer to 1-2%, especially given projected population
growth slowdown; and r might rise due to global competition to attract capital
 The relationship between r and g

• The balance between r and g depends on many factors that are difficult to predict:
technology (capital intensive sectors: real estate, energy, robots,..), saving behaviour,
etc.
• Scale effects in portfolio management, financial complexity: higher rates of return for
large portfolios
• r > g seems to particularly strong for billionaires and large capital endowments
• Maybe less true at €10m than at €1b
• We know little about current wealth dynamics: cross border assets, tax havens, lack of
financial transparency
How to deal with wealth inequality?
 The relationship between r and g
Ideal solution (according to Piketty)
• Financial transparency
• International transmission of bank information
• Global registry of financial assets
• Global coordination on wealth taxation, so that progressive wealth tax rates can be
adapted on the basis of reliable wealth statistics
• Other (more radical?) ways to redistribution wealth:
• Inflation
• Expropriation (China, Russia)
• Wars, etc…..
• Will the progressive wealth tax happen? The history of wealth and taxation is full of
surprises….
M a rg in a l ta x ra te a p p ly in g to t h e h ig h

Top income tax rates, 1900-2013

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

U.S. U.K. Germany France

0%
1900 1903 1906 1909 1912 1915 1918 1921 1924 1927 1930 1933 1936 1939 1942 1945 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011

The top marginal tax rate of the income tax (applying to the highest incomes) in the U.S. dropped from 70% in 1980 to 28% in 1988. Sources and series: see piketty.pse.ens.fr/capital21c.
T o p m a r g in a l t a x r a t e a p p ly in g t o t h e h ig

Top inheritance tax rates, 1900-2013

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

U.S. U.K. Germany France

0%
1900 1903 1906 1909 1912 1915 1918 1921 1924 1927 1930 1933 1936 1939 1942 1945 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011

The top marginal tax rate of the inheritance tax (applying to the highest inheritances) in the U.S. dropped from 70% in 1980 to 35% in 2013. Sources and series: see piketty.pse.ens.fr/capital21c.
M a rg in a l ta x ra te a p p ly in g to th e h ig

Top tax rate: "unearned income" vs. "earned income"

100%

90%

80%

70%

60%

50%

40%

30%

20%

10% USA (capital income) USA (labor income) UK (capital income)

UK (labor income)
0%
1900 1903 1906 1909 1912 1915 1918 1921 1924 1927 1930 1933 1936 1939 1942 1945 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011

In the 1970s-18980s, the top marginal tax rate on capital income (applying to the highest incomes) in the U.S. and the UK was higher than the top tax rate on labor income. Sources and series: see
piketty.pse.ens.fr/capital21c.
Case study: Spain
C. Martínez-Toledano, (2020), “House Price Cycles, Wealth Inequality and Portfolio Reshuffling”, available online at
https://wid.world/wp-content/uploads/2020/02/WID_WORKING_PAPER_2020_02_Spain_MartinezToledano.pdf
Criticism
 Criticisms
• Now Piketty’s grand argument may be wrong.
• It could be that in the future, capital will turn out to complement rather than substitute
for labour (low marginal elasticity of substitution), and the wealth accumulation of
plutocrats will generate their self-euthanasia as a social class by pushing down the rate
of profit;
• It could turn out that growing fortunes will be a lot harder in the future than Piketty
thinks it will;
• It could turn out that our plutocrats as a social class will decide to play the status game
of spend-their-money-and-change-the-world rather than enrich great-grandchildren
that they will never see;
• My guess is that the grimmer elements of Piketty’s forecast have only a 50-50 chance of
coming true even if plutocrats achieve and maintain a lock on politics for the next three
generations;
• But that is much more than enough to worry about the scenario he paints, and figure
out how to guard against it.
Book review by J. Bradford Delong (2015)
After reading week

Class: Evidence about the sugar tax

Lecture: The economics of the sugar tax
Readings

https://ideas.ted.com/thomas-pikettys-capital-in-the-twenty-first-century-explained/

http://piketty.pse.ens.fr/files/capital21c/en/Piketty2014IntroChap1.pdf
http://piketty.pse.ens.fr/en/capital21c2