A Review of Capital in the Twenty-First Century by Thomas Piketty: Proposals on Overcoming Inequality and the Debt Crisis
According to Thomas Piketty, income inequality in the 21st century is likely to increase. Governments should take measures to mitigate the increase. He argues that international cooperation in enforcing progressive taxation is the best way to reduce inequality and debt. Piketty proposes measures to reform the European Union in implementing this approach.
Before the modern times, one could become wealthier through inheritance than through education and effort. Most poor people stayed poor throughout their lives and understood that substantial wealth could not be acquired by merit. Unlike modern western societies, Society then did not claim to be meritocratic.
Nowadays, as the number of educated people grows, more people expect and are expected to achieve a high living standard. As educational standards rise, so does competition. The average person from each generation is expected to spend more years studying than the previous generations. Over time, more educated people become disappointed when they enter the workforce.
Pure fraud is rare, as is achieving wealth by pure merit. Piketty admits the importance of entrepreneurial ability, leading to innovations that increase economic growth. Yet he argues that luck and political connections, sometimes leading to illegal transactions, also help multinational corporations and other big businesses succeed.
The existing income inequality does not reflect productivity or competence differences. By 2000-2010, top managers amounted to 60-70% of the 0.1% people with highest incomes. In comparison, athletes and performers of all kinds amounted to less than 5% of that group. Though productivity changes may explain part of the increase, Piketty argues that top managers have excessive power to convince the Board that they deserve higher compensations. It is difficult to estimate the individual productivity of each manager. There is severe nepotism in appointing compensation committees. Piketty also argues that there is no statistically significant relationship between the decrease in marginal tax rates and productivity growth rates in developed countries in the 1980s. Per capita GDP grew at about the same rate after the 1980s in all rich countries. Increasing top incomes did not stimulate productivity enough to have a statistically significant impact, if one looks at the whole period and adjusts for population growth differences.
Piketty argues that well-enforced progressive taxation is practical in ensuring that unethically or illegally acquired money is spent on social services and assisting the poor. It is impossible for regulating entities to track all business transactions and cash flows. He proposes several methods to implement and enforce it.
There is sufficient evidence of tax evasion and avoidance being common. For example, the world experiences net negative cash flows, suggesting that “the Earth owes money to Mars,” but most likely, the money ends up in tax havens.
To improve tax collection and income distribution, Piketty proposes creating an international organization to collect progressive taxes on capital globally, particularly from multinational corporations. He admits that the idea is utopian, but argues that moves towards it are the best method to prevent global income inequality from increasing further and to resolve the debt crisis in developed countries. Countries should share banking data and cooperate in detecting tax evaders.
Alternative solutions, such as protectionism and capital controls, are less desirable, but likely to be implemented. Protectionism can protect infant industries from international competition and penalize countries that neglect international rules. Yet it usually slows growth on both sides. Also, protectionism does nothing to prevent investors from earning annual returns that exceed average annual economic growth. As was shown in part 1 of the review, such excess returns increase income inequality. Nevertheless, we see new protectionist policies being implemented in many countries nowadays.
Capital controls are likely to become more common as well. In the 1980s and early 1990s, developed countries and international organizations promoted complete financial liberalization. Yet the financial crises of the late 1990s and the late 2000s convinced many governments that this is not always the best approach, since the policies that the IMF and other international organizations had advised for were often poorly planned. Governments of Russia, Indonesia and Brazil stopped following their advice and generated excess foreign currency reserves in pursuing their own economic policies. Under capital controls, exchange rates became more manageable. Nevertheless, a disadvantage of capital controls is that investors do not invest if they cannot get capital out of the country or face restrictions in diversifying their investments abroad.
Piketty argues that the global tax on capital and increased financial transparency are necessary for the common good to take precedence over private interests. This is the goal of a well-functioning democracy. Opacity in wealth distribution makes discussing global problems difficult. In Europe, the existing European institutions should enable passing and enforcing the new tax, since there are no other alternatives.
There are three ways that a country or group of countries can reduce debt without defaulting: austerity, increasing inflation, and raising taxes. Austerity measures are the worst approach, since they directly hurt the least well-off people and reduce employment through the multiplier effect. If international cooperation helps collect sufficient tax revenues, taxing capital is the best approach, since only the rich directly pay for it. Piketty argues that the European Central Bank (ECB) should reconsider its bias towards lowering inflation at any cost. He admits, nevertheless, that though higher inflation helps reduce debt, it is difficult to estimate the optimum inflation level. If allowing inflation is needed, this policy should be used with caution.
Piketty proposes several policy measures to reform the European Union institutions. He describes the euro as a “stateless currency” and argues that the ECB should become more accountable to other European Union institutions. Piketty proposes reforming the European Parliament to make it consist of representatives of the national legislative assemblies of member states. This would improve its credibility and make it more responsive to the needs of each.
Thomas Piketty proposes progressive taxation to redistribute income, but mentions little about how to spend the collected revenues, apart from debt servicing. He does not specify what can be done to ensure that the money reaches those who need it most and to minimize the inefficiencies that may result from extending the state sector and providing more welfare services, such as increased red tape, reduced productivity and lower incentives to work.
Thomas Piketty argues for cooperation in tax collection between developed and developing countries, but this is difficult to achieve. Governments of developing countries have a stronger incentive to keep taxes low than do the governments of developed countries. When developed countries decrease and enforce taxes, ceteris paribus, investments into emerging markets increase. The resulting economic growth in rapidly developing countries that tend to have authoritarian regimes strengthens the case for authoritarianism and weakens the case for democracy.
Piketty takes plummeting birthrates and the resulting demographic aging and deceleration in population growth in developed countries for granted, but it may not be the case. Improvements in health conditions may not only increase life expectancy, but also enable older people to stay productive for longer time. Increasing access to health care, improving workforce training, lowering the tax wedge to increase labor market flexibility, and enhancing innovation through research and development can help improve productivity of older workers, according to a study of European productivity by Shekhar Aiyar, Christian Ebeke and Xiaobo Shao, of the International Monetary Fund. Furthermore, advances in in vitro fertilization (IVF) and other technologies that enable giving births artificially may reverse the current plummeting rates. According to the Center for Disease Control and Prevention, between 1 to 2% of U.S. births annually are via IVF. Between 1987 and 2015, about 1 million babies were born in the United States alone through IVF, reports Penn Medicine, a world-renowned academic medical center in Philadelphia. Over half a million babies are born each year using IVF and intracytoplasmic sperm injection (ISCI), another artificial birth technology, reports the European Society of Human Reproduction and Embryology, on Science Daily magazine. Though the chance of a live birth under IVF for women aged under 35 years is only 32.2%, chances of multiple births are higher than when babies are naturally conceived, reports Joseph Nordqvist, of Medical News Today, a website of Healthline Media UK Limited, a leading healthcare publishing company. New technologies may not fully offset the plummeting birth rates, yet their further popularization and advances may slow down the decrease.
Changing family norms and government support, enabling women to both work and take care of their children may help sustain birth and fertility rates. Since the early 2000s, France and Sweden have had one of the highest fertility rates in Europe, which amounted to 1.9 for both countries in 2017, compared to 1.6 in Germany, 1.3 in Italy and Spain, and 1.4 in Poland, reports the World Bank. Fertility rates in France have been on the rise since the late 1990s, reports The Guardian. Table 1 illustrates the female participation rates and birth and fertility rates in selected western countries. Since social norms and welfare benefits make it more acceptable for women in France and the Scandinavian countries to combine work and raising children than it is in more traditionalist societies, such as that of Italy, many more women are willing to give birth. Since the trend towards gender equality is likely to persist, the opportunity to combine work and raising children will enable sustaining or increasing fertility rates in Europe over time.
Sources: Organization for Economics Cooperation and Development, The World Bank
Table 1: Female participation rates and fertility rates in selected countries (2017)
* - standard corporate income tax rate
** - top corporate income tax rate
Source: The World Bank
Table 2: Trade Openness and Key Income Tax Rates in Central Asian Countries
The shadow economy in Central Asia is a big obstacle in tax enforcement. Schneider, Buehn, and Montenegro (2010) studied 162 countries and estimated that the shadow economy in 2007 amounted to 38.4% in Kazakhstan, 38.8% in Kyrgyzstan and 41% in Tajikistan, compared to the weighted average of 36.5% for a sample of 21 transition economies and 13.5% for a sample of 25 OECD countries. (The other two Central Asian countries were not included in the study.) It will be more difficult to enforce taxes in Central Asia than in developed countries, as there are bigger shadow economies to combat.
Aiyar, S. Ebeke, C. Shao, X. The impact of workforce aging on European productivity. International Monetary Fund. https://www.imf.org/external/pubs/ft/wp/2016/wp16238.pdf. 2016.
European Society of Human Reproduction and Embryology. More than 8 million babies born from IVF since the first in 1978. Science Daily. https://www.sciencedaily.com/releases/2018/07/180703084127.htm. 2018.
The Guardian. France’s baby boom secret: Get women into work and ditch rigid family norms. https://www.theguardian.com/world/2015/mar/21/france-population-europe-fertility-rate. 2015.
Heritage Foundation. Uzbekistan. https://www.heritage.org/index/country/uzbekistan. 2019.
Nordqvist, J. IVF: What Does It Involve? Medical News Today. https://www.medicalnewstoday.com/articles/262798.php. 2018.
Organization for Economic Cooperation and Development. OECD Family Database. http://www.oecd.org/els/family/database.htm. 2015.
Organization for Economic Cooperation and Development. OECD Labor Force Statistics 2018. https://read.oecd-ilibrary.org/employment/oecd-labour-force-statistics-2018_oecd_lfs-2018-en. 2018.
Penn Medicine. Fertility Blog: IVF by the Numbers. https://www.pennmedicine.org/updates/blogs/fertility-blog/2018/march/ivf-by-the-numbers. 2018.
Schneider, F. Buehn, A. Montenegro, C. Shadow Economies All Over the World: New Estimates for 162 Countries from 1999 to 2007. http://documents.worldbank.org/curated/en/311991468037132740/pdf/WPS5356.pdf. 2010.
The World Bank. Trade (% of GDP). https://data.worldbank.org/indicator/NE.TRD.GNFS.ZS. 2019.
(see the previous post to read the first part of the review)
Introduction
The role of merit
Nowadays, as the number of educated people grows, more people expect and are expected to achieve a high living standard. As educational standards rise, so does competition. The average person from each generation is expected to spend more years studying than the previous generations. Over time, more educated people become disappointed when they enter the workforce.
Pure fraud is rare, as is achieving wealth by pure merit. Piketty admits the importance of entrepreneurial ability, leading to innovations that increase economic growth. Yet he argues that luck and political connections, sometimes leading to illegal transactions, also help multinational corporations and other big businesses succeed.
The existing income inequality does not reflect productivity or competence differences. By 2000-2010, top managers amounted to 60-70% of the 0.1% people with highest incomes. In comparison, athletes and performers of all kinds amounted to less than 5% of that group. Though productivity changes may explain part of the increase, Piketty argues that top managers have excessive power to convince the Board that they deserve higher compensations. It is difficult to estimate the individual productivity of each manager. There is severe nepotism in appointing compensation committees. Piketty also argues that there is no statistically significant relationship between the decrease in marginal tax rates and productivity growth rates in developed countries in the 1980s. Per capita GDP grew at about the same rate after the 1980s in all rich countries. Increasing top incomes did not stimulate productivity enough to have a statistically significant impact, if one looks at the whole period and adjusts for population growth differences.
Improving tax collection: the global tax on capital
There is sufficient evidence of tax evasion and avoidance being common. For example, the world experiences net negative cash flows, suggesting that “the Earth owes money to Mars,” but most likely, the money ends up in tax havens.
To improve tax collection and income distribution, Piketty proposes creating an international organization to collect progressive taxes on capital globally, particularly from multinational corporations. He admits that the idea is utopian, but argues that moves towards it are the best method to prevent global income inequality from increasing further and to resolve the debt crisis in developed countries. Countries should share banking data and cooperate in detecting tax evaders.
Alternative solutions, such as protectionism and capital controls, are less desirable, but likely to be implemented. Protectionism can protect infant industries from international competition and penalize countries that neglect international rules. Yet it usually slows growth on both sides. Also, protectionism does nothing to prevent investors from earning annual returns that exceed average annual economic growth. As was shown in part 1 of the review, such excess returns increase income inequality. Nevertheless, we see new protectionist policies being implemented in many countries nowadays.
Capital controls are likely to become more common as well. In the 1980s and early 1990s, developed countries and international organizations promoted complete financial liberalization. Yet the financial crises of the late 1990s and the late 2000s convinced many governments that this is not always the best approach, since the policies that the IMF and other international organizations had advised for were often poorly planned. Governments of Russia, Indonesia and Brazil stopped following their advice and generated excess foreign currency reserves in pursuing their own economic policies. Under capital controls, exchange rates became more manageable. Nevertheless, a disadvantage of capital controls is that investors do not invest if they cannot get capital out of the country or face restrictions in diversifying their investments abroad.
Piketty argues that the global tax on capital and increased financial transparency are necessary for the common good to take precedence over private interests. This is the goal of a well-functioning democracy. Opacity in wealth distribution makes discussing global problems difficult. In Europe, the existing European institutions should enable passing and enforcing the new tax, since there are no other alternatives.
Resolving the European debt crisis
Piketty proposes several policy measures to reform the European Union institutions. He describes the euro as a “stateless currency” and argues that the ECB should become more accountable to other European Union institutions. Piketty proposes reforming the European Parliament to make it consist of representatives of the national legislative assemblies of member states. This would improve its credibility and make it more responsive to the needs of each.
Drawbacks and limitations of Piketty’s proposals
Thomas Piketty proposes progressive taxation to redistribute income, but mentions little about how to spend the collected revenues, apart from debt servicing. He does not specify what can be done to ensure that the money reaches those who need it most and to minimize the inefficiencies that may result from extending the state sector and providing more welfare services, such as increased red tape, reduced productivity and lower incentives to work.
Thomas Piketty argues for cooperation in tax collection between developed and developing countries, but this is difficult to achieve. Governments of developing countries have a stronger incentive to keep taxes low than do the governments of developed countries. When developed countries decrease and enforce taxes, ceteris paribus, investments into emerging markets increase. The resulting economic growth in rapidly developing countries that tend to have authoritarian regimes strengthens the case for authoritarianism and weakens the case for democracy.
Piketty takes plummeting birthrates and the resulting demographic aging and deceleration in population growth in developed countries for granted, but it may not be the case. Improvements in health conditions may not only increase life expectancy, but also enable older people to stay productive for longer time. Increasing access to health care, improving workforce training, lowering the tax wedge to increase labor market flexibility, and enhancing innovation through research and development can help improve productivity of older workers, according to a study of European productivity by Shekhar Aiyar, Christian Ebeke and Xiaobo Shao, of the International Monetary Fund. Furthermore, advances in in vitro fertilization (IVF) and other technologies that enable giving births artificially may reverse the current plummeting rates. According to the Center for Disease Control and Prevention, between 1 to 2% of U.S. births annually are via IVF. Between 1987 and 2015, about 1 million babies were born in the United States alone through IVF, reports Penn Medicine, a world-renowned academic medical center in Philadelphia. Over half a million babies are born each year using IVF and intracytoplasmic sperm injection (ISCI), another artificial birth technology, reports the European Society of Human Reproduction and Embryology, on Science Daily magazine. Though the chance of a live birth under IVF for women aged under 35 years is only 32.2%, chances of multiple births are higher than when babies are naturally conceived, reports Joseph Nordqvist, of Medical News Today, a website of Healthline Media UK Limited, a leading healthcare publishing company. New technologies may not fully offset the plummeting birth rates, yet their further popularization and advances may slow down the decrease.
Changing family norms and government support, enabling women to both work and take care of their children may help sustain birth and fertility rates. Since the early 2000s, France and Sweden have had one of the highest fertility rates in Europe, which amounted to 1.9 for both countries in 2017, compared to 1.6 in Germany, 1.3 in Italy and Spain, and 1.4 in Poland, reports the World Bank. Fertility rates in France have been on the rise since the late 1990s, reports The Guardian. Table 1 illustrates the female participation rates and birth and fertility rates in selected western countries. Since social norms and welfare benefits make it more acceptable for women in France and the Scandinavian countries to combine work and raising children than it is in more traditionalist societies, such as that of Italy, many more women are willing to give birth. Since the trend towards gender equality is likely to persist, the opportunity to combine work and raising children will enable sustaining or increasing fertility rates in Europe over time.
Country
|
Female participation rate by age, %
|
Birth and fertility rates
| |||
25-34
|
35-44
|
45-54
|
Crude birth rate (per 1,000 people)
|
Fertility rate, births per woman
| |
Denmark
|
78.1
|
84.6
|
84.9
|
11
|
1.8
|
France
|
80.6
|
83.9
|
83.7
|
11
|
1.9
|
Germany
|
79.1
|
82.5
|
85.3
|
10
|
1.6
|
Italy
|
65.1
|
70.3
|
66.2
|
8
|
1.3
|
Japan
|
78.5
|
75.3
|
78.8
|
8
|
1.4
|
Norway
|
81.6
|
85.7
|
82.8
|
11
|
1.7
|
Poland
|
75.5
|
80.9
|
79.9
|
11
|
1.4
|
Spain
|
83.7
|
85.3
|
77.3
|
8
|
1.3
|
Sweden
|
85.4
|
90.5
|
90.4
|
12
|
1.9
|
United Kingdom
|
80.3
|
80.6
|
82.0
|
11
|
1.8
|
United States
|
75.5
|
75.0
|
74.5
|
12
|
1.8
|
Table 1: Female participation rates and fertility rates in selected countries (2017)
Pearson’s correlation coefficients between the fertility rate and the female participation rate for ages 25-34 and 35-44, the age ranges of the mothers when most child births occur, are 0.45 and 0.48, correspondingly. This implies a moderate positive correlation between the female participation rate and the fertility rate. Correlation does not necessitate causality, however, and other factors need to be taken into account in assessing the importance of the female participation rate in making fertility rates high.
Family benefits also make raising children easier. As of 2015, France had the highest total spending on family benefits as a percent of GDP among the OECD countries, amounting to 3.68%, followed by the United Kingdom, at 3.6%, and Sweden, at 3.54%, reports the OECD Family Database. Pressures to increase government spending on family benefits in other countries may increase fertility rates, and birth rates may stabilize or increase. The government revenues to finance the increased spending may come from any source, depending on the country. Taxing capital may be unnecessary for mitigating the effects of 21st century demographic trends.
Relevance of issues for Central Asia
Like other developing countries, Central Asian countries are unlikely to cooperate with developed countries in enforcing a uniform capital tax. Pursuing integration and bound by agreements such as the Eurasian Economic Union, Kyrgyzstan and Kazakhstan may still discriminate in favor of neighboring Russia and China, setting lower taxes and tariffs for their companies than they would for developed countries. Tajikistan and especially Turkmenistan have more closed economies and participate in fewer international organizations. Their governments are more likely to continue to pursue independent policies, rather than sign international agreements. Uzbekistan has been undergoing trade liberalization. The trade openness ratio there increased from 46% in 2017 to 68% in 2018, reports the World Bank. The country is geopolitically neutral, but is likely to enter international agreeements, including an agreement on tax cooperation and enforcement, as it liberalizes its economy. Nevertheless, its current top corporate income tax is only 7.5%, the lowest in Central Asia, reports Heritage Foundation. The government keeps taxes low to attract investors. Since the rule of law remains weak, imposing higher taxes would be a step back in economic liberalization. Table 2 illustrates trade as a percent of GDP and corporate income tax rates in the five Central Asian countries.
Family benefits also make raising children easier. As of 2015, France had the highest total spending on family benefits as a percent of GDP among the OECD countries, amounting to 3.68%, followed by the United Kingdom, at 3.6%, and Sweden, at 3.54%, reports the OECD Family Database. Pressures to increase government spending on family benefits in other countries may increase fertility rates, and birth rates may stabilize or increase. The government revenues to finance the increased spending may come from any source, depending on the country. Taxing capital may be unnecessary for mitigating the effects of 21st century demographic trends.
Relevance of issues for Central Asia
Like other developing countries, Central Asian countries are unlikely to cooperate with developed countries in enforcing a uniform capital tax. Pursuing integration and bound by agreements such as the Eurasian Economic Union, Kyrgyzstan and Kazakhstan may still discriminate in favor of neighboring Russia and China, setting lower taxes and tariffs for their companies than they would for developed countries. Tajikistan and especially Turkmenistan have more closed economies and participate in fewer international organizations. Their governments are more likely to continue to pursue independent policies, rather than sign international agreements. Uzbekistan has been undergoing trade liberalization. The trade openness ratio there increased from 46% in 2017 to 68% in 2018, reports the World Bank. The country is geopolitically neutral, but is likely to enter international agreeements, including an agreement on tax cooperation and enforcement, as it liberalizes its economy. Nevertheless, its current top corporate income tax is only 7.5%, the lowest in Central Asia, reports Heritage Foundation. The government keeps taxes low to attract investors. Since the rule of law remains weak, imposing higher taxes would be a step back in economic liberalization. Table 2 illustrates trade as a percent of GDP and corporate income tax rates in the five Central Asian countries.
Year, for which the Trade Openness Ratio was Measured
|
Trade (Imports Plus Exports) as a Percent of GDP (Trade Openness Ratio), %
|
Corporate Income Tax, % (2019)
| |
Kazakhstan
|
2017
|
61
|
20*
|
Kyrgyzstan
|
2018
|
101
|
10*
|
Tajikistan
|
2017
|
57
|
15*
|
Turkmenistan
|
2018
|
35
|
8*
|
Uzbekistan
|
2018
|
68
|
7.5**
|
** - top corporate income tax rate
Source: The World Bank
Table 2: Trade Openness and Key Income Tax Rates in Central Asian Countries
Conclusion
In his book, Thomas Piketty showed that income inequality in developed countries is likely to increase during the 21st century and proposed international cooperation in progressive taxation as a remedy. Yet this remedy is difficult to attain in practice and some trends that Piketty predicts may not be realized. Nevertheless, I strongly recommend this book for its profound study of growth and inequality trends and factors affecting them.
References
European Society of Human Reproduction and Embryology. More than 8 million babies born from IVF since the first in 1978. Science Daily. https://www.sciencedaily.com/releases/2018/07/180703084127.htm. 2018.
The Guardian. France’s baby boom secret: Get women into work and ditch rigid family norms. https://www.theguardian.com/world/2015/mar/21/france-population-europe-fertility-rate. 2015.
Heritage Foundation. Uzbekistan. https://www.heritage.org/index/country/uzbekistan. 2019.
Nordqvist, J. IVF: What Does It Involve? Medical News Today. https://www.medicalnewstoday.com/articles/262798.php. 2018.
Organization for Economic Cooperation and Development. OECD Family Database. http://www.oecd.org/els/family/database.htm. 2015.
Organization for Economic Cooperation and Development. OECD Labor Force Statistics 2018. https://read.oecd-ilibrary.org/employment/oecd-labour-force-statistics-2018_oecd_lfs-2018-en. 2018.
Penn Medicine. Fertility Blog: IVF by the Numbers. https://www.pennmedicine.org/updates/blogs/fertility-blog/2018/march/ivf-by-the-numbers. 2018.
Schneider, F. Buehn, A. Montenegro, C. Shadow Economies All Over the World: New Estimates for 162 Countries from 1999 to 2007. http://documents.worldbank.org/curated/en/311991468037132740/pdf/WPS5356.pdf. 2010.
The World Bank. Trade (% of GDP). https://data.worldbank.org/indicator/NE.TRD.GNFS.ZS. 2019.
