
French economist Thomas Piketty, whose book Capital in the 21st Century, has turned around the debate on income inequality, talks to Sourabh Gupta. Edited excerpts:
Thomas Piketty is probably the most talked about economist on the planet right now and his book on income inequality, 'Capital in the 21st Century' (Harvard University Press), has led to fierce debates and discussions. In the book, the 43-year-old professor from the Paris School of Economics, using nearly 200 years of income data culled from historical tax records of over 20 countries, shows that income inequality increases in the long run, dismantling the standard Simon Kuznets' curve that claimed income inequality, after rising, will fall in a capitalist economy.
Piketty says this happens when the rate of return on capital exceeds the rate of growth of an economy, as is happening in developed countries now, where inequality, after falling for the past few decades, is peaking again. He also offers a corrective measure - progressive taxation on wealth - triggering a big controversy.
In an email interview with Business Today, Piketty says this phase of extreme inequality will also come to India in some time as growth rate diminishes, making return on capital, most of it inherited, higher. But the focus right now should be on education and investment in skills.
Q. Your work questions the popular Kuznets curve about reduction of inequality in the long run. Does it mean the 'trickle-down theory' does not work?
A. Sometime it does, sometime not. When Simon Kuznets first proposed his theory in the 1950s, he had reliable income inequality series for only one country, the United States, over a 35 year-period (1913-1948). He observed a reduction in inequality, but this was largely due to particular circumstances and policies. With the help of many scholars, we have been able to collect a unique set of data covering two centuries and over 20 countries. This is by far the most extensive database available in regard to the historical evolution of income and wealth. This book proposes an interpretative synthesis based upon this collective data collection project. The main objective is to understand when it is that "trickle-down" works and when it does not work.
Q. Can you elaborate on some of the expressions in your book such as the "past devouring the future" and the concept of "forces of convergence and forces of divergence"?
A. History tells us that there are powerful forces going in both directions: convergence (reduction in inequality) and divergence (amplification of inequality). Which one will prevail depends on the institutions and policies that we will collectively adopt. Historically, the main equalizing force - both between and within countries - has been the diffusion of knowledge and skills. However, this virtuous process cannot work properly without inclusive educational institutions and continuous investment in skills. This is a major challenge for all countries in the century underway.
In the very long run, one powerful force pushing in the direction of rising inequality is the tendency of the rate of return to capital r to exceed the rate of output growth g. That is, when r exceeds g, as it did in the 19th century and seems quite likely to do again in the 21st, initial wealth inequalities tend to amplify and to converge towards extreme levels. The top few percents of the wealth hierarchy tend to appropriate a very large share of national wealth, at the expense of the middle and lower classes. This is what happened in the past, and this could well happen again in the future.
Q. There has been criticism that you have not linked the rate of return on capital (r) to political dynamics. Is there such a link? Is there any other way to reduce inequality than progressive taxation?
A. The rate of return on capital is definitely influenced by political conflict and the changing bargaining power of capital owners and workers. So labour market institutions, unions, minimum wages, etc., can and should definitely play an important role. But they are not sufficient and need to be supplemented by massive investment in skills and by progressive taxation of income and wealth. We don't need to choose between these different institutions and policy responses. They are complementary to one another, not substitutes.
Q. Can you tell us more about the inequality pattern you saw in Indian data? Is r>g in India too?
A. The historical data that we have put together with Abhijit Banerjee suggests that top income shares in India have risen substantially in India in the 1990s-2000s, and might not be back to pre-Independence levels. I should say however that access to reliable fiscal data has been extremely difficult in India, particularly for the recent period. This is sad, because self-reported survey data is not sufficient and needs to be supplemented by administrative income tax data if we want to have a better understanding of the social distribution of growth.
Regarding the mechanisms behind inequality dynamics, I do not think that r > g is the main issue in India right now. Education and investment in skills are more important.
However, growth rates will diminish at some point in emerging economies, and then, the r>g mechanism will become as relevant as it is now for developed economies.
In any case, it is important for the proper working of democracy to have more transparency about how the different income and wealth groups are doing.
Progressive income and wealth taxes are an instrument for producing knowledge about how our societies are changing.
Q. You say economics should not be seen as a deterministic science with lot of maths but as a study of political economy, which borrows from social science and history. Why?
A. Maths and theoretical models can be useful, at the condition that they actually serve to explain a vast quantity of data and historical facts. The problem is that economists too often do the opposite. They use waste quantities of maths to explain very little data, or sometime no data at all.
In this book, I am trying to put the distributional question and the study of long-run trends back at the heart of economic analysis.
Follow the author at @sourabhgupta00