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Going Long

All the Things Thomas Pikkety Got Wrong

The author of Capital in the Twenty-First Century has a flawed view of capitalism.

Thomas Piketty’s book Capital in the Twenty-First Century, which examines the long-term changes in the distribution of income, has become an unexpected best seller in the U.S. Piketty concludes that the rich have become wealthier at the expense of the poor, and he claims that basic forces in a capitalist economy are the cause. He advocates a global “wealth tax” to redress the inequalities that he asserts undermine all democracies.

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There has been much criticism of Piketty’s data. But what most disturbs me are the weak and fallacious assumptions that form the foundation of his analysis.

The “fundamental laws of capitalism” that he describes in the first and fifth chapters are cases in point. Fundamental laws are important principles that govern the natural world, such as the laws of motion and gravity described by Isaac Newton. But Piketty’s laws provide no such revelations.

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For example, his first fundamental law is expressed as an equation which states that the share of national income that’s derived from capital—such as stocks, bonds and real estate—is equal to the rate of return on capital times capital divided by income. But that equation is not a fundamental law at all! It is a definition that holds for all countries at all times. Piketty actually admits as much, but nonetheless considers a definition critical to understanding the dynamic forces of capitalism.

The same can be said of his second fundamental law, which relates the amount of capital to the level of saving where there is a constant ratio of capital to income. I fail to see what, if anything, either of these two “laws” says about the distribution of income. Most distressingly, neither law has anything to do with capitalism. Capitalism is an economic and political system in which a country’s trade and industry are controlled by private owners who seek profit. But Piketty’s equations apply whether the economy is capitalist, socialist, communist or fascist. His equations are based on definitions of capital, output and growth that are true in all economies and have nothing at all to do with capitalism.

Questionable framework. Equally disturbing is Piketty’s identification of the “fundamental force” that causes the widening of income distribution. He claims that inequality is rising because the rate of return on capital is greater than the growth rate of the economy. When the return on capital exceeds growth, he says, then “it logically follows that inherited wealth grows faster than output or income.”

But this statement is absolutely wrong. Wealth grows faster than income only if investors consume little or none of their return on capital, and that is contradicted by historical data. When I wrote the first edition of Stocks for the Long Run in 1994, I determined that the average real long-term return on stocks was 6.7% per year, more than twice the real growth of the economy. But that doesn’t mean that the value of stocks grows faster than output; after all, investors consume part of the dividends and capital gains they receive. In fact, substantial evidence shows that the value of stocks (and other capital) grows over time at about the same rate as the real economy.

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In his “laws,” Piketty assumes that the ratio of capital to income remains constant. If that’s the case, then investors whose wealth rises relative to income are balanced by those whose wealth falls. He ignores the many fortunes that are dissipated by the profligate spending of heirs and the large sums that are given away to charity.

Piketty’s conceptual framework is so flawed that we should have little confidence in his sweeping conclusions. The distribution of wealth is indeed a valid subject for study. But Capital in the Twenty-First Century does nothing to advance our understanding of income inequality.

Columnist Jeremy J. Siegel is a professor at the University of Pennsylvania’s Wharton School and the author of Stocks for the Long Run and The Future for Investors.