Thomas Piketty’s Capital in the Twenty-First Century
Piketty relies on the fact that there was tremendous stability in both prices and interest rates during the 18th and 19th centuries:
In the novels of Jane Austen and Honoré de Balzac, the fact that land (like government bonds) yields roughly 5 percent of the amount of capital invested (or, equivalently, that the value of capital corresponds to roughly twenty years of annual rent) is so taken for granted that it often goes unmentioned
the two measuring scales were used interchangeably, as if rent and capital were synonymous, or perfect equivalents in two different languages. Now, at the beginning of the twenty-first century, we find roughly the same return on real estate, 4–5 percent, sometimes a little less, especially where prices have risen rapidly without dragging rents upward at the same rate.
To back up a bit: the first crucial fact to bear in mind is that inflation is largely a twentieth-century phenomenon. Before that, up to World War I, inflation was zero or close to it. Prices sometimes rose or fell sharply for a period of several years or even decades, but these price movements generally balanced out in the end.
More precisely, if we look at average price increases over the periods 1700–1820 and 1820–1913, we find that inflation was insignificant in France, Britain, the United States, and Germany: at most 0.2–0.3 percent per year. We even find periods of slightly negative price movements: for example, Britain and the United States in the nineteenth century (−0.2 percent per year if we average the two cases between 1820 and 1913).
Piketty is therefore able to look at hard-coded numbers in novels for guidance as to what an average and comfortable standard of living would cost.
In Great Britain, the average income was on the order of 30 pounds a year in the early 1800s, when Jane Austen wrote her novels.30 The same average income could have been observed in 1720 or 1770. Hence these were very stable reference points, with which Austen had grown up. She knew that to live comfortably and elegantly, secure proper transportation and clothing, eat well, and find amusement and a necessary minimum of domestic servants, one needed—by her lights—at least twenty to thirty times that much. The characters in her novels consider themselves free from need only if they dispose of incomes of 500 to 1,000 pounds a year.
Balzac, like Austen, described a world in which it took twenty to thirty times that much to live decently
Let’s consider today’s numbers and see if things are more or less equal. The Census Bureau says that median household income is about $53,000 per year. What would it mean to live comfortably and elegantly today? A modern Hyundai is much more comfortable than a horse-drawn carriage. A JetBlue Airbus with extra room seats is certainly better than enduring a sea voyage by sail. Amusement in our major cities could cost $500 to $1000 per week for people who want to go to professional sporting events, live theater, etc. Domestic servants have mostly been replaced by contractors, e.g., the housecleaners who come once per week or the people who deliver food from restaurants for those who don’t want to cook. Could we say that a family with two medical doctors earning a total of $400,000 per year was “comfortable and elegant”? If so, that’s a pre-tax ratio of 8:1 and a post-tax ratio of perhaps 6:1? Thus income inequality today is less than it was in Austen/Balzac’s time.
[Separately, of course, Austen’s upper class characters did not work so they had a lot more time to spend money and maybe that’s why they needed 20-30X the average income.]
[The preface might make you wonder why we have inflation today if we didn’t have it for most of human history. Piketty explains:
This world collapsed for good with World War I. To pay for this war of extraordinary violence and intensity, to pay for soldiers and for the ever more costly and sophisticated weapons they used, governments went deeply into debt. As early as August 1914, the principal belligerents ended the convertibility of their currency into gold. After the war, all countries resorted to one degree or another to the printing press to deal with their enormous public debts.
Between 1913 and 1950, inflation in France exceeded 13 percent per year (so that prices rose by a factor of 100), and inflation in Germany was 17 percent per year (so that prices rose by a factor of more than 300). In Britain and the United States, which suffered less damage and less political destabilization from the two wars, the rate of inflation was significantly lower: barely 3 percent per year in the period 1913–1950. Yet this still means that prices were multiplied by three, following two centuries in which prices had barely moved at all.
In addition to the question of relative prices, I will show that inflation per se—that is, a generalized increase of all prices—can also play a fundamental role in the dynamics of the wealth distribution. Indeed, it was essentially inflation that allowed the wealthy countries to get rid of the public debt they owed at the end of World War II. Inflation also led to various redistributions among social groups over the course of the twentieth century, often in a chaotic, uncontrolled manner. Conversely, the wealth-based society that flourished in the eighteenth and nineteenth centuries was inextricably linked to the very stable monetary conditions that persisted over this very long period.
]
What do readers think? Does a family today still need 20-30X the median income of $53,000 per year in order to be “comfortable and elegant”?
I’d suggest that anybody these days measuring their financial position primarily in terms of income probably hasn’t gotten to the same status as the people Austen was writing about. At least, not if they are having to work a job or run a business to get it. In order to have a “comfortable and elegant” life, you need to not be chained to a desk 40+ hours a week. At least, that’s my perspective as a modern day salaryperson. So, I’d think of it more in terms of “how much accumulated wealth does somebody need in order to not have to work but still afford the kind of lifestyle that the median income gained from working provides.”
I agree with Alex – and I think that you’re changing the frame of reference if you let Austen’s contemporaries be people of leisure while expecting their modern counterparts to be 80 hour per week doctors.
> In order to have a “comfortable and elegant” life, you need to not be chained to a desk 40+ hours a week
Exactly.
The original post does acknowledge that the upper class in Austen’s time did not have to work. It also acknowledges that today’s lower-middle income families can probably afford to travel once a year by airplane (assuming they can get the time off work!), something not even possible for the wealthiest of the wealthy in Austen’s time. Defining “comfortable and elegant” is kind of like trying to define what a “living wage” is. It’s going to be different for every individual. I would personally rather have my current income level and not have to work than have 50x my current income but no free time to spend it in. I think. (It’s easy to make that choice when I know neither option is realistic!)
Going along with the original spirit of the question: I would say, and I’m maybe not alone in this, that the modern day equivalent of the comfortable and elegant lifestyle for a family would be:
1) Only one parent has to work, leaving the other parent free to concentrate on childrearing (alternatively, both parents work but can afford a full-time nanny/au pair)
2) A spacious house/townhouse/apartment, either newly built or renovated, in a desirable neighborhood of a major metropolitan area close to the primary income-earner’s job, so likely restricted to a few very expensive neighborhoods.
3) The ability to afford private schools, private tutors and, eventually, full fare tuition at an Ivy League or other top American university.
4) Two (5 or fewer years old) luxury vehicles (obviously YMMV on this but it seems people in this class aren’t happy with anything other than a BMW/Merc/Audi/Lexus/Cadillac)
5) A second home at a vacation spot and/or multiple overseas or prime domestic location vacations per year, over and above any obligatory family visit travels
6) Domestic help
20x of 50,000 would be around $1 mil a year, which is probably the bare minimum required to sustain all that, so yeah, 20-30x is probably still accurate.
Alex: Where do I sign up for this lifestyle? It sounds wonderful! 🙂
[Living in not-very-spacious apartment, both parents working, sharing 7-year-old car, etc.]
So I guess instead of “two doctors” we need to posit “one fertility doctor and one radiologist working part-time”….
I’d sign up for said lifestyle too, except I’m single and neither have nor want children, which simplifies things considerably. I’m probably not really qualified to know what your average family these days would consider “comfortable and elegant”.
On a side note, most people with kids or plans to have kids that I am aware of compromise on these things by choosing a spacious modern house in a suburban hellhole, with public schools they find acceptable at least, that they have to spend 2-3 hours a day commuting to and from. I’ve started to wonder why more people don’t think it would be better for their kids to have them around more, (less commute time would mean more time actually spent playing with/interacting with their kids, and they’d probably be in a better mood to boot!) even if that meant they didn’t have a big backyard and were in urban public schools.
I’d like to posit that perhaps the idea of wealth, is to have 20 – 30 times what others have. It isn’t about things, but about status. I would suggest that this hasn’t really changed and may perhaps be fundamental to the human condition.
When given the choice between me getting $5,000 and my neighbor getting 0 or Me Getting $10,000 and my neighbor getting $20,000. Most will take the $5,000. IT turns out that all wealth is relative. If anything TV and modern culture have provided false expectations about what other people have, so we all feel poorer in the end.
I don’t think real wealth has anything to do with BMW’s, college education, second homes, or one parent working. At one point in history wealth had to do with tulips. Many people sold productive capital assets to buy tulips. To be wealthy is to have more than most people. If anything modern culture has turned that around a bit where even the wealthy don’t feel wealthy because there is always someone with more. If not, wait until Barron’s comes out next year, it is likely you will no longer be #1.
It is also well established that the correlation between money and happiness dies pretty quickly once you have enough to pay your basic expenses and have a bit of choice for a couple of luxuries.
To Phil’s other point. Inflation, on the macro scale, is simply changing the labels on the Y Axis. Sure in the micro, there are winners and losers, but the wealthy, are wealthy because they figured out how to stay in the winners column. Yes, the world collapsed at the end of World War I, and a new system was put in place at the end of World War II. In the new system, the wealthy are less likely to stay that way. Why? because of inflation. Inflation encourages those who do over those who have. If there is no inflation, it is much easier to live off of what you have done, or someone else has done that you are the beneficiary of.
The other interesting thing about what Phil said, is that there was little overall inflation, but that isn’t to say that there was no inflation. There was, it was just counterbalanced by deflation. We’ve actually had significantly more stability since world war II, we have inflation yes, which hurts savers, but we’ve also had stability, i.e. the amplitude of the business cycle is less.
Nowadays in rich countries there are many goods that are provided by the government, public schools, museums, health… Those goods are very valuable. A very rich Bolivian can have an income in the millions, but he still has to drive his Ferrari on the crappy roads of Bolivia and seek care for emergencies in a crappy Bolivian hospital. I think the main “gap” in this society is not income but education (it is hard to enjoy a good book if you are functionally illiterate). Most of the good things in life are not that expensive. Like my grandfather used to say “besides chicken, what do rich people eat?”
And there are many things that money cannot buy (as the last posting of Philip points out…)
“Does a family today still need 20-30X the median income of $53,000 per year in order to be “comfortable and elegant”?”
I guess you don’t know how Class system works to asking such a question.
1800s, Yale ranked its students according to the family’s wealth.
With the raising of Inequality question. a lot of wealthy people
are all of sudden concerned about charity.
CNBC showed Eli Manning at a brokerage raising money for some
god forsaken cause. Silicon Valley all of sudden is concerned about
low income housing so giving to charity as tokenism.
1. No low-income housing built in US by government since 1980. All shifted to Charity.
2. 50,000 government run food pantry in 1980. Today it is 500. All shifter to Charity.
3. Price of fresh food and vegetables up 40% since 1980.
4. Price of processed food down 40% since 1980.
5. Obesity rose 40% since 1980.
innocuous: http://www.heritage.org/research/reports/2010/06/confronting-the-unsustainable-growth-of-welfare-entitlements-principles-of-reform-and-the-next-steps has a chart of total federal and state government Welfare spending from 1950 through 2008, in inflation-adjusted 2008 dollars.
Chart 5 in the article shows USDA food stamp/SNAP spending having grown from about $10 billion in 1980 to $54 billion in 2010. It isn’t clear if the data are in nominal or constant dollars. The chart references http://www.fns.usda.gov/sites/default/files/pd/SNAPsummary.pdf , which shows that the 2013 cost is actually up to $80 billion. If we assume that these are nominal dollar amounts, using the BLS’s CPI calculator, we find that the $9.2 billion figure from the USDA PDF would have been worth about $26 billion in 2013, so spending in constant dollars has roughly tripled.
(Though of course this does not necessarily mean that food is more affordable to people receiving food stamps, since the USDA simultaneously has a lot of programs designed to increase the income of farmers by restricting competition in agriculture.)
Wealth and financial independence are not the same thing. Someone frugal will need less wealth to sustain his lifestyle without working than someone with expensive tastes. That said, yields are also much more variable nowadays, and most investors would kill to get 5% aafter-inflation yields today when those would have been considered inadequate ten years ago.
Living elegantly should be considered in relative terms, since that reflects a deep-seated human need to fit within a pecking order. If we say “living elegantly” means living at the threshold of the 1%. I believe it’s about $350K (before taxes) today. Since dividends are less taxed than regular income, let’s say about $250K to $300K. At 5% yields, $6M in wealth would suffice. At 1% (the new normal), you’d need $30M.
As for Piketty, he is one of the key advisers to French President François Hollande, whose predictably disastrous economic policies discredit their source. As a Frenchman who lives in the US, I experience the same feeling of incredulity when I see Americans, specially academics, fawning over charlatans like Derrida or Piketty, as Americans feel when French intellectuals rave about Jerry Lewis.
Fazal Majid: I have read Piketty’s “Capital” and I think he makes some interesting points. In what concerns Jacques Derrida I have only read “De l’esprit” (I don’t know the title in English, I’m one of those guys who because circumstances of life speaks several languages with a heavy accent and less-than-perfect grammar). I don’t think either author is a “charlatan.” I’m really curious, why do you think Piketty and Derrida fall into that category?
By the way, I believe most Americans (including “academics”) don’t know who Derrida is and only a few have read him. Which is quite alright. I myself have not read many great authors.
It seems to me quite obvious that everyone (especially the poor) are much better off now than in Austen’s time, and that inequality has decreased substantially since then as well. Does Piketty say otherwise? I understood (from commentary; have not ready myself) Piketty’s point was that inequality has started increasing again since the 1980s due to tremendous income growth at the top (I understood that the highest income groups have captured virtually all of the income gains since that time). Is this understanding wrong?
philg: Hopefully that increase in food stamp spending did some good for the recipients, but it certainly wouldn’t do much to address growing inequality. A 45 billion dollar nominal increase in spending is minuscule compared with the 12 trillion dollar growth in nominal gdp over the same time period.
Assuming that a pound then still corresponded to a pound of silver ($312 at today’s rate), an Austen minimum income would correspond to 150-300 thousand dollars. Post-tax, I presume.
Anonymous: yes, that’s correct. Piketty describes inequality as dropping dramatically in the aftermath of World Wars I and II, and then rising again more recently as economic growth has slowed. He suggests that as inequality continues to rise, we may return to the situation described by the character Vautrin in Balzac’s Pere Goriot, where obtaining a fortune through inheritance or marriage — or a paternity suit, as Philip would no doubt point out — may become more lucrative than all but the most successful careers.
Piketty spends some time describing increasing inequality in labor income at the very top (in particular, soaring executive pay, which Philip has commented on before). Figure 8.5 shows that in the US, the share of total pre-tax national income received by the top 10% rose from less than 35% in the 1970s to nearly 50% in the 2000s and 2010s. Figure 8.6 shows that the top 1% received most of the increase.
But he spends considerably more time discussing the implications of slowing economic growth. If the average return on capital (from interest, rents, dividends, capital appreciation, etc.) is 4 or 5%, while the growth of the overall economy is only 1-2%, then capital will become more and more concentrated. Table 7.2 shows that even in egalitarian Scandinavia in the 1970s and 1980s, the top 10% owned 50% of total national capital; that rises to 70% in the US today. (In prewar Europe, the figure was 80-90%, so we’re not there yet.)
If I inherit a billion dollars, I don’t need any particular business talent to keep it growing: I just put half in a broad stock market index fund and half in bonds. If I can get 4-5%, that’s 40-50 million dollars a year. If I save most of the growth, then in 30 years (one generation) it should double twice, to about four billion dollars. Pass along to my 1-4 children, repeat. At the top, this starts to look a lot like an aristocratic society.
Here in Canada, where we don’t have the history of revolutionary egalitarianism of the US or France, and where the influence of money in politics is limited, my guess is that we would just shrug and use progressive taxes to redistribute the income from capital, rather than trying to redistribute the capital itself.