Thomas Piketty, inequality, demand and growth


Thomas Piketty

The work of economist Thomas Piketty, in particular his Capital in the Twenty-First Century, painstakingly documents the changing evolution of inequalities in income and wealth since the 18th century. The part of the book that has received a great deal of attention focusses on rising inequality since the mid-1970s in industrial countries.

Piketty argues that r, the rate of return on capital, broadly defined, has in recent decades been greater than g, the rate of growth of income. This has resulted in rising inequality and accompanied slow growth as the accumulation of wealth by the richest percentiles has grown faster than income, especially from wages, among poorer groups. This is likely to continue, contends Piketty, leading to political instability and the undermining of democracy, unless far more progressive tax rates are implemented. He admits that this is unlikely, given current political realities.

It is not the purpose of this entry to contest Piketty’s theory; instead, I wish to outline the possible impact on economic growth of the widening inequality he describes.

If growth is constrained by demand rather than supply then, in post-Keynesian theory, differences in the propensity to spend between different social classes, such as rentiers, capitalists and workers, can affect growth in both the short and the long run.

If, as Piketty claims, wealth becomes increasingly concentrated in the hands of a small elite, then the growth outcomes will be affected by their marginal propensity to consume (MPC) as a class, compared with the MPC of other classes. If growth is constrained by saving, there is a greater potential for a rising concentration of wealth to support growth if an increase in income for richest tends to be saved, and these funds are channelled into investment by the financial system. However unless the economy is at full employment, an attempt to save more will reduce consumption levels and provide less impetus for firms to invest in new capacity. As the economy tends to operate at less than full employment, this ‘over-saving’ will reduce demand, output and employment.

It is likely that the MPC of the wealthy is lower than that of poorer groups, so that rising inequality has a negative impact on growth unless the latter are able to maintain consumption growth through a rise in debt. Many economists have argued that this was a characteristic of a number of economies in the run-up to the Global Financial Crisis in 2008.

If some of the wealthiest individuals set up new firms and become successful entrepreneurs then this could lead to some increase in investment and job creation. However this kind of process does not necessitate rising inequality in a capitalist economy with a well-functioning financial system. The latter should be able to fund investment into new ventures by individuals from any social group. It is difficult to argue that the rise of a plutocracy is necessary for flourishing entrepreneurship.

If the MPC of the wealthy is the same as that of workers, rising inequality will change the composition of consumption as it shifts more towards an increased demand for luxury goods. The affect of this on growth is debatable. Right wing and libertarian thinkers tend to see no problem with ever-rising inequality, claiming that is simply an outcome of freedom of choice and successful wealth-creation. How this can be squared with the periodic debt-fuelled rises in asset prices is difficult to countenance. These have created and favoured an elite social group with considerable political power, less through individual effort and more via macroeconomic forces and policy choices across the developed world. This is not to deny that those employed in finance often work long hours in stressful roles, more to emphasise that financial innovation and expansion have permitted and encouraged an unsustainable rise in private debt levels. It is the latter which has sustained the growing profits of the financial sector and contributed to much increased inequality. The economic effects of the reduction of this debt will necessarily fall unevenly on particular social groups, with some losing much more than others. That this has not been widely discussed in the political arena may be a testament to the scale of the changes in wealth and income required. But there are choices involved and a debate to be had.

Returning to the main theme of this post: rising inequality of income and wealth could lead to slower rates of growth if it constrains rising consumption among the majority and reduces the resultant growth of investment. Some economists have argued that this is the story of recent decades, papered over for a limited time by unsustainable increases in private debt.

It is foolish to claim that capitalism is always just and fair; rather it remains the best system yet discovered for increasing material wealth and the social changes that this can provoke. But if the unequal distribution of its fruits remains on an ever-rising trend, and income growth for most of us stagnates, history tells us that this may well lead to political and social unrest and disaffection with established elites. This is already happening, as can be seen by the rise of support for parties and figures previously on the fringes of the left or right in Europe and the US. At least some of Piketty’s theses may therefore be correct.


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