I found myself backtracking after working through Piketty’s discussion of inequality of labor income. That’s because there’s data that works against his main thesis that, because r>g, capital becomes ever more important than labor.

He observes the rise in income inequality in America and then reports: 

What primarily characterizes the United States at the moment is a record level of inequality of income from labor (probably higher than in any other society at any time in the past, anywhere in the world, including societies in which skill disparities were extremely large) together with a level of inequality of wealth less extreme than levels observed in traditional societies or in Europe in the period 1900-1910.

In other words, being really rich in America today is largely a function of being paid a very large salary, not a function of having a large investment portfolio. As Piketty puts is, we’re in a “super manager” and not a rentier era.

This is not what his “laws of capitalism” predict. It should be capital’s predominance and not highly paid labor that drives inequality. And so he wonders how highly paid labor can command so much income.

He gives reasonable answers. One involves the observation that top managers tend to be on boards that set salaries for other top managers. In other words, there’s rent-seeking behavior among elites when it comes to their salaries—not at all implausible. Another points to cultural trends that have created a cult of the super manager and entrepreneur—Steve Jobs, for example. This is also undoubtedly a factor.

But the difference between the old inequality of the Gilded Age—one based on the very large capital/income ratio (meaning that owners got the lion’s share of national income)—and our new inequality based in earned income is quite extreme. This suggests something at work that’s much more powerful than the usual rent-seeking that characterizes clubby elites or the cult of the super manager.

One explanation is in the data Piketty presents earlier in the book. The rate of return on capital has been trending down over the last few decades and is presently at a historic low. (He has charts for Britain and France on page 202.) This downward trend is surely very disturbing for owners of capital.

We see this in the present “stretch for yield.” Wealthy individuals living on investments, pension funds, insurance companies, and other entities that depend on reliable returns on capital are very anxious in our low interest environment. Like a character from a Jane Austen novel, they made plans counting on five percent, but the present investment climate only returns four—thus throwing a wrench into their assumptions about what’s needed to sustain their business plans. And so they add risk in order to sustain higher returns.

In this climate of declining returns, one can imagine that capital (if you’ll permit me the personification) will become very eager for the services of anyone who can promise higher returns. That’s true even if, for the most part, the promises aren’t reliable. (Think of cancer patients who opt for untested drugs in the hope of finding a cure.)

In other words, during periods of declining returns on capital we should expect increasing competition for “super managers” whom corporate boards (rightly or wrongly) believe capable of somehow beating the average. Therefore (and contrary to the general thrust of Piketty’s book), it’s the vulnerability of capital—its fear of falling rates of return (and inflation, which amounts to the same thing)—and not its triumph that may be the major cause of income inequality in America.

Articles by R. R. Reno


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