What Thomas Piketty Gets Wrong About Capitalism

The French economist and his admirers perform an intellectual sleight of hand.


It's hardly a mystery why Thomas Piketty's Capital in the 21st Century has generated so much intellectual excitement here in the United States. The subject of the book, economic inequality, has become in recent years a major fault line in American ideological and partisan conflict. President Barack Obama, for his part, has called it "the defining challenge of our time."

And now, in the grand tradition of Frenchmen who explain us to ourselves, along comes Professor Piketty with a magisterial work whose painstaking empirical rigor is matched only by its vaulting theoretical ambition. Peering into centuries of income and wealth data for countries around the world, Piketty has found what he believes to be a fundamental law of capitalism: r > g.

There is an inherent tendency, he argues, for the return on capital (r) to exceed the rate of economic growth (g). As a result, the ratio of wealth to incomes rises over time with baleful consequences for the distribution of income and opportunity. The shape of things to come, Piketty warns, is a "patrimonial capitalism" in which the inherited wealth of an entrenched plutocracy dominates economic, social, and political life. An admiring Paul Krugman, writing in The New York Review of Books, proclaims that Piketty's bold thesis "amounts to a unified field theory of inequality."

Ah, but there's a catch—and Krugman, to his credit, spots it. In what Krugman calls "a sort of intellectual sleight of hand," Piketty offers an explanation for the rise of U.S. income inequality that is quite distinct from the purported relationship between r and g. "The main reason there has been a hankering for a book like this is the rise, not just of the one percent, but specifically of the American one percent," Krugman writes. "Yet that rise, it turns out, has happened for reasons that lie beyond the scope of Piketty's grand thesis."

So what has been driving the growing spread in U.S. incomes? According to Piketty, the main story has been, not the relentless accumulation of capital, but the vertiginous rise of labor incomes at the very top of the pay scale. Indeed, U.S. income trends over the past generation appear "fractal" in nature—that is, the same pattern repeats itself at progressively smaller scales. Thus, compare the top 10 percent of American earners to the other 90 percent and you'll see the high earners pulling away from the pack: Piketty's data show that their share of total income rose from below 35 percent in the 1970s to nearly 50 percent in the past decade.

But you'll see the same thing if you drill down an order of magnitude and focus just on the top decile, only this time it's the top 1 percent of earners pulling away from the rest of the top tenth. Drill down once more by comparing the top 0.1 percent of earners to the rest of the top centile and you'll see the same thing again. "Of the 15 additional points of national income going to the top decile," Piketty writes, "around 11 points, or nearly three-quarters of the total, went to 'the 1 percent' (those making more than $352,000 a year in 2010), of which roughly half went to 'the top 0.1 percent' (those making more than $1.5 million a year)."

Although the brilliance of Piketty's empirical work is widely acknowledged, its ultimate accuracy is not beyond dispute. In particular, Cornell economist Richard Burkhauser has used a different but plausible methodology to measure incomes and finds no rise in inequality since the 1980s. (Scott Winship of the Manhattan Institute offers a useful comparison of Piketty and Burkhauser's methodologies and results here.)

But for present purposes, let's assume Piketty's numbers are right. And if they are, then all the Sturm und Drang over rising U.S. income inequality boils down to a complaint about trends at the very tippy top of the income scale—those 150,000 or so top earners who, in any given year, comprise the top 0.1 percent. (Of course there is considerable turnover in that group from year to year, and thus the specific members of the club change over time.)

Who are these people? Piketty relies on the analysis in a 2012 working paper by Jon Bakija of Williams College, Adam Cole of the U.S. Treasury Department, and Bradley Heim of Indiana University. According to their work, roughly 60 percent of the top 0.1 percent are executives, managers, and financial professionals (41 percent in non-finance, 19 percent in finance). Lawyers, doctors, and real estate developers make up another 15 percent or so, while media and sports stars constitute under 4 percent. Piketty surveys these data and concludes that "the new US inequality has much more to do with the advent of 'supermanagers' than with that of 'superstars.'"

Here then is the crux of the matter, according to Piketty: "This spectacular increase in inequality largely reflects an unprecedented explosion of very elevated incomes from labor, a veritable separation of the top managers of large firms from the rest of the population." And indeed, executive compensation has skyrocketed in recent decades: according to one measure, average compensation for CEOs has risen (in inflation-adjusted constant dollars) from about $1.1 million in 1970 to $10.9 million in 2011 (down from a peak of $18.2 million in 2000). Although the escalation in CEO pay is probably the most dramatic, other senior corporate executives have also experienced whopping increases in remuneration.

What accounts this phenomenon? Piketty says there are two alternatives. One, which fairly reeks of moldy straw, is that "the skills and productivity of these top managers suddenly rose in relation to those of other workers." The other, favored by Piketty, is that "these top managers by and large have the power to set their own remuneration." "It may be excessive to accuse senior executives of having their 'hands in the till,'" Piketty writes, "but the metaphor is probably more apt than Adam Smith's metaphor of the market's 'invisible hand.'"

For Piketty, the only plausible explanation for skyrocketing executive pay is self-dealing: managers are taking advantage of weak corporate governance to benefit themselves at the expense of shareholders. This is certainly a popular view, and it has its scholarly defenders—most notably, Lucian Bebchuk and Jesse Fried at Harvard Law School. But there is one rather glaring problem with the theory: by all accounts corporate governance has improved considerably in recent decades, just as CEO pay has gone through the roof. Consequently, "none of the evidence that we have found suggests that the ability of executives to set their own pay can explain the dramatic increase in compensation over the century"—so conclude Carola Frydman of MIT and Raven Saks of the U.S. Federal Reserve in a 2010 paper that surveys trends in CEO compensation since the 1930s.

If abuse of managerial power isn't the answer, what is? The vexing fact of the matter is that nobody really knows: the long-term trends in executive compensation defy easy explanation. Increases in firm size, greater reliance on equity-based pay to better align managers' incentives with the interests of shareholders, the great bull market of 1983-2000, more intense competition for top talent as reliance on promotion from within the firm has lessened, the stimulus provided by lower income tax rates to bidding wars for top talent, adjustments for risk as executives' tenure has grown less secure, changing cultural norms about both loyalty to one's employer and the seemliness of huge pay packages, government interventions relating to compensation and their often unintended consequences—all these factors and others besides have likely played a role in the story.

In the bigger picture, there doesn't seem to be anything especially distinctive about corporate executives compared to other members of the top 0.1 percent. Top lawyers and surgeons, hedge fund managers, venture capitalists, media and sports stars—all have seen comparable increases in pay.

This isn't to say that executive compensation isn't problematic. There is no obvious way to tell in advance what corporate managers are really worth, nor is there any perfect compensation structure that optimizes the incentives that executives face. Meanwhile, the stakes are large: Product market competition may provide the ultimate discipline for wayward managers; but well-designed compensation systems hold out the promise of avoiding waste on a colossal scale.

Although solving, or at least not botching, the riddle of executive compensation is important, it is nonetheless a fairly narrow and technical issue. We're talking about figuring out the appropriate level and structure of remuneration for about 100,000 positions in a 140 million-worker economy.

This is the real sleight of hand in Piketty's magnum opus: call it the incredible shrinking inequality problem. Krugman, while noting that Piketty departs from his profundities about r and g to explain U.S. inequality, treats that departure as simply inelegant—a bit of necessary ad hockery to make sense of a messy world. But the way I see it, the contrast between Piketty's main theoretical edifice and the little outbuilding he constructs to account for the United States is of much greater significance.

I call it a bait and switch—perpetrated not by the author on his audience, but by his most admiring readers on themselves. Piketty is being celebrated for supposedly demonstrating that the deep structures of capitalism tend toward ever-greater inequality. But in the United States—the most unequal of all the advanced economies—the main explanation offered for the growing gap between rich and poor is that 100,000 or so corporate managers are being overpaid. What's getting all the attention is Piketty's depiction of rising inequality as the tragic flaw at the heart of the entire capitalist economic system. But what's really going on, at least according to Piketty, is a comparatively narrow and shallow problem of corporate governance.

Getting CEO pay right is surely a challenge, but does anybody on earth think it is the defining challenge of our time?

NEXT: Panic Through the Ages

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  1. Does anyone have data on the ratios of C-level compensation to company revenue and to profitability?

    1. I’m still waiting for data on the number of police officers killed or severely maimed by dogs in the previous ten-year period.

    2. 97% of economists agree that C-levels are supposed to rise dramatically over the next 100 years.

      1. +1 Consensus

  2. a magisterial work whose painstaking empirical rigor is matched only by its vaulting theoretical ambition

    Sorry, what? Imma have a lot more to say about this article, if comments work that is, but what about the bizarro madeup data about minimum wage increases? Has the takedown been refuted? If so I’m not aware of that.

  3. What Thomas Piketty Gets Wrong About Capitalism


    1. I was going to post, “most if not all”… but your answer seems better.

  4. “Of the 15 additional points of national income going to the top decile,” Piketty writes, “around 11 points, or nearly three-quarters of the total, went to ‘the 1 percent’ (those making more than $352,000 a year in 2010), of which roughly half went to ‘the top 0.1 percent’ (those making more than $1.5 million a year).”

    Those lucky high earners. They’re able to somehow get more and more of the national income to go to them.

    1. Isn’t this entire subject just begging the question? It starts with the assumption that economic inequality is bad. Does Piketty explain why it’s bad?

      1. Does Piketty explain why it’s bad?

        It’s a self evident truth! How can you argue against it? Why do you kiss the capitalist boots that hold you down? Why is it fair that rich people live longer, have better educations, more opportunities, and feel better about themselves than the poor? What did they do to deserve it? Most wealth is inherited! That’s not fair! And once someone is rich then they’re always rich forever because in a capitalist economy money just grows! If you don’t have money you stay poor and work for a capitalist! Forever! What the fuck is wrong with you? You defend the people who make your life miserable! You fucking wealth apologist! Die! Die in a fucking fire!

        1. Greetings comrade! I am glad to see you are not imbued with the false consciousness that so many others here have fallen into! Yes, facts, analysis, data, and empirical evidence all only serve to brainwash the masses into insanity, believing that they are in control!

      2. I can see why more equality of income would be a good thing, but there are trade-offs and what’s traded may not be worth it. It’s best to have a stable set of reasonable laws that apply to everyone equally and let income adjust however it will. Pretty much what most people have advocated for quite a long time.

        1. DarrenM|5.23.14 @ 6:23PM|#
          “I can see why more equality of income would be a good thing, but there are trade-offs and what’s traded may not be worth it.”

          Free-market econs desire inequality; it serves a purpose as an incentive.
          Other than that, I can’t see a value one way or the other, except as a sop to those who favor the politics of envy. And there’s no gain in satisfying them.

          1. Until everyone has equality of effort, I absolutely oppose equality of outcome.

        2. “I can see why more equality of income would be a good thing

          You can? Really? Care to explain it to me? Because so far as I can see the history of increased income equality has taken the form of the majority moving more into alignment with the very poor, while a tiny elite grants itself all kinds of perks.

          Frankly, my instinct when I hear somebody talking about income equality is to put one hand on my wallet and wonder how long it would take me to put my other hand on a gun.

      3. WOW!! You actually used “begging the question” correctly on the internets! O Frabjous Day, Callooh! Callay!

    2. Piketty also doesn’t seem to be taking into account that those high earners rarely stay in that bracket for long.

      1. Why would he if it disproves his argument?

        1. That is to say, he’s cherry-picking evidence to suit his conclusion. I’d hate to use the word fraud, but he’s definitely dishonest by omission.

          1. …”I’d hate to use the word fraud,”…

            He hopes you won’t, either.

            1. I would say he’s a charlatan. Fraudulent, for sure. He’s a Marxist “scholar” – anything to prove socialism, evidence be damned!

              Watched the “Financial Times” video explaining his charts – he basically made up his own when the statistics didn’t match his desired conclusion. Fraud.

  5. Getting CEO pay right is surely a challenge, but does anybody on earth think it is the defining challenge of our time?

    Piketty has issues with way more than CEO pay. He doesn’t seem to think there is any basis on which to evaluate “dessert” of, seemingly, any white-collar workers?whom he seems not to consider “labor” at all, in some way.

    1. Well, clearly, white-collar ‘workers’ produce nothing of value, donchaknow?

      1. If there was ever an outdated term that needed to die, it’s ‘white-collar’ vs ‘blue-collar’.

        1. That’s exactly what a blue-collar person would say.

          1. I don’t know what collar I am. There was a time I think I would have been considered white-collar. But as a boots-on-the-ground IT person, I’m sometimes in a closet with a toolbelt, working with the hardhats (my preference).

            Other times I’m sitting in meetings, in my white-collar dress shirt (and sometimes a tie) shooting daggers through my eyes at the idiot droning through his powerpoint.

      2. It’s all alienation, right?

        Nikki: I remember reading an older summary of the Piketty’s book here at Reason that he’s pretty mendacious about the concept of “profit” altogether.

        It’s not about “helping” the poor, but about hurting the rich.

        The guy is envy and animosity personified.

  6. Karl Marx is one Black Looking Jew.

  7. (Of course there is considerable turnover in that group from year to year, and thus the specific members of the club change over time.)

    Because when you’re in the tippity top .1 percent, your wealth is ephemeral. It may be largely based on the stock value in the company you own.

    You might have a bad year resulting in a moderate dip in your stock value, and you lose a full third of your ‘wealth’.

    I presume that Mr. Zuckerberg was considerably richer the morning of the Facebook IPO, and considerably poorer a few days later.

    And it feels like Reason outsourced its website management to India.

    1. They are talking about income, not wealth, when talking “1%” or whatever, aren’t they?

      Still, I think what you say works in a slightly different way. A lot of people will get bumped temporarily into the top 0.1% of income if they get a big bonus or big capital gains one year.

      1. Income, wealth, money, it’s all the same! And the rich have more of it! They’re holding you down with their hoarded cash, yet you continue to apologize for them! Why? Why do you lick the capitalist boot that holds you down?

        1. So many here are totally brainwashed, it’s ridiculous! They have purchased their own shackles and love the rich plutocratic robber barons for the crumbs they are given!

          I mean, it’s so obvious when we look at the big picture – they have wealth because they stole directly from the hands of the poor. The poor would have nice cars and yachts if only the rich hadn’t stolen them!

        2. “Why do you lick the capitalist boot that holds you down?”

          Because it pays better than licking the socialist boot that not only holds me down, but wants to disarm me as well.

          1. False consciousness!

            1. The State only subjugates out of love!

              1. You’re missing the part where the socialist boot means you starve.

                1. By the time the socialist boot kicks your teeth out you wouldn’t have been able to eat anything anyway.

      2. I’m honestly not sure. I’m guessing wealth. Because CEOs go by ‘compensation package’. And no one talks about income purely. Bill Gates famously only drew a salary of something like $150,000 a year from Microsoft. No one would ever say he wasn’t in the .1%

        1. I’m pretty sure it’s income. Which makes it even stupider. It’s a lot harder to get numbers about the top 1% wealth-wise than if you just measure by income.

        2. Oh, now I can comment.

          No one would ever say he wasn’t in the .1%

          No, they wouldn’t. But .1% of what? I’m in the top 1% of people named Zeb for general awesomeness. This article seems to be talking about income distribution, not general wealth. I bet a lot of the wealthiest people aren’t usually in the very top of the income scale as so much wealth is in unrealized capital gains.

  8. Assume a can opener comment.

  9. So, a frog comes here and tells us that we should fix our economy the way that they have over in Froggyland so that we can enjoy the same economic prosperity that they do.

    The pinkos just never give up, do they?

    1. If you consider infant morality, life span and various “Happiness Indexes”, they are well ahead of us.

      If we consider the number of air conditioned square feet we each occupy and the size of our SUV’s in tonnage, we kick their ass.

      In short – their money seems to buy them a better value of happiness and life….ours buys more stuff. “Economic Prosperity” is almost as muddy as white and blue collar.

      1. Disaggregate by demographics and…oh dear, everything you said is fucking wrong!

        1. Except the parts that can’t be measured; the parts it’s easy to lie about.

        2. It’s Shreek 3.0

          1. “It’s Shreek 3.0”

            Dunno. First time I noticed the handle, craig was assuring us that the EPA definitely did cost/benefit calcs, but then it seems they were calcing with ‘unquantifiable’ values; IOWs, the came to a conclusion and made up justifications later.
            Shreeks’ arguments are usually less technically mendacious.

            1. BTW, I’m pretty sure craig is ignoramus enough to think his claims of EPA c/b analysis was going to carry the argument simply based on the claim.
              He seemed surprised when the claim was questioned based on his link: Lefty egotist.

      2. Oh, and craig:
        “In short – their money seems to buy them a better value of happiness and life….ours buys more stuff. “Economic Prosperity” is almost as muddy as white and blue collar.”

        So less money = better “happiness” outcomes?
        Seems you should contact Piketty and tell him we need to applaud the happiness of a greater and greater cohort of people!

        1. Hahah – Every product in the socialist paradise will have the adjective “happy”, just to remind people how happy they are that they can’t afford anything.

    2. Well, well paid French intellectuals think it’s worth it to trade some prosperity for, I don’t know, more time drinking wine and smoking Gauloises or whatever French people do these days. Doesn’t seem to work quite so well for a lot of people there, though.

  10. FT reporting that his spreadsheets have all kinds of flaws. So the empirical work that many on both left and right praised about the book appears to be full of shit as well.

    Once the data are cleaned and simplified the European results do not show any tendency towards rising wealth inequality after 1970.


    1. “FT reporting that his spreadsheets have all kinds of flaws”

      They also show a link to hiss response, but I can’t open it; any comment?

  11. Wouldn’t we expect the bell curve of income distribution to expand to the right with increasing GDP? This all seems like worrying over nothing.

    1. Yes

  12. What Thomas Piketty Gets Wrong About Capitalism


  13. In Douglas Adams famous non-fiction series on galactic economic history, “The Hitchhiker’s Guide to the Galaxy”, we are presented with a description of the tragedy of the planet Frogstar B.

    On Frogstar B, for a time shoe production increased faster than the rate of overall economic growth. As a result, with time, shoe production became a larger and larger fraction of the economy, until finally the Shoe Event Horizon was hit, at which point nothing but shoes could be manufactured, and lacking any other goods or services, their civilization collapsed.

    Thomas Piketty’s “Capital in the Twenty-First Century” describes a similar tragedy that lies inevitably in our future, the point at which the only economic activity left is investment, all money is held by a tiny minority of wealthy people, and our civilization permanently ends.

    1. That’s good.

      HHGG is one of the best philosophical novels ever.

  14. Back in the ’80s corporations were losing big bucks will CEOs were making huge (at the time) salaries. Not fair yelled the left. Make CEOs responsible for the performance of their companies. So stock options became the solutions. Only if the stock increased in value would the executives make a lot of money. Little did the left realize how much money.

  15. The most critical point is the one shrugged off in a parenthetic comment: “there is considerable turnover”.

    That is: the 1% today are not the same 1% tomorrow or next year. From what I’ve read, Piketty just ignores that, creating the impression of a fixed set of “overlords” getting wealthier than everyone else.

    Income inequality isn’t as “important” (to the top of the scale) as *wealth inequality*, which has been stable for many decades. But, again, it isn’t the same fixed “class” of people: 30-40% move from top to bottom or bottom to top.

    It is true that some justly earn it (or lose it), while others are just lucky at picking their parents.

  16. Can someone explain something very, extremely, fundamentally basic to me?

    How can r -gt g be the defining equation of capital? Eventually capital would grow so big that it would exceed the economy of which it is a subset.

    Every single review I have read of Pinketty ignores this. They must be comparable since the equation compares them, so it’s not an apples vs oranges comparison and thus irrelevant. But it must also be so blindingly obvious that no one considers it worth even mentioning.

    I feel incredibly dumb about this.

    1. You are correct, and the reviewers miss that because it’s a core tenet of marxism.

      1. It’s my contention that capital has the same diminishing marginal utility as everything else.

        1. “It’s my contention that capital has the same diminishing marginal utility as everything else.”

          (can’t remember the writer)
          Said writer uses that as an explanation of why people fear losing more than hope for gains:
          If you have X-dollars, X+1 means a gain with a value smaller than a loss to X-1.
          Simple; clear; understandable.

    2. Well perhaps it’s like the idea that a minimum wage or government spending generate economic growth, but I think the real answer is that capital growth exceeds general economic growth until capital is the entire economy (or close to it). Then the two run in lock step.

      It’s a silly notion, but he is French, and they basically outlawed work there.

  17. Basically, part of Piketty’s argument rests on Marx’s old assertion that when capital increases, it becomes more accrued on the top by the aristocracy. Except that Marx never proved his “thesis” and roughly 150 years of empirical data have disproven it. (Marxism isn’t religion? Anyone?)

    Also: blaming some stuff on bizarre contracts where some CEOs have pay scales based on dividends or have a set salary is not the fault of the free market, but those who wrote the contracts. Piketty is cherrypicking information to make a general grand statement.

    Basically, Piketty’s “Capital” shouldn’t pass muster in any kind of argumentative field.

    Oh wait. Marxist. That’s right. Argument and facts aren’t important.

  18. “So what has been driving the growing spread in U.S. incomes? ”

    Cronyism, plain and simple. The fat cats get protectionist legislation passed which keeps their competitors at bay by legislative fiat.

    “We’re talking about figuring out the appropriate level and structure of remuneration for about 100,000 positions in a 140 million-worker economy.”

    The Free Marked does that automagically. It is the nature of the Free Market to distribute resources equitably. This has been demonstrated to be the truth every single time the free market has been allowed to operate naturally.

    1. “Cronyism, plain and simple.”

      I think there’s more to it than that. Example: Our current un-emp’t benes encourage people to avoid work, as the difference between a starting job pay and the bene’s suggests you might just as well sleep in today.
      We then also load the med-insurance regs to favor 30-hour jobs.
      So gov’t-sponsored cronyism plays a part, but gov’t distortion of the labor market is far more wdespread than that.
      Natch, a froggy is gonna claim ‘free market!’, but froggies gonna frog.

  19. Thomas Piketty is little more than a revivalist preacher of born-again socialism. Piketty is easily debunked. Thomas Piketty, 696 Pages Of Foolery Destroyed In Less Than Five Minutes

    Piketty frets over return to capitalists growing faster than GDP, but many times wages (return to laborers) grow faster than GDP and even politicians’ spending grows faster than GDP.

    I’ve written about it here: The Second Great Awakening Of Socialism Has Come to America.

    1. That first link is a classic fisking. VERY nice.

  20. Scarecrow Repair|5.23.14 @ 5:46PM|#
    “Can someone explain something very, extremely, fundamentally basic to me?”
    Hey, S R, I’m not bright enough to explain the conundrum, but it looks like this guy is:

    “The return to capitalists never can exceed total profit. All returns to capitalists are shares of profit and not sales. ”

    Right up above: http://bizarrotheater.blogspot…..olery.html

  21. The really amazing thing in this story is that Paul Krugman pointed out the error that he did. Who knew Krugman still maintained a shred of intellectual respectability, and hadn’t become just a total partisan hack at this point?

    1. It could just be Krugman trying to save his own skin at this point too.

  22. Start working at home with Google. It’s a great work at home opportunity. Just work for few hours. I earn up to $100 a day. I can’t believe how easy it was once I tried it out

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