Capital in the Twenty-First Century (63 page)

The economic model generally used to explain this relative stability of the return
on capital at around 4–5 percent (as well as the fact that it never falls below 2–3
percent) is based on the notion of “time preference” in favor of the present. In other
words, economic actors are characterized by a rate of time preference (usually denoted
θ
) that measures how impatient they are and how they take the future into account.
For example, if
θ
=
5 percent, the actor in question is prepared to sacrifice 105 euros of consumption
tomorrow in order to consume an additional 100 euros today. This “theory,” like many
theoretical models in economics, is somewhat tautological (one can always explain
any observed behavior by assuming that the actors involved have preferences—or “utility
functions” in the jargon of the profession—that lead them to act that way), and its
predictive power is radical and implacable. In the case in point, assuming a zero-growth
economy, it is not surprising to discover that the rate of return on capital must
equal the time preference
θ
.
¹⁷
According to this theory, the reason why the return on capital has been historically
stable at 4–5 percent is ultimately psychological: since this rate of return reflects
the average person’s impatience and attitude toward the future, it cannot vary much
from this level.

In addition to being tautological, the theory raises a number of other difficulties.
To be sure, the intuition that lies behind the model (like that which lies behind
marginal productivity theory) cannot be entirely wrong. All other things equal, a
more patient society, or one that anticipates future shocks, will of course amass
greater reserves and accumulate more capital. Similarly, if a society accumulates
so much capital that the return on capital is persistently low, say, 1 percent a year
(or in which all forms of wealth, including the property of the middle and lower classes,
are taxed so that the net return is very low), then a significant proportion of property-owning
individuals will seek to sell their homes and financial assets, thus decreasing the
capital stock until the yield rises.

The problem with the theory is that it is too simplistic and systematic: it is impossible
to encapsulate all savings behavior and all attitudes toward the future in a single
inexorable psychological parameter. If we take the most extreme version of the model
(called the “infinite horizon” model, because agents calculate the consequences of
their savings strategy for all their descendants until the end of time as though they
were thinking of themselves, in accordance with their own rate of time preference),
it follows that the net rate of return on capital cannot vary by even as little as
a tenth of a percent: any attempt to alter the net return (for example, by changing
tax policy) will trigger an infinitely powerful reaction in one sense or another (saving
or dissaving) in order to force the net return back to its unique equilibrium. Such
a prediction is scarcely realistic: history shows that the elasticity of saving is
positive but not infinite, especially when the rate of return varies within moderate
and reasonable limits.
¹⁸

Another difficulty with this theoretical model (in its strictest interpretation) is
that it implies that the rate of return on capital,
r,
must, in order to maintain the economy in equilibrium, rise very rapidly with the
growth rate
g
, so that the gap between
r
and
g
should be greater in a rapidly growing economy than in one that is not growing at
all. Once again, this prediction is not very realistic, nor is it compatible with
historical experience (the return on capital may rise in a rapidly growing economy
but probably not enough to increase the gap
r
−
g
significantly, to judge by observed historical experience), and it, too, is a consequence
of the infinite horizon hypothesis. Note, however, that the intuition here is again
partially valid and in any case interesting from a strictly logical point of view.
In the standard economic model, based on the existence of a “perfect” market for capital
(in which each owner of capital receives a return equal to the highest marginal productivity
available in the economy, and everyone can borrow as much as he or she wants at that
rate), the reason why the return on capital,
r,
is systematically and necessarily higher than the growth rate,
g,
is the following. If
r
were less than
g
, economic agents, realizing that their future income (and that of their descendants)
will rise faster than the rate at which they can borrow, will feel infinitely wealthy
and will therefore wish to borrow without limit in order to consume immediately (until
r
rises above
g
). In this extreme form, the mechanism is not entirely plausible, but it shows that
r
>
g
is true in the most standard of economic models and is even more likely to be true
as capital markets become more efficient.
¹⁹

To recap: savings behavior and attitudes toward the future cannot be encapsulated
in a single parameter. These choices need to be analyzed in more complex models, involving
not only time preference but also precautionary savings, life-cycle effects, the importance
attached to wealth in itself, and many other factors. These choices depend on the
social and institutional environment (such as the existence of a public pension system),
family strategies and pressures, and limitations that social groups impose on themselves
(for example, in some aristocratic societies, heirs are not free to sell family property),
in addition to individual psychological and cultural factors.

To my way of thinking, the inequality
r
>
g
should be analyzed as a historical reality dependent on a variety of mechanisms and
not as an absolute logical necessity. It is the result of a confluence of forces,
each largely independent of the others. For one thing, the rate of growth,
g,
tends to be structurally low (generally not much more than 1 percent a year once
the demographic transition is complete and the country reaches the world technological
frontier, where the pace of innovation is fairly slow). For another, the rate of return
on capital,
r,
depends on many technological, psychological, social, and cultural factors, which
together seem to result in a return of roughly 4–5 percent (in any event distinctly
greater than 1 percent).

Let me now turn to the consequences of
r
>
g
for the dynamics of the wealth distribution. The fact that the return on capital
is distinctly and persistently greater than the growth rate is a powerful force for
a more unequal distribution of wealth. For example, if
g
=
1 percent and
r
=
5 percent, wealthy individuals have to reinvest only one-fifth of their annual capital
income to ensure that their capital will grow faster than average income. Under these
conditions, the only forces that can avoid an indefinite inegalitarian spiral and
stabilize inequality of wealth at a finite level are the following. First, if the
fortunes of wealthy individuals grow more rapidly than average income, the capital/income
ratio will rise indefinitely, which in the long run should lead to a decrease in the
rate of return on capital. Nevertheless, this mechanism can take decades to operate,
especially in an open economy in which wealthy individuals can accumulate foreign
assets, as was the case in Britain and France in the nineteenth century and up to
the eve of World War I. In principle, this process always comes to an end (when those
who own foreign assets take possession of the entire planet), but this can obviously
take time. This process was largely responsible for the vertiginous increase in the
top centile’s share of wealth in Britain and France during the Belle Époque.

Furthermore, in regard to the trajectories of individual fortunes, this divergent
process can be countered by shocks of various kinds, whether demographic (such as
the absence of an heir or the presence of too many heirs, leading to dispersal of
the family capital, or early death, or prolonged life) or economic (such as a bad
investment or a peasant uprising or a financial crisis or a mediocre season, etc.).
Shocks of this sort always affect family fortunes, so that changes in the wealth distribution
occur even in the most static societies. Note, moreover, the importance of demographic
choices (the fewer children the rich choose to have, the more concentrated wealth
becomes) and inheritance laws.

Many traditional aristocratic societies were based on the principle of primogeniture:
the eldest son inherited all (or at any rate a disproportionately large share) of
the family property so as to avoid fragmentation and to preserve or increase the family’s
wealth. The eldest son’s privilege concerned the family’s primary estate in particular
and often placed heavy constraints on the property: the heir was not allowed to diminish
its value and was obliged to live on the income from the capital, which was then conveyed
in turn to the next heir in the line of succession, usually the eldest grandson. In
British law this was the system of “entails” (the equivalent in French law being the
system of
substitution héréditaire
under the Ancien Régime). It was the reason for the misfortune of Elinor and Marianne
in
Sense and Sensibility:
the Norland estate passed directly to their father and half-brother, John Dashwood,
who decided, after considering the matter with his wife, Fanny, to leave them nothing.
The fate of the two sisters is a direct consequence of this sinister conversation.
In
Persuasion,
Sir Walter’s estate goes directly to his nephew, bypassing his three daughters. Jane
Austen, herself disfavored by inheritance and left a spinster along with her sister,
knew what she was talking about.

The inheritance law that derived from the French Revolution and the Civil Code that
followed rested on two main pillars: the abolition of
substitutions héréditaires
and primogeniture and the adoption of the principle of equal division of property
among brothers and sisters (equipartition). This principle has been applied strictly
and consistently since 1804: in France, the
quotité disponible
(that is, the share of the estate that parents are free to dispose of as they wish)
is only a quarter of total wealth for parents with three or more children,
²⁰
and exemption is granted only in extreme circumstances (for example, if the children
murder their stepmother). It is important to understand that the new law was based
not only on a principle of equality (younger children were valued as much as the eldest
and protected from the whims of the parents) but also on a principle of liberty and
economic efficiency. In particular, the abolition of entails, which Adam Smith disliked
and Voltaire, Rousseau, and Montesquieu abhorred, rested on a simple idea: this abolition
allowed the free circulation of goods and the possibility of reallocating property
to the best possible use in the judgment of the living generation, despite what dead
ancestors may have thought. Interestingly, after considerable debate, Americans came
to the same conclusion in the years after the Revolution: entails were forbidden,
even in the South. As Thomas Jefferson famously put it, “the Earth belongs to the
living.” And equipartition of estates among siblings became the legal default, that
is, the rule that applied in the absence of an explicit will (although the freedom
to make one’s will as one pleases still prevails in both the United States and Britain,
in practice most estates are equally divided among siblings). This was an important
difference between France and the United States on the one hand, where the law of
equipartition applied from the nineteenth century on, and Britain on the other, where
primogeniture remained the default in 1925 for a portion of the parental property,
namely, landed and agricultural capital.
²¹
In Germany, it was not until the Weimar Republic that the German equivalent of entails
was abolished in 1919.
²²

During the French Revolution, this egalitarian, antiauthoritarian, liberal legislation
(which challenged parental authority while affirming that of the new family head,
in some case to the detriment of his spouse) was greeted with considerable optimism,
at least by men—despite being quite radical for the time.
²³
Proponents of this revolutionary legislation were convinced that they had found the
key to future equality. Since, moreover, the Civil Code granted everyone equal rights
with respect to the market and property, and guilds had been abolished, the ultimate
outcome seemed clear: such a system would inevitably eliminate the inequalities of
the past. The marquis de Condorcet gave forceful expression to this optimistic view
in his
Esquisse d’un tableau historique des progrès de l’esprit humain
(1794): “It is easy to prove that fortunes tend naturally toward equality, and that
excessive differences of wealth either cannot exist or must promptly cease, if the
civil laws do not establish artificial ways of perpetuating and amassing such fortunes,
and if freedom of commerce and industry eliminate the advantage that any prohibitive
law or fiscal privilege gives to acquired wealth.”
²⁴

How, then, are we to explain the fact that the concentration of wealth increased steadily
in France throughout the nineteenth century and ultimately peaked in the Belle Époque
at a level even more extreme than when the Civil Code was introduced and scarcely
less than in monarchical and aristocratic Britain? Clearly, equality of rights and
opportunities is not enough to ensure an egalitarian distribution of wealth.