This article is an excerpt from the Shortform book guide to "Capital in the Twenty-First Century" by Thomas Piketty. Shortform has the world's best summaries and analyses of books you should be reading.
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What does “capital’s share of income” mean? Should you worry about capital accumulating national income?
Thomas Piketty warns that the rising capital-to-income ratio will result in capital accumulating an ever-growing share of national income. In his book Capital in the Twenty-First Century, he explains how this happens and why it’s bad.
Continue reading to understand how capital’s share of income contributes to inequality.
Capital’s Share of National Income
As Piketty writes, understanding the capital-income ratio allows us to understand capital’s share of income—which is always equivalent to the rate of return on capital multiplied by the capital-to-income ratio.
According to Piketty, the average rate of return on capital in most advanced economies is around 5%. And, as we saw earlier, the capital-to-income ratio is usually around 600%. If we multiply the two, this gives capital a 30% share of national income—meaning labor earns 70%. But if the capital-to-income ratio rises—which will happen as population growth begins to decline—capital will consume an ever-larger share of national income. This contributes to inequality because it leaves a smaller slice of the overall economic pie for labor.
R>G: Returns Are Higher Than Growth
Piketty observes that historically, the rate of return on capital r has almost always been higher than the economic growth rate g. Piketty expresses this mathematically as r>g, and he labels it as one of the fundamental laws of capitalism.
This means that the capital-to-income ratio has a natural tendency to grow—because the returns on existing capital enable the accumulation of ever-greater stocks of capital, which earn more returns, which are then reinvested to acquire even more capital, and so on.
Piketty stresses that these massive fortunes of the ultra-wealthy are so astronomical that they can’t help but grow on their own, even once their owners stop working. They simply generate much more income than can be spent in multiple lifetimes so that nearly all of the returns can be reinvested into the capital stock to earn more returns. It’s nearly impossible for wealth accumulation to stop at such a threshold.
For example, Facebook founder Mark Zuckerberg has a net worth of nearly $60 billion. Even if he earned “only” the average return of 5% per year, that would earn him an additional $300 million per year just on the returns from his existing wealth. Since that $300 million is, by itself, a staggering sum that most people would struggle to spend in a lifetime, Zuckerberg could consume only a relatively small portion of those returns (perhaps $37 million to purchase another sprawling estate in Palo Alto) and reinvest the remaining returns into his existing portfolio to earn even greater returns the next year.
Over time, the law of r>g will result in an enormous divergence of wealth. Piketty warns that, if left unchecked, a rising capital/growth ratio will enable capital to devour an ever-growing share of global income.
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Here's what you'll find in our full Capital in the Twenty-First Century summary :
- An analysis of incomes, tax returns, and estate tax returns across different countries
- How capitalism, by its nature, generates economic inequality
- How inherited wealth will soon account for more than earned income