Capital in the Twenty-First Century (35 page)

According to simulations (central scenario), the world capital/income ratio could
be close to 700 percent by the end of the twenty-first century.

Sources and series: see
piketty.pse.ens.fr/capital21c
.

By definition, the law
β
=
s
/
g
applies only to those forms of capital that can be accumulated. It does not take
account of the value of pure natural resources, including “pure land,” that is, land
prior to any human improvements. The fact that the law
β
=
s
/
g
allows us to explain nearly the entirety of the observed capital stock in 2010 (between
80 and 100 percent, depending on the country) suggests that pure land constitutes
only a small part of national capital. But exactly how much? The available data are
insufficient to give a precise answer to this question.

Consider first the case of farmland in a traditional rural society. It is very difficult
to say precisely what portion of its value represents “pure land value” prior to any
human exploitation and what corresponds to the many investments in and improvements
to this land over the centuries (including clearing, drainage, fencing, and so on).
In the eighteenth century, the value of farmland in France and Britain attained the
equivalent of four years of national income.
³³
According to contemporary estimates, investments and improvements represented at
least three-quarters of this value and probably more. The value of pure land represented
at most one year of national income, and probably less than half a year. This conclusion
follows primarily from the fact that the annual value of the labor required to clear,
drain, and otherwise improve the land was considerable, on the order of 3–4 percent
of national income. With relatively slow growth, less than 1 percent a year, the cumulative
value of such investments was undoubtedly close to the total value of the land (if
not greater).
³⁴

It is interesting that Thomas Paine, in his famous “Agrarian Justice” proposal to
French legislators in 1795, also concluded that “unimproved land” accounted for roughly
one-tenth of national wealth, or a little more than half a year of national income.

Nevertheless, estimates of this sort are inevitably highly approximate. When the growth
rate is low, small variations in the rate of investment produce enormous differences
in the long-run value of the capital/income ratio
β
=
s
/
g
. The key point to remember is that even in a traditional society, the bulk of national
capital already stemmed from accumulation and investment: nothing has really changed,
except perhaps the fact that the depreciation of land was quite small compared with
that of modern real estate or business capital, which has to be repaired or replaced
much more frequently. This may contribute to the impression that modern capital is
more “dynamic.” But since the data we have concerning investment in traditional rural
societies are limited and imprecise, it is difficult to say more.

In particular, it seems impossible to compare in any precise way the value of pure
land long ago with its value today. The principal issue today is urban land: farmland
is worth less than 10 percent of national income in both France and Britain. But it
is no easier to measure the value of pure urban land today, independent not only of
buildings and construction but also of infrastructure and other improvements needed
to make the land attractive, than to measure the value of pure farmland in the eighteenth
century. According to my estimates, the annual flow of investment over the past few
decades can account for almost all the value of wealth, including wealth in real estate,
in 2010. In other words, the rise in the capital/income ratio cannot be explained
in terms of an increase in the value of pure urban land, which to a first approximation
seems fairly comparable to the value of pure farmland in the eighteenth century: half
to one year of national income. The margin of uncertainty is nevertheless substantial.

Two further points are worth mentioning. First, the fact that total capital, especially
in real estate, in the rich countries can be explained fairly well in terms of the
accumulation of flows of saving and investment obviously does not preclude the existence
of large local capital gains linked to the concentration of population in particular
areas, such as major capitals. It would not make much sense to explain the increase
in the value of buildings on the Champs-Elysées or, for that matter, anywhere in Paris
exclusively in terms of investment flows. Our estimates suggest, however, that these
large capital gains on real estate in certain areas were largely compensated by capital
losses in other areas, which became less attractive, such as smaller cities or decaying
neighborhoods.

Second, the fact that the increase in the value of pure land does not seem to explain
much of the historic rebound of the capital/income ration in the rich countries in
no way implies that this will continue to be true in the future. From a theoretical
point of view, there is nothing that guarantees long-term stability of the value of
land, much less of all natural resources. I will come back to this point when I analyze
the dynamics of wealth and foreign asset holdings in the petroleum exporting countries.
³⁵

{SIX}

The Capital-Labor Split in the Twenty-First Century

We now have a fairly good understanding of the dynamics of the capital/income ratio,
as described by the law
β
=
s
/
g
. In particular, the long-run capital/income ratio depends on the savings rate
s
and the growth rate
g
. These two macrosocial parameters themselves depend on millions of individual decisions
influenced by any number of social, economic, cultural, psychological, and demographic
factors and may vary considerably from period to period and country to country. Furthermore,
they are largely independent of each other. These facts enable us to understand the
wide historical and geographic variations in the capital/income ratio, independent
of the fact that the relative price of capital can also vary widely over the long
term as well as the short term, as can the relative price of natural resources.

I turn now from the analysis of the capital/income ratio to the division of national
income between labor and capital. The formula
α
=
r
×
β
, which in
Chapter 1
I called the first fundamental law of capitalism, allows us to move transparently
between the two. For example, if the capital stock is equal to six years of national
income (
β
=
6), and if the average return on capital is 5 percent a year (
r
=
5%), then the share of income from capital,
α
, in national income is 30 percent (and the share of income from labor is therefore
70 percent). Hence the central question is the following: How is the rate of return
on capital determined? I shall begin by briefly examining the evolutions observed
over the very long run before analyzing the theoretical mechanisms and economic and
social forces that come into play.

The two countries for which we have the most complete historical data from the eighteenth
century on are once again Britain and France.

FIGURE 6.1.
   The capital-labor split in Britain, 1770–2010

During the nineteenth century, capital income (rent, profits, dividends, interest
…) absorbed about 40 percent of national income versus 60 percent for labor income
(including both wage and non-wage income).

Sources and series: see
piketty.pse.ens.fr/capital21c
.

We find that the general evolution of capital’s share of income,
α
, is described by the same U-shaped curve as the capital/income ratio,
β
, although the depth of the U is less pronounced. In other words, the rate of return
on capital,
r
, seems to have attenuated the evolution of the quantity of capital,
β
:
r
is higher in periods when
β
is lower, and vice versa, which seems natural.

More precisely: we find that capital’s share of income was on the order of 35–40 percent
in both Britain and France in the late eighteenth century and throughout the nineteenth,
before falling to 20–25 percent in the middle of the twentieth century and then rising
again to 25–30 percent in the late twentieth and early twenty-first centuries (see
Figures 6.1
and
6.2
). This corresponds to an average rate of return on capital of around 5–6 percent
in the eighteenth and nineteenth centuries, rising to 7–8 percent in the mid-twentieth
century, and then falling to 4–5 percent in the late twentieth and early twenty-first
centuries (see
Figures 6.3
and
6.4
).

The overall curve and the orders of magnitude described here may be taken as reliable
and significant, at least to a first approximation. Nevertheless, the limitations
and weaknesses of the data should be noted immediately. First, as noted, the very
notion of an “average” rate of return on capital is a fairly abstract construct. In
practice, the rate of return varies widely with the type of asset, as well as with
the size of individual fortunes (it is generally easier to obtain a good return if
one begins with a large stock of capital), and this tends to amplify inequalities.
Concretely, the yield on the riskiest assets, including industrial capital (whether
in the form of partnerships in family firms in the nineteenth century or shares of
stock in listed corporations in the twentieth century), is often greater than 7–8
percent, whereas the yield on less risky assets is significantly lower, on the order
of 4–5 percent for farmland in the eighteenth and nineteenth centuries and as low
as 3–4 percent for real estate in the early twenty-first century. Small nest eggs
held in checking or savings accounts often yield a real rate of return closer to 1–2
percent or even less, perhaps even negative, when the inflation rate exceeds the meager
nominal interest rate on such accounts. This is a crucial issue about which I will
have more to say later on.

FIGURE 6.2.
   The capital-labor split in France, 1820–2010

In the twenty-first century, capital income (rent, profits, dividends, interest …)
absorbs about 30 percent of national income versus 70 percent for labor income (including
both wage and non-wage income).

Sources and series: see
piketty.pse.ens.fr/capital21c
.

At this stage it is important to point out that the capital shares and average rates
of return indicated in
Figures 6.1
–
4
were calculated by adding the various amounts of income from capital included in
national accounts, regardless of legal classification (rents, profits, dividends,
interest, royalties, etc., excluding interest on public debt and before taxes) and
then dividing this total by national income (which gives the share of capital income
in national income, denoted
α
) or by the national capital stock (which gives the average rate of return on capital,
denoted
r
).
¹
By construction, this average rate of return aggregates the returns on very different
types of assets and investments: the goal is in fact to measure the average return
on capital in a given society taken as a whole, ignoring differences in individual
situations. Obviously some people earn more than the average return and others less.
Before looking at the distribution of individual returns around the mean, it is natural
to begin by analyzing the location of the mean.