Capital in the Twenty-First Century (36 page)

FIGURE 6.3.
   The pure rate of return on capital in Britain, 1770–2010

The pure rate of return to capital is roughly stable around 4–5 percent in the long
run.

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

FIGURE 6.4.
   The pure rate of return on capital in France, 1820–2010

The observed average rate of return displays larger fluctuations than the pure rate
of return during the twentieth century.

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

Another important caveat concerns the income of nonwage workers, which may include
remuneration of capital that is difficult to distinguish from other income.

To be sure, this problem is less important now than in the past because most private
economic activity today is organized around corporations or, more generally, joint-stock
companies, so a firm’s accounts are clearly separate from the accounts of the individuals
who supply the capital (who risk only the capital they have invested and not their
personal fortunes, thanks to the revolutionary concept of the “limited liability corporation,”
which was adopted almost everywhere in the latter half of the nineteenth century).
On the books of such a corporation, there is a clear distinction between remuneration
of labor (wages, salaries, bonuses, and other payments to employees, including managers,
who contribute labor to the company’s activities) and remuneration of capital (dividends,
interest, profits reinvested to increase the value of the firm’s capital, etc.).

Partnerships and sole proprietorships are different: the accounts of the business
are sometimes mingled with the personal accounts of the firm head, who is often both
the owner and operator. Today, around 10 percent of domestic production in the rich
countries is due to nonwage workers in individually owned businesses, which is roughly
equal to the proportion of nonwage workers in the active population. Nonwage workers
are mostly found in small businesses (merchants, craftsmen, restaurant workers, etc.)
and in the professions (doctors, lawyers, etc.). For a long time this category also
included a large number of independent farmers, but today these have largely disappeared.
On the books of these individually owned firms, it is generally impossible to distinguish
the remuneration of capital: for example, the profits of a radiologist remunerate
both her labor and the equipment she uses, which can be costly. The same is true of
the hotel owner or small farmer. We therefore say that the income of nonwage workers
is “mixed,” because it combines income from labor with income from capital. This is
also referred to as “entrepreneurial income.”

To apportion mixed incomes between capital and labor, I have used the same average
capital-labor split as for the rest of the economy. This is the least arbitrary choice,
and it appears to yield results close to those obtained with the other two commonly
used methods.
²
It remains an approximation, however, since the very notion of a clear boundary between
income from capital and income from labor is not clearly defined for mixed incomes.
For the current period, this makes virtually no difference: because the share of mixed
income in national income is small, the uncertainty about capital’s share of mixed
income affects no more than 1–2 percent of national income. In earlier periods, and
especially for the eighteenth and nineteenth centuries when mixed incomes may have
accounted for more than half of national income, the uncertainties are potentially
much greater.
³
That is why available estimates of the capital share for the eighteenth and nineteenth
centuries can only be counted as approximations.
⁴

Despite these caveats, my estimates for capital’s share of national income in this
period (at least 40 percent) appear to be valid: in both Britain and France, the rents
paid to landlords alone accounted for 20 percent of national income in the eighteenth
and early nineteenth centuries, and all signs are that the return on farmland (which
accounted for about half of national capital) was slightly less than the average return
on capital and significantly less than the return on industrial capital, to judge
by the very high level of industrial profits, especially during the first half of
the nineteenth century. Because of imperfections in the available data, however, it
is better to give an interval—between 35 and 40 percent—than a single estimate.

For the eighteenth and nineteenth centuries, estimates of the value of the capital
stock are probably more accurate than estimates of the flows of income from labor
and capital. This remains largely true today. That is why I chose to emphasize the
evolution of the capital/income ratio rather than the capital-labor split, as most
economic researchers have done in the past.

The other important source of uncertainties, which leads me to think that the average
rates of return indicated in
Figures 6.3
and
6.4
are somewhat overestimated, so that I also indicate what might be called the “pure”
rate of return on capital, is the fact that national accounts do not allow for the
labor, or at any rate attention, that is required of anyone who wishes to invest.
To be sure, the cost of managing capital and of “formal” financial intermediation
(that is, the investment advice and portfolio management services provided by a bank
or official financial institution or real estate agency or managing partner) is obviously
taken into account and deducted from the income on capital in calculating the average
rate of return (as presented here). But this is not the case with “informal” financial
intermediation: every investor spends time—in some cases a lot of time—managing his
own portfolio and affairs and determining which investments are likely to be the most
profitable. This effort can in certain cases be compared to genuine entrepreneurial
labor or to a form of business activity.

It is of course quite difficult—and to some extent arbitrary—to calculate the value
of this informal labor in any precise way, which explains why it is omitted from national
accounts. In theory, one would have to measure the time spent on investment-related
activities and ascribe an hourly value to that time, based perhaps on the remuneration
of equivalent labor in the formal financial or real estate sector. One might also
imagine that these informal costs are greater in periods of very rapid economic growth
(or high inflation), for such times are likely to require more frequent reallocation
of investments and more time researching the best investment opportunities than in
a quasi-stagnant economy. For example, it is difficult to believe that the average
returns on capital of close to 10 percent that we observe in France (and to a lesser
degree in Britain) during periods of postwar reconstruction are simply pure returns
on capital. It is likely that such high returns also include a nonnegligible portion
of remuneration for informal entrepreneurial labor. (Similar returns are also observed
in emerging economies such as China today, where growth rates are also very rapid.)

For illustrative purposes, I have indicated in
Figures 6.3
and
6.4
my estimates of the pure return on capital in Britain and France at various times.
I obtained these estimates by deducting from the observed average return a plausible
(although perhaps too high) estimate of the informal costs of portfolio management
(that is, the value of the time spent managing one’s wealth). The pure rates of return
obtained in this way are generally on the order of one or two percentage points lower
than the observed returns and should probably be regarded as minimum values.
⁵
In particular, the available data on the rates of return earned by fortunes of different
sizes suggest that there are important economies of scale in the management of wealth,
and that the pure returns earned by the largest fortunes are significantly higher
than the levels indicated here.
⁶

The principal conclusion that emerges from my estimates is the following. In both
France and Britain, from the eighteenth century to the twenty-first, the pure return
on capital has oscillated around a central value of 4–5 percent a year, or more generally
in an interval from 3–6 percent a year. There has been no pronounced long-term trend
either upward or downward. The pure return rose significantly above 6 percent following
the massive destruction of property and numerous shocks to capital in the two world
wars but subsequently returned fairly rapidly to the lower levels observed in the
past. It is possible, however, that the pure return on capital has decreased slightly
over the very long run: it often exceeded 4–5 percent in the eighteenth and nineteenth
centuries, whereas in the early twenty-first century it seems to be approaching 3–4
percent as the capital/income ratio returns to the high levels observed in the past.

We nevertheless lack the distance needed to be certain about this last point. We cannot
rule out the possibility that the pure return on capital will rise to higher levels
over the next few decades, especially in view of the growing international competition
for capital and the equally increasing sophistication of financial markets and institutions
in generating high yields from complex, diversified portfolios.

In any case, this virtual stability of the pure return on capital over the very long
run (or more likely this slight decrease of about one-quarter to one-fifth, from 4–5
percent in the eighteenth and nineteenth centuries to 3–4 percent today) is a fact
of major importance for this study.

In order to put these figures in perspective, recall first of all that the traditional
rate of conversion from capital to rent in the eighteenth and nineteenth centuries,
for the most common and least risky forms of capital (typically land and public debt)
was generally on the order of 5 percent a year: the value of a capital asset was estimated
to be equal to twenty years of the annual income yielded by that asset. Sometimes
this was increased to twenty-five years (corresponding to a return of 4 percent a
year).
⁷

In classic novels of the early nineteenth century, such as those of Balzac and Jane
Austen, the equivalence between capital and rent at a rate of 5 percent (or more rarely
4 percent) is taken for granted. Novelists frequently failed to mention the nature
of the capital and generally treated land and public debt as almost perfect substitutes,
mentioning only the yield in rent. We are told, for example, that a major character
has 50,000 francs or 2,000 pounds sterling of rent but not whether it comes from land
or from government bonds. It made no difference, since in both cases the income was
certain and steady and sufficient to finance a very definite lifestyle and to reproduce
across generations a familiar and well-understood social status.

Similarly, neither Austen nor Balzac felt it necessary to specify the rate of return
needed to transform a specific amount of capital into an annual rent: every reader
knew full well that it took a capital on the order of 1 million francs to produce
an annual rent of 50,000 francs (or a capital of 40,000 pounds to produce an income
of 2,000 pounds a year), no matter whether the investment was in government bonds
or land or something else entirely. For nineteenth-century novelists and their readers,
the equivalence between wealth and annual rent was obvious, and there was no difficulty
in moving from one measuring scale to the other, as if the two were perfectly synonymous.

It was also obvious to novelists and their readers that some kinds of investment required
greater personal involvement, whether it was Père Goriot’s pasta factories or Sir
Thomas’s plantations in the West Indies in
Mansfield Park.
What is more, the return on such investments was naturally higher, typically on the
order of 7–8 percent or even more if one struck an especially good bargain, as César
Birotteau hoped to do by investing in real estate in the Madeleine district of Paris
after earlier successes in the perfume business. But it was also perfectly clear to
everyone that when the time and energy devoted to organizing such affairs was deducted
from the profits (think of the long months that Sir Thomas is forced to spend in the
West Indies), the pure return obtained in the end was not always much more than the
4–5 percent earned by investments in land and government bonds. In other words, the
additional yield was largely remuneration for the labor devoted to the business, and
the pure return on capital, including the risk premium, was generally not much above
4–5 percent (which was not in any case a bad rate of return).