Capital in the Twenty-First Century (39 page)

The Cobb-Douglas production function became very popular in economics textbooks after
World War II (after being popularized by Paul Samuelson), in part for good reasons
but also in part for bad ones, including simplicity (economists like simple stories,
even when they are only approximately correct), but above all because the stability
of the capital-labor split gives a fairly peaceful and harmonious view of the social
order. In fact, the stability of capital’s share of income—assuming it turns out to
be true—in no way guarantees harmony: it is compatible with extreme and untenable
inequality of the ownership of capital and distribution of income. Contrary to a widespread
idea, moreover, stability of capital’s share of national income in no way implies
stability of the capital/income ratio, which can easily take on very different values
at different times and in different countries, so that, in particular, there can be
substantial international imbalances in the ownership of capital.

The point I want to emphasize, however, is that historical reality is more complex
than the idea of a completely stable capital-labor split suggests. The Cobb-Douglas
hypothesis is sometimes a good approximation for certain subperiods or sectors and,
in any case, is a useful point of departure for further reflection. But this hypothesis
does not satisfactorily explain the diversity of the historical patterns we observe
over the long, short, or medium run, as the data I have collected show.

Furthermore, there is nothing really surprising about this, given that economists
had very little historical data to go on when Cobb and Douglas first proposed their
hypothesis. In their original article, published in 1928, these two American economists
used data about US manufacturing in the period 1899–1922, which did indeed show a
certain stability in the share of income going to profits.
¹⁸
This idea appears to have been first introduced by the British economist Arthur Bowley,
who in 1920 published an important book on the distribution of British national income
in the period 1880–1913 whose primary conclusion was that the capital-labor split
remained relatively stable during this period.
¹⁹
Clearly, however, the periods analyzed by these authors were relatively short: in
particular, they did not try to compare their results with estimates from the early
nineteenth century (much less the eighteenth).

As noted, moreover, these questions aroused very strong political tensions in the
late nineteenth and early twentieth centuries, as well as throughout the Cold War,
that were not conducive to a calm consideration of the facts. Both conservative and
liberal economists were keen to show that growth benefited everyone and thus were
very attached to the idea that the capital-labor split was perfectly stable, even
if believing this sometimes meant neglecting data or periods that suggested an increase
in the share of income going to capital. By the same token, Marxist economists liked
to show that capital’s share was always increasing while wages stagnated, even if
believing this sometimes required twisting the data. In 1899, Eduard Bernstein, who
had the temerity to argue that wages were increasing and the working class had much
to gain from collaborating with the existing regime (he was even prepared to become
vice president of the Reichstag), was roundly outvoted at the congress of the German
Social Democratic Party in Hanover. In 1937, the young German historian and economist
Jürgen Kuczynski, who later became a well-known professor of economic history at Humboldt
University in East Berlin and who in 1960–1972 published a monumental thirty-eight-volume
universal history of wages, attacked Bowley and other bourgeois economists. Kuczynski
argued that labor’s share of national income had decreased steadily from the advent
of industrial capitalism until the 1930s. This was true for the first half—indeed,
the first two-thirds—of the nineteenth century but wrong for the entire period.
²⁰
In the years that followed, controversy raged in the pages of academic journals.
In 1939, in
Economic History Review,
where calmer debates where the norm, Frederick Brown unequivocally backed Bowley,
whom he characterized as a “great scholar” and “serious statistician,” whereas Kuczynski
in his view was nothing more than a “manipulator,” a charge that was wide of the mark.
²¹
Also in 1939, Keynes took the side of the bourgeois economists, calling the stability
of the capital-labor split “one of the best-established regularities in all of economic
science.” This assertion was hasty to say the least, since Keynes was essentially
relying on data from British manufacturing industry in the 1920s, which were insufficient
to establish a universal regularity.
²²

In textbooks published in the period 1950–1970 (and indeed as late as 1990), a stable
capital-labor split is generally presented as an uncontroversial fact, but unfortunately
the period to which this supposed law applies is not always clearly specified. Most
authors are content to use data going back no further than 1950, avoiding comparison
with the interwar period or the early twentieth century, much less with the eighteenth
and nineteenth centuries. From the 1990s on, however, numerous studies mention a significant
increase in the share of national income in the rich countries going to profits and
capital after 1970, along with the concomitant decrease in the share going to wages
and labor. The universal stability thesis thus began to be questioned, and in the
2000s several official reports published by the Organisation for Economic Cooperation
and Development (OECD) and International Monetary Fund (IMF) took note of the phenomenon
(a sign that the question was being taken seriously).
²³

The novelty of this study is that it is to my knowledge the first attempt to place
the question of the capital-labor split and the recent increase of capital’s share
of national income in a broader historical context by focusing on the evolution of
the capital/income ratio from the eighteenth century until now. The exercise admittedly
has its limits, in view of the imperfections of the available historical sources,
but I believe that it gives us a better view of the major issues and puts the question
in a whole new light.

I begin by examining the inadequacy of the Cobb-Douglas model for studying evolutions
over the very long run. Over a very long period of time, the elasticity of substitution
between capital and labor seems to have been greater than one: an increase in the
capital/income ratio
β
seems to have led to a slight increase in
α
, capital’s share of national income, and vice versa. Intuitively, this corresponds
to a situation in which there are many different uses for capital in the long run.
Indeed, the observed historical evolutions suggest that it is always possible—up to
a certain point, at least—to find new and useful things to do with capital: for example,
new ways of building and equipping houses (think of solar panels on rooftops or digital
lighting controls), ever more sophisticated robots and other electronic devices, and
medical technologies requiring larger and larger capital investments. One need not
imagine a fully robotized economy in which capital would reproduce itself (corresponding
to an infinite elasticity of substitution) to appreciate the many uses of capital
in a diversified advanced economy in which the elasticity of substitution is greater
than one.

It is obviously quite difficult to predict how much greater than one the elasticity
of substitution of capital for labor will be in the twenty-first century. On the basis
of historical data, one can estimate an elasticity between 1.3 and 1.6.
²⁴
But not only is this estimate uncertain and imprecise. More than that, there is no
reason why the technologies of the future should exhibit the same elasticity as those
of the past. The only thing that appears to be relatively well established is that
the tendency for the capital/income ratio
β
to rise, as has been observed in the rich countries in recent decades and might spread
to other countries around the world if growth (and especially demographic growth)
slows in the twenty-first century, may well be accompanied by a durable increase in
capital’s share of national income,
α
. To be sure, it is likely that the return on capital,
r
, will decrease as
β
increases. But on the basis of historical experience, the most likely outcome is
that the volume effect will outweigh the price effect, which means that the accumulation
effect will outweigh the decrease in the return on capital.

Indeed, the available data indicate that capital’s share of income increased in most
rich countries between 1970 and 2010 to the extent that the capital/income ratio increased
(see
Figure 6.5
). Note, however, that this upward trend is consistent not only with an elasticity
of substitution greater than one but also with an increase in capital’s bargaining
power vis-à-vis labor over the past few decades, which have seen increased mobility
of capital and heightened competition between states eager to attract investments.
It is likely that the two effects have reinforced each other in recent years, and
it is also possible that this will continue to be the case in the future. In any event,
it is important to point out that no self-corrective mechanism exists to prevent a
steady increase of the capital/income ratio,
β
, together with a steady rise in capital’s share of national income,
α
.

FIGURE 6.5.
   The capital share in rich countries, 1975–2010

Capital income absorbs between 15 percent and 25 percent of national income in rich
countries in 1970, and between 25 percent and 30 percent in 2000–2010.

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

I have just shown that an important characteristic of contemporary economies is the
existence of many opportunities to substitute capital for labor. It is interesting
that this was not at all the case in traditional economies based on agriculture, where
capital existed mainly in the form of land. The available historical data suggest
very clearly that the elasticity of substitution was significantly less than one in
traditional agricultural societies. In particular, this is the only way to explain
why, in the eighteenth and nineteenth centuries, the value of land in the United States,
as measured by the capital/income ratio and land rents, was much lower than in Europe,
even though land was much more plentiful in the New World.

This is perfectly logical, moreover: if capital is to serve as a ready substitute
for labor, then it must exist in different forms. For any given form of capital (such
as farmland in the case in point), it is inevitable that beyond a certain point, the
price effect will outweigh the volume effect. If a few hundred individuals have an
entire continent at their disposal, then it stands to reason that the price of land
and land rents will fall to near-zero levels. There is no better illustration of the
maxim “Too much capital kills the return on capital” than the relative value of land
and land rents in the New World and the Old.

The time has come to turn to a very important question: Has the apparently growing
importance of human capital over the course of history been an illusion? Let me rephrase
the question in more precise terms. Many people believe that what characterizes the
process of development and economic growth is the increased importance of human labor,
skill, and know-how in the production process. Although this hypothesis is not always
formulated in explicit terms, one reasonable interpretation would be that technology
has changed in such a way that the labor factor now plays a greater role.
²⁵
Indeed, it seems plausible to interpret in this way the decrease in capital’s share
of income over the very long run, from 35–40 percent in 1800–1810 to 25–30 percent
in 2000–2010, with a corresponding increase in labor’s share from 60–65 percent to
70–75 percent. Labor’s share increased simply because labor became more important
in the production process. Thus it was the growing power of human capital that made
it possible to decrease the share of income going to land, buildings, and financial
capital.

If this interpretation is correct, then the transformation to which it points was
indeed quite significant. Caution is in order, however. For one thing, as noted earlier,
we do not have sufficient perspective at this point in history to reach an adequate
judgment about the very long-run evolution of capital’s share of income. It is quite
possible that capital’s share will increase in coming decades to the level it reached
at the beginning of the nineteenth century. This may happen even if the structural
form of technology—and the relative importance of capital and labor—does not change
(although the relative bargaining power of labor and capital may change) or if technology
changes only slightly (which seems to me the more plausible alternative) yet the increase
in the capital/income ratio drives capital’s share of income toward or perhaps beyond
historic peaks because the long-run elasticity of substitution of capital for labor
is apparently greater than one. This is perhaps the most important lesson of this
study thus far: modern technology still uses a great deal of capital, and even more
important, because capital has many uses, one can accumulate enormous amounts of it
without reducing its return to zero. Under these conditions, there is no reason why
capital’s share must decrease over the very long run, even if technology changes in
a way that is relatively favorable to labor.