Capital in the Twenty-First Century

Thomas Piketty

Book cover

I finished this several weeks ago now, but with all of the reviews in the media, I keep putting off writing my own because I feel like it needs to be really good! I am going to avoid doing a comprehensive review, since you can read many of those on the internet. Instead, here are some of my idiosyncratic observations on the book:

-First, I highly recommend this book to anyone who is interested in the subject matter. Yes, it is long, but Piketty’s writing (jointly, Goldhammer’s translation) is extremely clear and very much appropriate for the non-specialist. There are only a few equations in the whole thing, and all of them are quite straightforward (3 terms at most, all in some kind of standard algebraic relationship). If you are interested but have been feeling daunted, don’t!

-My biggest personal takeaway from the book was how much the economic patterns of the 20th century appear to be a historical anomaly. Nearly every graph in the book shows a fairly steady state over the course of the nineteenth century, a huge downward shock in the twentieth century (due to the Great Depression and the World Wars), followed by a near-complete recovery to the steady state. It is largely thanks to Piketty’s work that we can observe the 20th century in this historical context. The most significant “interrupted pattern” of the 20th century was the dominance of inherited capital over labor income. Before the twentieth century, there was so much accumulated capital in Europe that a striver would have no chance of reaching the upper echelons of economic resources just by getting an education and working hard (as Piketty illustrates by examples given in Balzac). In the twentieth century, there was such wholesale destruction of capital by the depression and the world wars that this ceased to be true, and a decent job and hard work could land you near the top. As capital has recovered over the second half of the 20th century, however, this is decreasingly the case. At any rate, Piketty’s interesting global observation is that much of modern economic theory and empirical work has been based on observation of time series collected during an anomalous historical period, and thus it may have limited “external validity.” We should try to make some kind of rough mental correction for this fact when looking at statistics such as, for example, the average annual return of the stock market. What is the “average number of wars per century”?

-Another finding that jumped out at me was Piketty’s claim that the data clearly contradict Modigliani’s life-cycle savings hypothesis. Briefly, M’s hypothesis is that saving behavior is generally motivated by intent to spend down savings during retirement, so that the lifetime pattern of wealth would look like a triangle–rising from zero during a working career, peaking at retirement, then falling back to zero at death. (As a side note, Nick Rowe has perceptively argued that the phenomenon of “retirement” itself presents a puzzle for economic theory: What Piketty shows is that the lifetime pattern of wealth does not resemble this kind of triangle; rather, wealth tends to increase monotonically over the life cycle. (This type of behavior can be consistent with bequest motives, but Piketty says it also holds for those with no identifiable heirs.) In line with what I was discussing above, Piketty points out that M’s hypothesis was likely consistent with the data in the immediate postwar period when M was writing, with very little role for inherited capital, but not in general. I think this is an important point, because for most upper-middle class people, M’s hypothesis is consistent with their intuitive understanding of capital, because it is consistent with their own lived experience of wealth accumulation. But the fact is that the aggregate amount of capital held by the 99% is relatively insignificant, and the dynamics of capital above the level of the upper middle class change dramatically.

-Piketty discusses the question: do larger fortunes earn better returns? As a small-time investor, believer in index funds, hedge-fund skeptic, etc., I am interested in the answer to this question. Do the rich really have access to “better opportunities” than the rest of us? (David Swensen, the investment manager for Yale’s endowment, believes that the answer is affirmative–he set out to write a book about how individuals could use Yale’s investing strategies, but concluded that they cannot.) Unfortunately, it is one of the areas where Piketty (avowedly) has the least data to bring to bear. The main data source he looks at for this question are the annual returns on university endowments. He sorts endowments by size and documents the pattern of returns by size category. In general, Piketty’s answer to the question is affirmative, with larger endowments showing better returns. I was able to look at the underlying Excel files he has posted to his website (thanks!) and my general conclusion is that this phenomenon is probably mainly due to larger endowments being able to take more equity (or equity-like) exposure. Smaller endowments need to be somewhat more defensive, so they have higher percentages of lower-returning fixed-income assets. Historical returns are more or less consistent with near-100% equity exposures for larger endowments, and lower exposures for smaller ones. However, the main anomaly I observed, and don’t have a good explanation for, is that endowments by and large seemed to avoid significant losses in the tech bubble burst (though they later had significant losses in the subprime crisis). With some casual Googling, I have not been able to find documentation of why and how university endowments were able to avoid that particular collapse–sectoral position limits maybe?

Many reviewers have presented critiques of Piketty’s arguments, and I think at least some of them have some validity. However, I don’t think that any of them invalidate the broad arguments he puts forth. Which is all very sobering, especially since his policy prescription of a global wealth tax is (again, avowedly) quite unrealistic politically.

My Goodreads rating: 4 stars