Finance & Development, June 2014, Vol. 51, No. 2

Sarwat Jahan and Chris Papageorgiou

PDF version

The Rise of the Top 1 Percent

Thomas Piketty

Capital in the Twenty-First Century
Belknap Press, Cambridge, Massachusetts, 2014, 685 pp., $39.95 (cloth).

This important and fascinating book surely ranks among the most influential economic analysis of recent decades. Much of the debate over inequality in recent years is the result of the work of Thomas Piketty and his fellow researchers.

Earlier research on inequality focused on data from household surveys described in terms of the “Gini” index, which measures the income distribution in a country. But the Gini misses much of the action at the top of the income distribution, partly because the very rich tend not to report all their income. And at best, these surveys measure income, not wealth.

Piketty has painstakingly drawn on new data sources to show that income inequality has risen sharply in recent decades to extremely high levels in the United States and, to a lesser extent, in a handful of other English-speaking countries. The rise has been driven mostly by wage inequality between the top 1 percent of the wealthiest in society, and everyone else. (I wish there had been room in this long book to address the critics who attribute these results to distortions in the data.)

A standard explanation is that education has failed to keep up with increasing demands for skilled labor. Unlikely, says Piketty. That doesn’t explain why inequality increased sharply even among graduates from top colleges.

Could these sky-high salaries reflect top CEOs’ ability to generate huge increases in value? No, winner-take-all forces would presumably also be at work in other developed economies such as Japan, France, and Germany, and we see no such relative wage increases.

Maybe these other countries have resisted the relative wage implications of technological change, precipitating the slowdown in growth observed in several of these countries around the time inequality started to rise in the United States in the late 1970s. But real per capita growth has been about the same in both sets of countries since about 1980.

For Piketty, the most plausible explanation—though here he has less clear evidence—is essentially cultural and political; that the political elite in the United States and the United Kingdom engaged in radical market-oriented reforms that lowered the top tax rates, kept minimum wages from rising, weakened unions, and contributed to a change in what is considered an acceptable pay differential.

With a corporate governance structure in which the elite choose each other’s pay, little remained to constrain top wages. The solution, for Piketty, is to reverse those changes. He notes that growth did not increase in the United States and the United Kingdom as they lowered their marginal tax rates, relative to their continental peers.

Wage income inequality is limited to a handful of countries, but wealth is extremely unevenly distributed in all developed economies. Before World War I, however, things were even worse. The Great Depression and World War II brought about a huge leveling. At the same time, and continuing through the 1970s, public policy in the form of confiscatory top tax rates and high inheritance taxes kept the wealth distribution fairly stable.

But this may have been a temporary respite. The system is biased against the little guy: big fortunes earn higher returns than smaller ones, and the rich save more (presumably—Piketty doesn’t say enough about saving rates). Meanwhile, population growth has halted and productivity growth is slowing, which imply a trend toward a 19th century–style society dominated by inherited wealth.

For Piketty, such a society is inconsistent with the meritocratic and democratic values that underlie modern Western countries. Last time it took the cataclysms of the Great Depression and World War II to induce major change. But Piketty remains optimistic that ideas (and data) can influence policy. His main recommendation is a tax on all forms of capital, which would require international coordination and probably cross-border capital controls.

This book contains important lessons for economists. It is a (perhaps unwelcome) reminder that what they measure reflects political choices. It cautions them to be wary of viewing recent decades as some sort of “steady state”; the evolution of post–World War II incomes and wealth reflect the unwinding of earlier events, and the point is more general. And it reminds them of the rhetorical and explanatory power of simple comparisons of facts, once collected and arranged, relative to complex statistics and models.

Nobel Prize–winning economist Robert Lucas, Jr., commenting on questions of long-run economic growth, said that “once one starts to think about them, it is hard to think about anything else.” But readers are left with the thought that it is the distribution of the product of growth that will shape the economic and political nature of society in 25 or 50 years—and that this is the issue that demands our attention.

Andrew Berg
Assistant Director
IMF Research Department

Development by Way of Rights

William Easterly

The Tyranny of Experts
Basic Books, New York, 2013, 416 pp.,
$29.99 (cloth).

I loved the premise and conclusions of William Easterly’s new book. The intervening 300 pages gave less cause for celebration.

Easterly sees development as hijacked by technocrats: “The technocratic illusion is that poverty results from a shortage of expertise, whereas poverty is really about a shortage of rights.” The founding of the World Bank is the moment of original sin (the IMF gets off lightly). The resulting polemic is sweetly written, packed with fascinating human interest stories to bring alive what could have been dry conceptual debates.

For Easterly, the individual is hero, either unleashed to transform the world or confounded by the malignity of politicians. It is a quintessentially American, even Hollywood, take on the human condition. His view of power is summed up in the title of the chapter on institutions: “We oppress them if we can.”

Easterly’s gurus are Adam Smith and Friedrich Hayek; he reserves his scorn for development economists like Gunnar Myrdal and W. Arthur Lewis, who created a special economics that discarded free choice and individualism.

The book contains thought-provoking accounts of the origins of the technocratic approach, which Easterly dates to 1919 (not Truman’s 1949 speech, customarily cited as the dawn of aid). He sees it as rooted in attempts to divert attention away from the rights agenda, whether over U.S. anti-Chinese discrimination in the 1920s and 30s, Britain’s attempts to resist postwar decolonization, or the struggles over civil rights in the 1950s and 60s. He traces a direct lineage to more recent wars (Cold; on Terror; on Drugs), where a focus on technocratic development enabled a convenient blind eye to be turned when rights violators lined up on the West’s side.

This readiness to forget rights was music to the ears of dictators of all stripes, who grabbed the planner approach (or at least its language) as a way to ignore the opposition and consolidate their own economic and political power. He sees this abandonment of individual rights as the “moral tragedy of development today.”

There is much to agree with here: his criticism of the blank slate approach, which ignores national and local specificities; the abuse of individual rights in the name of some higher national purpose; and the efficacy of spontaneous solutions rather than conscious design (neatly equating planners with anti-evolutionists).

Easterly even comes out as a growth skeptic: “If there is one number to which the rights of millions will be happily sacrificed, it is the national GDP growth rate.”

But his argument founders on the China (or more broadly east Asia) question. Confronted with the historic reality that high-speed growth in east Asia has taken place under a variety of autocratic systems (the so-called developmental states), advocates of the American Dream confront two options: either accept that there may be trade-offs between growth and rights or try to explain away the east Asian miracle as a triumph for individual rights and market forces.

The World Bank attempted the latter with its much-derided East Asian Miracle of 1993, but Easterly makes that exercise in spin look positively timid: “There is more evidence for attributing the rise of China as an economic superpower to the anonymous spread of the potato than to Deng Xiaoping’s economic policies.” This is desperate stuff.

By entering the terrain of rights, he expands on his earlier book, The White Man’s Burden, which put forward a distinction between searchers and planners—a dichotomy I have found very useful over the years. But his grasp of rights is selective and flawed. For Easterly, rights are always individual, never collective—no mention of trade unions, women’s or indigenous movements, or producer organizations.

Moreover, this portrayal of heroic individuals struggling for rights draws extensively on U.S. history, but completely ignores the institution that in recent years has done more than any other to promote human rights: the United Nations. That those contemptible planners and bureaucrats in New York should be advancing rights for all sorts of marginalized groups around the world clearly contradicts the premise, so they must be airbrushed out of the picture.

Finally, Easterly’s conclusion is that if you care about rights, you should oppose aid. Mine is the opposite. Done well, aid can support poor people’s struggles (individual and collective) for their rights, something I have seen firsthand in numerous countries in my work for Oxfam.

Duncan Green

Strategic Adviser, Oxfam GB
Author of the blog
From Poverty to Power

Progress in Political Economy

Michael Mandelbaum

The Road to Global Prosperity
Simon & Schuster, New York, 2014, 272 pp., $28.00 (cloth).

Globalization—greater connectedness, to be more precise—dominates in our era, and making sense of its virtues and vices may be the central question. Most politicians try a practical approach—as the old saw goes, “The only thing worse than being exploited by multinational capitalism is not being exploited by multinational capitalism.” Yet the literature on globalization has been much more polarized between enthusiasts, who consider free trade, open capital markets, and the free flow of people the great engines of human progress, and critics who blame those forces for wrecking communities and the environment.

Michael Mandelbaum is in the first camp. His new book is breezy, accessible, and peppered with facts. It tries to restate the optimist’s position while calibrating enthusiasm down a few notches to fit the post-financial-crisis mood. His central argument is simple: if economics is the solution, politics is the problem. The “global economy, when it is working successfully—indeed because it is working successfully—cannot help but provoke opposition to its workings, which in turn produces political conflicts.”

After the obligatory canter through free trade theory, and a quick gallop through the headlines of recent economic history, the book hits its stride with its description of how politics obstructs rational economics, particularly in the so-called BRICS (Brazil, Russia, India, China, South Africa). India will be let down by its messy, corrupt democratic politics. But will it be a greater disrupter than China, whose ability to compete in services will threaten far more than the West’s manufacturing workforce? Russia must cope with bribery—20 percent of GDP in 2005. It also suffers from an unhealthy mix of populism, authoritarianism, and inefficiency, with “energy revenues high enough to generate widespread corruption and prevent robust growth, but not high enough to sustain the standard of living to which Russians aspire.” Brazil is also vulnerable to populism: 13 percent of its GDP goes for pensions, and proponents of greater public expenditure are likely to defeat “those favouring prudence who have economic history on their side.”

Mandelbaum nearly always blames the people or, more precisely, the way democracy mobilizes populist sentiment to defy economic rationality. The argument’s theoretical fuel is the Stolper-Samuelson theorem, which says that countries as a whole gain from trade, but the gains are distributed unequally.

You might think that the obvious question prompted by the Stolper-Samuelson theorem is how to handle the political economy of progress. If a society as a whole gains from trade, but some lose along the way, it may make sense to share the pain as well as the gain. People in the world of policy and politics realize this. But apparently not the author. And he has no response to the case made by Occupy Wall Street and others who don’t take issue with globalization as such, but rather with the hugely uneven distribution of the gains between the 1 percent and the 99 percent, and the widening gulf between returns to capital and to labor.

The book says it’s about political economy, but is naïve when it comes to politics, especially when it comes to global solutions. We’re told, “the alternative to the current global economic order is . . . nothing.” An undergraduate would get an F for that statement. There may be no comprehensive and realistic alternative waiting in the wings, but innumerable policies have been proposed by central bankers as well as antiglobalists, Nobel Prize winners as well as nongovernmental organizations. At the very least these deserve some comment.

Mandelbaum’s prognosis is breezily optimistic: “The global economy will continue to grow. Its growth will make everyone richer. While not inevitable this is the likely future.” I hope he’s right. There is much in his book I agree with. If you want to give a non-Westerner insight into the worldview of the U.S. elite this is not a bad place to start. It’s fairly well informed, and easy to read.

But its arguments are better understood as symptoms of the problem than answers. Robert MacNamara concluded that the biggest strategy errors arise from failures of empathy rather than of analysis. A book whose references are almost all American, and all English language centered, struggles to understand how the world looks from the bottom up rather than the top down. Its vices are complacency and parochialism—something of an irony for a book that purports to be about the glories of a much more connected world.

Geoff Mulgan
Author of The Locust and the Bee:
Predators and Creators in Capitalism’s Future
Chief Executive, NESTA
(UK National Endowment of Science,
Technology and the Arts)