Piketty’s Capital: IV

I’ve made some observations about Thomas Piketty’s Capital in the Twenty-First Century already, here, here, and here, and in this post want to note the way that the twentieth-century welfare state has contributed to the inequality that Piketty has observed.

Piketty observes that growing inequality is the result of the return on capital being greater than the growth in wages (which is determined by aggregate economic growth). If people owned capital in proportion to the wages they earn, inequality would not increase, but because those at the top of the income distribution own significantly more capital, their incomes and wealth grow faster than those at the bottom.

One way to mitigate this inequality would be for those at the bottom of the income distribution to increase their ownership of capital. Indeed, Piketty notes that this happened for the middle class in the twentieth century. The middle class that was almost as poor as the lower class at the beginning of the century had accumulated substantial wealth by the end of the century. But the lower class remains with almost no wealth, which serves to increase inequality.

Inequality perpetuates itself and grows over time, Piketty argues, because of inherited wealth. The children of the rich start out with an advantage, because of their inheritances, while the children of the poor start with nothing because their parents had little to bequeath.

One reason the lower class (Piketty includes the bottom 50% here, so it differs from what one might ordinarily consider poor) has little incentive to save is that the welfare state has taken much of that incentive away.

One good reason to accumulate assets now is for precautionary purposes. Saving for retirement, for unexpected health care costs, and for the possibility of losing one’s job are examples. Programs like Social Security, Medicare, Medicaid, and unemployment compensation take away much of the incentive for precautionary saving.

The bottom half of the income distribution is wealthier than they appear from wealth statistics, because they “own” a claim to future retirement and health care benefits—a claim that they have paid for in their current and past taxes. But the difference between these claims to future government payments and services when compared to precautionary saving is that precautionary saving is an asset that (if there is any left at death) can be passed on to heirs. Government benefits end at death, and heirs get nothing.

Piketty supports government provision of health care and pensions for everyone. This is not inconsistent with his dislike of inequality, but the more secure the welfare state makes people feel, the lower the incentive to set aside precautionary saving, which is the main reason people at the lower end of the income distribution have to save. And the less they save, the greater the imbalance of capital ownership will skew toward those at the upper end.

Why set aside precautionary savings rather than take a vaction, or buy a new car, when government programs exist to take care of those contingencies? The government policies Piketty advocates contribute toward the reason he cites for growing inequality.

Randall G. Holcombe is a Research Fellow at the Independent Institute and DeVoe Moore Professor of Economics at Florida State University. His Independent books include Housing America (edited with Benjamin Powell); and Writing Off Ideas.
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