So I called Piketty at his office in Paris, and he agreed to walk me through it.
He suggested imagining a hypothetical village from centuries ago in which neither the population nor the economy was growing. Every year, the village produced the same amount of goods for the same number of people to divide — a reality that was typical before the Enlightenment, when material living standards and human longevity barely rose. (The peasants of the 15th century were not better off than peasants in ancient Rome.) Even in a zero-growth society, however, assets that helped people produce goods — also known as capital — had value. Capital, Piketty told me, counts as anything “useful, any kind of equipment. Basic tools. Stones in prehistorical times.” Anything, in other words, that “makes people more productive.”
In our hypothetical village, a large farm might produce $10,000 worth of crops in a year and yield $1,000 in profit for its owner. A small farm might have the same 10 percent rate of return: $1,000 in annual crop sales, yielding $100 in profit. If the large farmer and small farmer each spent all of their money every year, the situation could continue ad infinitum, Piketty said, and the rate of inequality in the village would not change.
But one of capital’s great advantages is that its owners can make enough income to spend some of their money and sock the rest of it away. If the large farmer saved $500 of that $1,000 profit, he could buy more capital, which would bring more profit. Perhaps a few owners of smaller farms had debts to pay, and one of the large farmers bought them out. Eventually, the owner of the expanding farm might find himself owning land that yielded $1,500 or $2,000 in annual profit, allowing him to put aside more and more for future capital acquisitions. Less-stylized versions of this story have been playing out for centuries.
I have come to think of this idea as Piketty’s First Law of Inequality. The fact that the rich earn enough money to save money allows them to make investments that other people simply cannot afford.
As I was reading about this imaginary village I realized I'd lived in just such a village, in Nepal 25 years ago. And it was obvious how a basic inequality of capital influenced inequality of outcome. I lived in a big house, owned by a wealthy family, in a region where people produced for subsistence. The biggest inputs after land itself was seed, water, and human labor (performed largely by family members and especially women family members.) Large families had more labor, but large families also tended to divide land and end up with smaller plots. Wealthy families farmed their land by hiring labor from poorer families. This was done with a combination of money and manipulation of important local inputs like food, seed, water, loans, gifts, and social connections. A wealthy family, like my family, could afford to loan out food and to hoard seed in return for labor at a season in which labor was in demand. Poor families, which needed that labor themselves, needed food or seed during other parts of the year. An underdeveloped market for other products, no ready cash, no banking system other than loans extended by rich families, meant that they had to trade what they had (labor) in exchange for necessities when their bargaining power was low. Even where poor families owned something of value--land, gold, labor--the leverage that wealthy families had over poor families was the ability to time their transactions. Larger amounts of something desirable (land, gold, labor, power, seed, water, government connections) meant that wealthy families could use their surplus at seasonally or socially critical times to force access to labor at other critical times at a price they preferred. Sound familiar?
So why isn't it inevitable? Well, lots of things can break into the system--new technology can replace family technology and make small families more productive (so they don't have to split their land up among too many children). New sources of off farm employment can arise--in the case of Nepal, in the old days, men who went off to serve with the Gurkhas could send cash back to buy new land, in new locations, or to employ laborers to take their own place in the system. Each of these influxes of cash money into the economy disrupted the control of the former elites. Education which created new choices for elites other than farming drew elite families out of the village entirely and rendered farming and control over the farming economy irrelevant. For an interim period, before the collapse of the farming economy, foreign seed banks and low cost loans also intervened between local elites and their control over the labor economy. No system has to stay at the equilibrium preferred by the elites. As Leonhardt and Piketty both argue rising inequality is a choice.
Cross posted at No More Mr. Nice Blog