Capital in the 21st Century - Income and Output

#Capital-in-the-21st-Century---Income-and-Output
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Welcome to the next post in our ongoing series of Thomas Pikkety's Capital in the Twenty-First Century, a chapter which introduces the reader to a lot of definitions used in the book. Pikkety discusses the concepts of national income, capital and the capital/income ratio, and draws attention to the distributional conflict where the inequality of wealth and the consequential income generated from capital is greater than the inequality of income from labour. This is his r > g theory of inequality.

Pikkety introduces the two fundemental laws of capital:

  • @@0@@, where @@1@@ is capital’s share of income, @@2@@ is the rate of return on capital, and @@3@@ the capital/income ratio, essentially defining capital's share of income as the rate of return on capital multiplied by the capital stock. Piketty argues that this equation holds across all societies throughout all periods of history.

  • the higher the savings rate and the lower the growth rate, the higher the capital/income ratio (@@4@@) will be.

The figures below summarise Pikkety's arguments and conlusions on the history of the world distribution of income and income inequity.

Distribution of World Output

#Distribution-of-World-Output
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Distribution of World Population

#Distribution-of-World-Population
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From most of the 1900s, the majority of global production was concentrated in Europe and America, but dropped to circa 50% by 2010. Pikkety predicts that it will continue to fall, and perhaps drop as low as 20-30% at some point during the current century, back to pre-19th century levels, and consistent with the European-American share of the world's population. This graph shows us the major impact that the industrial revolution had on production in Europe and America which, at it's height, was two to three times their share of the global population. We have since embarked on a period of convergence, which, bar any political or economic reversals in countries like China, doesn't look like ending anytime soon.

Evolution of Global Inequality

#Evolution-of-Global-Inequality
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The figure above illustrates Pikkety's assertion that the pattern of convergence is far from over. Per-capita GDP in Asia-Africa went from 37% of the world's average in 1950 to 61% in 2012.

What isn't shown here is the distribution of this GDP per capita within regions, rather than across continents. For example, the yearly per capita income of countries within the EU is approx. €27,000 (this figure rises to €32,000 for the UK, France, Germany, Spain and Italy alone and falls to €16,000 for the eastern bloc), while the per capita output in Russia and Ukraine is about €15,000, only 50% above the global average.

Similar differences can be seen across regions throughout Asia and Africa too.

Exchange rate and purchasing power parity, 1990-2012

#Exchange-rate-and-purchasing-power-parity,-1990-2012

Pikkety further expands on his analysis of how we conventionally define inequality. For example, global inequality would be markedly higher if we used current exchange rates rather than purchasing power parities, as he has done thus far.

For example, consider the euro/dollar. In 2012 this rate was €1/\$1.30.

This means a European with an income of €1,000 could buy \$1,300

on the foreign exchange market. If they took that money to the US, their PPP would be \$1,300.

However, European prices are about 10% higher than American prices, meaning that if that same person were spend the same money in Europe instead, their PPP would be closer to an American income of \$1,200.

Pikkety highlights this parity rather than the official exchange rate to compare the GDP of different countries through PPP, as consumers generally tend to spend their income at home rather than abroad. Using PPP, the purchasing power of the euro, for example, has been steadily increasing since it's inception in 1990s.

Euro/Dollar

#Euro/Dollar
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Below, you can find a list of figures for the official market exchange rates and PPP exchange rates for the euro and dollar against a host of developing countries' currencies.

Euro/Yuan

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Euro/Rupee

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Euro/Yen

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Dollar/Yuan

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Dollar/Rupee

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Dollar/Yen

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Using purchasing power parities, the above figures further demonstrate Pikkety's convergence argument, that the share of income in wealthy countries has been steadily declining over the past 50 years or so. The world's rich and poor countries are inarguably converging in income.

Discussing which forces are driving the convergences illustrated above, Pikkety utilises the range of real income per person between the poorest (e.g. sub-Saharan Africa) and richest regions, and the evolution of this distribution through time. Pikkety makes a specific distinction between national income and GDP, since the wealthiest countries tend to own part of the capital of other countries, therefore recieving additonal positive flows of income from abroad, such that national income will exceed national product.

He draws particular focus to Africa, where a substantial share of capital is owned by foreign investors (circa 20% to be precise, even higher in some sectors). He points out that, while global inequality has been falling in recent decades, this convergence can, in some regions, be explained by significant foreign-owned industrial capital. While conventional economic theory would ascertain that this free flow of capital and the mechanisms of market forces and competition should and will lead to convergence between rich and poor countries.

Pikkety argues that this assumption has a number of defects, namely:

  • The spread of capital does not guarantee convergence of per capita income. Once rich countries have invested in their poorer counterparts, they may continue to own a significant share of their economy, which may also grow to levels, further hindering any potential convergence on an income-basis.
  • Capital mobility has not been the primary factor promoting convergence or developmental catch-up in many Asian countries, such as Japan, South Korea and China, who financed the growth themselves.

Pikkety goes on to state that gains from further openness actually stem from the transfer of knowledge and from the productivity gains of open borders, rather than the efficiency benefits of capital flows. Knowledge diffusion and large-scale investment in education and training provided by a legitimate and efficient government, are required to achieve long-term, sustainable convergence.

Charts adapted from the originals in Thomas Piketty’s “Capital in the Twenty-first Century."

For sources and series, see: http://piketty.pse.ens.fr/files/capital21c/en/xls/