0:33 Intro. [Recording date: September 16, 2014.] Russ: Your book, Capital in the 21st Century, is a remarkable book, and it's received a remarkable amount of attention. I don't think there is a book since Keynes's General Theory that has generated as much interest. So, first, I want to say congratulations. Guest: Thank you. Russ: The book is an incredible collection of data, much of it done by you with various coauthors. And it's also a series of explanations for what's in the data. I want to start with what you consider the main empirical findings. What are they? Guest: Okay. Well, there are really several important empirical findings, because this is first of all a book about the history of income and wealth distribution over 20 countries over 3 centuries. So, it couldn't be that this can be summarized with just one evolution or one mechanism. There are many different sources, sometimes contradictory, that are going on. And I really first want to stress that the primary purpose of this group is to put together the vast quantity of empirical data that I could never have collected on my own, and that was collected with several dozen scholars, Tony Atkinson, Emmanuel Saez, Stefanie Stantcheva, Gabriel Zucman--many scholars from many countries. And the primary purpose of the book is really to make this material accessible, to try to tell a story in plain language that allows everybody and certainly economists to access the historical material so that people can make up their own mind about the future, about the explanation. I certainly do not claim the ultimate explanation for everything. We know a little bit more than we used to, but we still know far too little. So, one of the key patterns and one of the key evolutions that I have learned about in this research is the following. We've seen in most developed countries and important reduction in inequality in the first half of the 20th century. And then, starting somewhere in the 1970s or 1980s, depending on the country, we've seen an important rise in income and what is inequality. And this reflects really different mechanisms. Some have to do with inequality of labor income. And some that have to do with the inequality of wealth. And both are important. To a large extent what the book is trying to do is to shift the attention from the inequality of labor inequality to the inequality of wealth, which is a very long-run idea. Even more important; but really both evolutions are important and involve different mechanisms. So the rise in the inequality of labor income, which has been particularly strong in the United States and somewhat less strong in Europe and Japan, you also find it there; it's usually analyzed in terms of changing patterns for the supply and demand of skill, the impact of globalization, competition with emerging countries. And this is certainly part of this explanation. But one of the points I make in my book is that this cannot be the entire explanation, because a very large part of the rise in labor income inequality in fact has to do with the very, very top incomes, you know, the risk of very top managerial compensation, the top 1% or some tiny, even .01%, earnings, typically executives in very large corporations. And that's difficult to explain just on the basis of supply and demand for skill because it's not the top 1% labor earners are a lot more educated than the next few percent. So if you really want to explain it, and that's what I do in the book using joint research with Emmanuel Saez and Stefanie Stantcheva, you have to look at the transformation of the institution governing the base-setting process at the very top of large corporations. And to summarize very quickly our conclusion, we feel that the theory of marginal productivity is a bit naive, I think for this top part of the labor market. That is to say when a manager manages to get a pay increase from $1 million a year to $10 million a year, according to the textbook based on marginal productivity, this should be due to the fact that his marginal contribution to the output of his company has risen from 1 to 10. Now it seems a bit naive. It could be that in practice individual marginal productivities are very hard to observe and monitor, especially in a large corporation. And there is clearly strong incentives for top managers to try to get as much as they can. And the change, very sharp change in the tax progressivity that has happened in the United States since the 1970s, 1980s probably changed quite radically the incentives for top managers to try to do as much as they can to get this pay increase. Russ: You are talking about the reduction in marginal tax rates. Guest: Right. Exactly so. Russ: And your argument in the book is that this meant that if you could get a raise you could keep more of it than you would before. This is the opposite of what standard economic theory would predict, which is decreases in marginal tax rates should actually lower pre-tax income but increase after-tax income. But you have a different model, then, of what determines pay. Guest: Well, in the standard model when you cut the marginal tax rate, people react by working more, being more productive. And this should raise income. Now, this is one possible channel. But what we find in the data is that there could be another channel, which is simply that you are going to bargain more aggressively for bigger pay. So, to be very concrete, when the top income tax rate in the United States between 1930 and 1980, which is a very long period of time, was on average 82%. That's a [?] level. You had periods when it was 91%, periods when it was 70%. On average it was 82%. Now, when the top tax rate is 82%, now of course you always want to be paid $1 million more, but on the margin when you get a pay increase of $1 million, 82% is going to go straight to the Treasury, so your incentive to bargain very aggressively and put the right people in the right compensation committee are going to be not so strong. And also your shareholders, your subordinates, maybe will tend to tell you, look, this is very costly. Whereas when the top tax rate goes down to 20, 30% or even 40%, so you keep 2/3rds or 60% of the extra $1 million for you, then the incentives are very, very different. Now, this model seems to explain part of what we observe in the data. In particular, it's very difficult to see any improvement in the performance of managers who are getting $10 million instead of $1 million. When we put together a data base with all the publicly traded companies in North America, Europe, Japan, trying to compare in the companies that are paying their managers $10 million instead of $1 million, it's very difficult to see in the data any extra performance. And if anything what you see given the elasticity of top managerial pay with respect to profits of the company is actually higher for the variations in profits that have nothing to do with individual performance or for instance when you have industry-wide changes in profits or shocks to the terms of trade or other macro parameters that affect the profitability of your business, then the elasticity of the top managerial pay is even higher. So we truly suggest that basically when you have more cash on the table you tend to take it, particularly in countries and time periods where the tax rate is lower. Russ: Steven-- Guest: Anyway, that's one of the mechanisms [?]--

10:24 Russ: Let me ask you about that. Steven Kaplan, who was a guest on EconTalk a while back, in his work with Joshua Rauh on the top 1%, they argue that because the gains are very similar in the top 1% across sectors--so that the corporate sector does get higher pay, but so do the non-corporate sector--lawyers, athletes and others in the top 1% have similar increases--that it's hard to believe that it's corporate governance, failure of corporate governance to bargain appropriately with top managers. What do you think of their work? Guest: Well, I think the top managers are in fact a much, much bigger fraction of the top 1%, the top 0.1%, than athletes and movie stars and such professions. So in fact, I do believe that most of the action comes from top executives in large corporations. I think one reason why Kaplan and his coauthors don't see it that way is that they only count the top 5 earners in large corporations. But in large corporations it's actually a lot more than 5 people that are making it to the top 1% or even to the top 0.1%. So they actually don't have the data because they only use publicly released data and the top 5 earners in each corporation. But if you use the tax return file where you have the entire universe of income earners and wage earners in the United States, then in fact you can see that top executives broadly defined, all those that make--you know, if you want to be the top 1% you have to make more than $400 or $500 thousand dollars; if you want to make it to the top 0.1%, $1 million, $5 million depending on which share you look at. But if you take such thresholds you will see that top executives in large corporations are indeed driving the process. One limitation--another limitation in the data they are using is that they basically only look at the United States. So, I think the United States is a very interesting country of course, but I think the rest of the world is interesting also. And in order to understand what are the true reasons for what we observe, I think that the cross-country perspective is important. Because it's very difficult to explain--one reason where it's so difficult to explain the data simply with the skill-based, talent-based story is that it's hard to understand why it would happen so much in the United States and much less in Germany or Japan or Sweden. Russ: One explanation would be that combined with globalization, U.S. corporations tend to be larger. And there have been studies that find that there's a correlation between compensation and size of firm. Guest: Well, no. If you look at international data and you control for size, you still have the main part is less than explained. So the main part of the extra inequality that you find in the United States is less than explained. So this is what we do in a paper with Emanual Saez and Stefanie Stantcheva, it was published in the American Economic Journal earlier this year in 2014, and as far as I know this is the first paper in taking a cross-country perspective and top pay setting. And we do have control for some size; we do have control for industry. So, you know, it's not that you have bigger companies in the United States, it's not that you have more financial companies in the United States or the United Kingdom that's going to be enough to explain the particularly strong rise in the inequality in those two countries, particularly in the United States. We put these controls in the regression, and what we find is, what matters much more is the change in the top tax rate over time in these different countries. But, you know, I think these cross-country analyses are more complete than other analyses of this sort, but I certainly do not claim that this is the final word. I think the supply and demand for skill explanation, globalization explanation, also matters. I think we don't have to choose between the two. I think that the two are important. I just think that for the very top end, institutional forces are probably even more important.

15:16 Russ: Well, we'll come back to this, because I want to come back to the United States in particular in the labor inequality; but I want to make sure we get to the wealth inequality issues. You write that r > g is the central contradiction of capitalism. Explain what r and g are, and why their relative size is important. Because that's really one of the central themes of the book, that runs through the entire book. Guest: Right. So, my book is trying, as I say, to shift attention from rising inequality of labor income to rising wealth inequality. And indeed, in order to analyze the long run evolution of wealth concentration, there is one central force that I emphasize, which is the tendency of the rate of return to capital to exceed the economy's growth rate. So, what are we talking about? So, r is the rate of return on capital, which is what is the return that you get in one year on your capital investment. So, the easiest form of capital earning[?] would be, imagine you own an apartment, on average worth $1 million. What is going to be the rental value during one year? So, if the rental value is $40,000 during your year, then that would be a return of 4%. Now, when you invest your money on the stock market, which is typically a more risky investment than housing, the return in the long run is typically bigger than that--it could be 6%, 7%. So of course it's very volatile across assets. It's not just saying for the different assets, but typically it can be 4%, 5% or more for more risky investment. The growth rate of the economy is a completely different concept. So, the growth rate of the economy in the long run reflects, first, the growth rate of population, so how much population is increasing. And next, the growth rate of productivity; so this is the growth rate of per capita GDP (Gross Domestic Product)--how much the output per inhabitant is rising due to the rise of productivity, technical knowledge. So the growth rate of the economy is determined both by demographic forces, by innovation, and of course the forces have not much to do with the forces that determine the rate of return to capital, which are primarily how useful capital is for production. And there's no reason why r and g should be equal. And in practice, what we observe, and we can talk a lot more about why we observe this, is that in the long run, there is a tendency for r to exceed g. Which means something very concrete. So let's take an example. Assume r is 5% a year and g is 1%. What does this mean? This means that if you own a lot of wealth to begin with, then you can consume 4/5ths of the return to your capital and you can reinvest only 1/5th of the return, so 20%. And this will be enough to ensure that your wealth will rise at the same speed as the size of the economy. So this is a very nice situation for initial owners of wealth in the sense that you can sustain a high living standard, reinvest only a small part of your income and still your wealth and the wealth of your family, your successors, can rise as much. Now, that does not imply that inequality will rise to infinity, because people indeed will typically consume part of their return to their wealth. There will always be-- Russ: Sometimes they give it away. Guest: Sure. So there will always be some ability in wealth, because some people give it away, some people have many children, some people have too few children, some people die too late, some people die too soon, some people make crazy investments, some people make very good investments. So, you know, you will always have some mobility. But other things equal, bigger gap between r and g will lead to an equilibrium distribution of wealth that is more unequal and that will involve more reproduction over time of inequality. Okay? So the bigger r-g, the more inequality, the less mobility. And of course there are many other forces that are important. The saving behavior, are you going to give it away, the demographic behavior, do the rich have more children than the poor, how do the financial markets operate, or for instance financial deregulation in recent decades probably increased the inequality in rate of return for people with different wealth levels. From the data that we have and analyze in the book, for instance for large university endowments, it looks as if the bigger your endowment, the more you are able to access to sophisticated financial product or financial derivatives, etc. that give you some time a much bigger return than the typical middle class families sometimes getting pretty lousy returns. So the inequality in return around the average return is also going to play a big role. But taking all of this, all the factors as given, the bigger the gap between the average rate of return and the economy's growth rate will tend to lead to greater inequality. And what I argue in the book and what I have shown using historical data is that this is probably one of the key forces explaining why historically wealth concentration has been so large in most societies and most civilizations, actually until WWI. If you take in particular most European countries, you have very, very large concentration of wealth well until WWI. And what I argue using historical materials that I found, especially for France and Britain, is that the fact that, historically, it was the fact that the rate of return was bigger than the growth rate was pretty [?] during most of human history simply because the growth rate was close to zero. So during most of the until the Industrial Revolution the population was almost stationary. Productivity was rising very, very slowly. So the total growth rate of GDP was less than 0.1 or 0.2% per year. So, of course, the rate of return was a lot larger than that. Typical rental value to land or to buildings would be at least 3% and generally 4 or 5%. So that's a lot bigger than 0.1%. And now with the Industrial Revolution in the 19th century you have of course a rise in the growth rate. But at the same time the rate of return to capital is also rising, somewhat because you have new investment opportunities, new forms of capital accumulation. So maybe growth rate goes from 0 to 1%, in per capita terms and the rate of return goes from 4-5 to 5-6, sometimes 7%. So at the end of the day the gap between the two is not very strongly affected. And it's important to realize that the growth rate in the very long run is typically not 5%. The only time in history where you observe a growth rate of 5% or above 5% are countries that are catching up with other countries. So typically Germany or Japan or France in the post-war period are growing faster than 5% per year. But this is just because in 1945, you know, these countries have very low GDP, so they have to catch up in particular with the United States. Or today China is catching up with the rest of the world so they have very fast growth rate. But when you are at the world technological frontier, there is no example of a country where per capita GDP growth is higher than maybe 1.5%. So some people think it's even less than that in the very long run. In any case, there are reasons to believe that we might again, have in the 21st century this inequality of developed countries and maybe also in emerging countries when they will have completed this catch-up process, we will have this inequality between r and g. Together with the final [?] that has increased inequality in r, this is one of the mechanisms that can contribute to explain relatively high and rising inequality of wealth.

24:43 Russ: Okay, so let me raise some issues I think are relevant. First, it's clearly true that if I save all my income and I don't eat anything and I don't give any of it away and have lots of children--I have one child, say--that that one child will have gotten an enormous extra benefit from the fact that the parent can invest the money at r. That child will have an advantage over a wage earner who doesn't have any access to capital. It seems to me though that in the 20th century--in the 20th century, and a little bit in the 21st--first there is an increased access to capital by the general public in the form of retirement plans and stock programs and low-priced opportunities to invest in equity, in particular indexed mutual funds. And the real question though, is, why should I care? Let's talk philosophically. And by the way, the r you are talking about is risky, of course, the average rate. So it's not always true that the rich are able to just get this risk-free rate. It's not risk free. But let's talk philosophically for a minute. There are a lot of people who are wealthier than I am. A lot of them didn't earn it. Sam Walton, who founded Walmart, 4 of his either relatives or descendants are in the top 10 of the Forbes 400; they are 4 of the richest of the 10 richest Americans right now. Steve Jobs or his descendants--they are doing better than I am. They have a lot more access to money than I do. And there are people with less than I have. Why should I be concerned about that? In particular, do you see any role for the accumulation of capital to help people other than those who hold it? Is there any worry that your interest in reducing capital concentration could affect the growth rate? Because you don't seem to suggest any connection between the two. So those are a lot of questions there. Sorry. Take a shot at it. Guest: Yes, you say so much that I don't know where to start. But let me make clear that I love capital accumulation and I certainly don't want to reduce capital accumulation. The problem is the concentration. So let me make very clear that inequality in itself is of course not a problem. Inequality can actually be useful for growth. Up to a point. The problem is when inequality of wealth and concentration of wealth gets too extreme, it is not useful any more for growth. And it can even become bad, because it leads to high perpetuation of inequality over time, so it can reduce social mobility. And it can also be bad for the working of our democratic institutions. So where is the tipping point--when is it that inequality becomes excessive? Well, I'm sorry to tell you that I don't have a mathematical formula for that. Russ: At least you are honest. Guest: All I have, all we have, collectively, is historical evidence. And all I do in my work is put together a lot of historical evidence to see what we can learn about the location of the tipping point. So, what can we learn about the location of the tipping point? Let me tell you a couple of things we can learn. First of all, the kind of extreme concentration of wealth that we had in every European country until WWI, I think was not useful. It was excessive. At that time, there was a lot more concentration than what we have today in Europe and even more than what we have today in the United States. Basically there was almost no middle class, so 90% of the wealth would belong to the top 10%. Now, whether it's useful for growth--there's very little evidence for this claim. If you look at the evidence we have, you have a huge reduction in concentration following WWI, the Great Depression, WWII also, following the public policies: universal education, the welfare state, progressive taxation that were adopted from these shocks. Now, were these bad for growth? No, it was not bad for growth. If anything, growth in the post-war period has been higher than what it has ever been. And even today although it is not great it is of the same order order of magnitude or actually better than what we had in the 19th century, early 20th century. And the reason is simply that the middle class, the fact that we have significant share of wealth that does not belong to the top 10% and that belongs to a broad middle class that have access to wealth. It's certainly not bad for growth. So, inequality above a certain point is just not useful any more. So I think we don't want to return to this kind of extreme form of inequality. And I think at some abstract philosophical level, everybody agrees that inequality is acceptable as long as it is in the common interest, or as long as it benefits all of society through more innovation, more growth. Now, right now, if you look at the data we have on wealth dynamics one striking finding that I put forward in my book is that, you know, first I think what we need is we need more transparency about wealth. We know too little about wealth dynamics and you know, one of the reasons why I am in favor of wealth tax and we can talk more about that, is that this will produce more transparency, more data on wealth dynamics. But for now we need to do with what we have, and what we have are typically Forbes's ranking of wealth in the United States or similar rankings in the rest of the world. Now, if you look at these data, what you find is the following. Over the past 30 years, if you start in 1987 which is when Forbes started producing their global wealth ranking, and you go until 2013, what you find is that the top wealth holders--usually what people do is just to say, okay, you have more and more billionaires in the world, we know, in a growing world economy is not too surprising. So what I do is a little bit more sophisticated. You take a big fraction of the world population again and you have a rising world population, but you take a few percentage at the very top and you look at the evolution of the average wealth of this group. And you compare to average growth of the world economy. So of course this group, as you mention very rightly, is not made of the same people. There is a lot of mobility. The world billionaires of 1987 and those of 2013 are not the same. But still it's interesting to look at how the average wealth of this group is changing because if we were in an equilibrium of the world distribution of wealth, you know in principle, you have some mobility--some people go down, some people go up. But on average the average wealth of this group should be rising approximately at the same speed as the size of the world economy. I'm not saying it should rise exactly at the same speed, but it should be comparable rate of growth. Not this is not at all what you observe. So, according to the data we have from Forbes's global wealth ranking, these very top groups have been rising at 6-7% per year for that period. Now, world GDP has been rising at 3, 3.2% per year over the period. But in fact half of it is due to population. So if you take per capita income at the world level and per capita wealth at the world level, it has been rising at 1.5-2% per year. So in other words your top is rising 3 to 4 times faster than the average. Now of course this cannot continue forever. And I'm not saying this will continue forever. You can see that if it was to continue forever--if the top was to rise 3 to 4 times faster than the size of the world economy forever, then 30 years from now you will have close to 100% of world wealth belongs to a little group of billionaires. And you know some of them are U.S. billionaires, some of them are Russian oligarchs-- Russ: Sure-- Guest: Lots of people. Russ: Some of them-- Guest: You know, 100% would be too much. So I think you agree with me that this cannot continue forever and actually it will not continue forever. Russ: [?] Guest: The question--well, you agree that you cannot have forever the top rising 3 or 4 times faster than the average. Even if you have mobility, even if these are not the same people, from a purely logical perspective this cannot continue forever.

33:31 Russ: Right but the-- Guest: You agree with that. Russ: But the question is: What's the underlying causal mechanism? And let's take two examples, one of which is very mundane and one of which is not mundane. So, the Waltons, who we talked about before, who were not there in 1987 but are there now, they changed retailing in the United States and probably in the world; and they made it easier. They figured out ways to deal with inventory and to control costs using technology-- Guest: Sure. You are right. I agree with you. Russ: And they made millions of people better off. And they got richer being in the top 1% than the people before them. Guest: You know, I exactly agree with you. There is no problem with that. But still-- Russ: So they made the world a better place. Guest: I am asking you the question again--can I ask you a question? Russ: Do you agree that they made the world a better place? Guest: Oh, yeah, of course. Of course. Russ: Okay. Go ahead. Guest: Much better place. And Bill Gates as well, as well as lots of entrepreneurs in the world, which are extremely useful, of course. Who can deny that? But still, even if, you know, these people were all different entrepreneurs each year and that are very useful for the world, do you agree that the average wealth of the top cannot grow forever 4 times faster than the size of the world economy? Russ: I don't think that's the relevant question. The relevant question is-- Guest: No, no, but look. It's a very simple logical question. And of course so let me try to [?]-- Russ: Well, I think they can get-- [?] They can get an ever increasing share. The fundamental question is: What's the value to the rest of us as they get an ever increasing share? And if their increasing share is coming from an increase in technology and globalization--which is limited--that will slow down. The globalization will slow down. So the ability to capture large amounts of wealth relative to the past Guest: Well, I think you are remarkably optimistic about natural forces, and this is great. I love market forces as well. But I think at some point it's important to look at the numbers. And when a group is growing 3 to 4 times faster than the average, just simple computation, simple logical computation which show you that in 30, 40 years, the share of national wealth going to a very tiny group can get enormously high. So, let's be again-- Russ: But there's-- Guest: concrete about what are the wealth shares. Let's be very concrete. Let's take the United States. In the United States right now, the bottom 50% of the population own about 2% of national wealth. And the next 40% own about 20, 22% of national wealth. And this group, the middle 40%, the people who are not in the bottom 50% and who are not in the top 10%, they used to own 25-30% of national wealth. And this has been going down in recent decades, as shown by a recent study by Saez and Zucman and now is closer to 20, 22%. Now, how much should it be? I don't know. I don't know. But the view that we need the middle class share to go down and down and down and that this is not a problem as long as you have positive growth, I think is excessive. You know, I think, of course we need entrepreneurs. I'm not saying, look, if it was perfect equality the bottom 50% should own 50% and the next 40% should own 40. I am not saying that we should have this at all. I'm just saying that when you have 2% for the bottom 50 and 22 for the next 40, you know, the view that we cannot do better than that although why is you won't have entrepreneurs any more, you won't have growth any more, is very ideological. Russ: I don't dispute that-- Guest: And therefore is not at all consistent with historical evidence we have, which is that some inequality is useful for growth. Look, you know, the problem is that the growth performance in recent decades of the U.S. economy and marginally of developed countries has not been particularly good. If you look at per capita GDP-- Russ: Agreed. Guest: in the United States between 1980 and 2010, you have 1.5%. So if it was a 5% growth rate, maybe it would be worth a declining middle class share. But if you have 1.5% growth rate and the share going to the middle class and the bottom is reduced, then is this a good deal? Russ: I'm only saying-- Guest: Is this the best we-- Russ: I'm only saying it's misleading to look at the share, because I partly care--mostly care, actually--about whether the wellbeing of people is increasing and not their particular share of the pie. The pie is getting bigger-- Guest: Well, I think a solid middle class you know is important for the economy and for the democracy. I think society, European societies again in the 19th century, it was less extreme in the United States at that time because of a growing population, new immigrants. So you had less of sort of a big accumulation of family wealth or [?] in this case. So it was less extreme in the United States. But speaking from Europe, I can tell you that the kind of extreme concentration of wealth you had in Europe until WWI, you know it's not good. It's not useful for the economy when it is so extreme. Russ: I agree. Guest: It leads to perpetuation over time of inequality. And it's not good for democracy. You know, I think a middle class having access to wealth and showing that this is not contradictory with economic efficiency--that's important for our society in general.

39:14 Russ: I don't disagree with any of that. Well, maybe--well, I agree with most of that. I think it's perfectly legitimate to argue what I've tried to argue and then still believe that we should have a large tax. I'm not in favor of it, but I understand the point about incentives--the effects may be small. I'm just trying to get at the mechanics, because I think it matters a lot for why inequality has risen. So, for example, if somebody has gotten wealthy because they've been able to be bailed out using my tax dollars, then I would resent that. But if somebody is wealthy because they've created something marvelous, then I don't resent it. And my argument is that when we look at the Forbes 400, or the top 1%, many of the people in their, their incomes, their wealth has risen at a greater rate than the economy as a whole not because they are exploiting people, not because of corporate governance, but because of an increase in globalization that allows people to capture--make more people happy. Make more people--provide more value. My favorite example is sports. Lionel Messi makes about 3 times--the great soccer player, the great footballer, makes about 3 times what Pele made in his best earning years, 40 years ago. That's not because Messi is a better soccer player. He's not. Pele, I think, is probably a better soccer player. But Messi reaches more people, because of the Internet, because of technology and globalization. You can still argue that he doesn't need $65 million a year and you should tax him at high tax rates. But I think as economists we should be careful about what the causal mechanism is. It matters a lot. Guest: Oh, yes, yes, yes. But this is why my book is long, because I talk a lot about this mechanism. And I talk a lot about the entrepreneur, and the reason there is a lot of entrepreneurial wealth around, but my point is certainly not to deny this. My point is twofold. First, even if it was 100% entrepreneurial wealth, you don't want to have the top growing 4 times faster than the average, even if it was complete mobility from one year to the other, you know, it cannot continue forever, otherwise the share of middle class in national wealth goes to 0% and you know, 0% is really very small. So that would be too much. And point number 2, is that when you actually look at the dynamics of top wealth holders, you know it's really a mixture of, you know, you have entrepreneurs but you also have sons of entrepreneurs; you also have ex-entrepreneurs who don't work any more but their wealth is rising as fast and sometimes faster than when they were actually working. You have--it's a very complicated dynamics. And also be careful actually with Forbes's ranking, which probably are even underestimating the rise of top wealth holders and you know, there are a lot of problems counting for inherited diversified portfolios. It's a lot easier to spot people who have created their own company and who actually want to be in the ranking because usually they are quite proud of it, and maybe rightly so, than to spot the people, you know, who just inherited from the wealth. And so I think this data source is very biased in the direction of entrepreneurial wealth. But even if you take it as perfect data you will see that you have a lot of inherited wealth. You know, look: I give this example in the book, which is quite striking. The richest person in France and actually one of the richest in Europe, is Liliane Bettencourt. Actually, her father was a great entrepreneur. Eugene Schueller founded L'Oreal, number 1 cosmetics in the world, with lots of fancy products to have nice hair; this is very useful, this has improved the world welfare by a lot. Russ: Pleasant. It's nice. Guest: The only problem is that Eugene Schueller created L'Oreal in 1909. And he died in the 1950s, and you know, she has never worked. What's interesting is that her fortune, between the [?], between 1990 and 2010, has increased exactly as much as the one of Bill Gates. She has gone from $5 to $30 billion, when Bill Gates has gone from like $10 to $60. It's exactly in the same proportion. And you know, in a way, this is sad. Because of course we would all love Bill Gates' wealth to increase faster than that of Liliane. Look, why would I--I'm not trying to--I'm just trying to look at the data. And when you look at the data, you would see that the dynamics of wealth that you mention are not only about entrepreneurs and merit, and it's always a complicated mixture. You have oligarchs who are seated on a big pile of oil, which you know, I don't know how much of it is their labor and talent but some of it is certainly direct appropriation. And once they are seated on this pile of wealth, the rate of return that they are getting by paying tons of people to make the right investment with their portfolio can be quite impressive. So I think we need to look at these dynamics in an open manner. And when Warren Buffet says, I should not be paying less tax than my secretary, I think he has a valid point. And I think the issue, the idea that we are going to solve this problem only by letting these people decide how much they want to give individually is a bit naive. I believe a lot in charitable giving, but I think we also need collective rules and laws in order to determine how each one of us is contributing to tax revenue and the common good. Russ: Well, the share contributed by the wealthy in the United States is relatively high. You could argue it should be higher. As you would point out, I don't really have a model to know what that would be. But real question for me is the size of government. If there's a reason for it to be larger, if money can be spent better by the government, that would be one thing. And again, the other question is what should be the ideal distribution of the tax burden.

45:36 Russ: Let's talk a little bit about the middle class. Because my real point about the Forbes 400, or wealthy entrepreneurs, is that it is their contributions, their innovations, that have made our lives better. And that's a good thing. And the fact that their income is growing faster, their wealth is growing faster than the average is a sign of just how much more they've created. They've created wealth. They haven't expropriated it. So in your world, the change in the middle class, which you talk about quite a bit in the book, what explains the growth in the middle class in that 1950-1980 period, or the 1914-1980 period? Guest: That's an interesting and complicated question. I think in a number of countries, war has induced very large shocks to top wealth holders. And even in the United States, even though there was no destruction on U.S. soil, the Great Depression was a major shock to top wealth holders. These shocks and destruction of top wealth holdings are part of the explanation. Now, another part of the explanation are the institutions, policies that were put in place-- Russ: How do average people get wealthy or better off by rich people doing badly? What happened there? What's the mechanism? Guest: Oh, the simplest mechanism is that if you have a destruction of wealth, the rate of return to wealth is going to increase, and you know, this creates space for accumulation from people who start from less wealth or zero wealth and that work for labor incomes they can invest. So think there was a rise of new managerial elites and new groups of wealth accumulators in the post-WWII era, partly most in Europe and the United States because some of the former elites had lost their position. The other part of the explanation is a very fast growth rate of the post-war period, which allows labor income earners to accumulate you know it's easier to catch up with higher wealth holders when you have higher growth rates, so it's easier, r vs. g logic: when you have, you know in the post-war period if you take Germany or France or Japan you have 5% growth rate per year. So wealth accumulated in the past is less important and the new wealth out of new savings is a lot more important. So high growth is part of it. And also tax systems become more progressive as compared to pre-WWI period, implies that there is, the tax system is eking[?] less out of the middle class and the bottom groups and out of the [?] group, which again contributes to more wealth mobility and more accumulation of wealth for the middle and the bottom relative to the concentration at the top. You know, what's interesting is that in the recent period the growth rate both in the United States and in Europe in the past 20 or 30 years has not been terribly good. It has actually been quite mediocre. So top wealth holders are rising 3, 4 times faster than the average--if this had been happening forever of course would we have a very different distribution of wealth than we have today. So when you say this is a condition for having growth, my reaction is: Well, okay, but except that growth has not been very good. And in that period in the past where growth was [?] better, without the top rising 3 times faster than the average. So you can see that this is not the only possible equilibrium. I think it depends on a number of policy trajectories[?]. It also depends on circumstances like war, the baby boom, which you cannot easily affect or actually you don't want to affect. This also depends on policy trajectories[?]--the labor[?] of tax progressivity, the period of time when you have most tax progressivity will also period of with reducing inequality and influencing[?] higher growth than what we have today. And so that's one policy dimension that can play a role. I think financial deregulation has also, as I said earlier, increased has contributed to the rise in inequality, both because of very large bonuses in the financial sector, benefit to the real economy that has not been always very clear[?], and also because financial deregulation has probably contributed to actually rising inequality in access to high yield investment. Russ: One thing-- Guest: And so these kind of institution rules do matter a lot in inequality dynamics. Russ: One thing we agree on is that it's not just deregulation of financial markets but also government coddling and subsidizing of investors has certainly artificially boosted the share of the top 1%. Which I'm very opposed to. And it's gotten worse in the last 5 years than it was before.

51:16 Russ: One example you give in the book is increases in the minimum wage. You talk about different policy examples. So, you point out that in France the minimum wage has risen steadily since 1970 in real terms. And it's been flat or falling in the United States. But one of the things I worry about is I think that's a very bad way to reduce inequality. We know that in France the unemployment rate among the least educated people has risen dramatically over that time period. So the reduction in inequality that you champion because of the French policy may simply be because people have dropped out of the labor force and aren't able to be observed in the data. Do you worry about that? Guest: Yes, sure. It's all a matter of proportion. You know, I don't champion any country. I love all countries. There is a lot to learn from every national experience and I am not here to defend any particular country or any particular policy. I think it's all a matter of proportion. It's like progressive taxation. There is a minimum wage--can be useful. But of course if you increase it too much then it is going to create unemployment. So it's all a matter of proportion. What I find striking in the U.S. case is that the [?] thing that view of the minimum wage is now at the federal level is now smaller than what it was in the 1960s, which was 50 years ago. And at that time there was actually less unemployment than what you have today. And this is quite striking. If during half a century you cannot increase at all the minimum wage, at least you would expect that this is because it allows you to have a job for everyone. But in fact, no. You have more unemployment today than 50 years ago. So, what are we doing exactly? Maybe, I think we could increase the minimum wage in the United States at least by some amount. Russ: We have a very bad [?] system. Guest: Now I also agree with you--I also agree with you that you cannot do that too much. So at the end of the day, the main policy to reduce inequality is not progressive taxation, is not the minimum wage. It's really education. It's really investing in skills, investing in schools. And this is what I say from page 1 in my book. From page 1 in my book I make very clear that the primary mechanism to reduce inequality in the long run is diffusion of knowledge, diffusion of skills, diffusion of idea of productivity. This is what can explain convergence at the international level-- Russ: Correct. Guest: with emerging countries catching up with [?] countries. And it can also lead to a reduction of inequality within countries, assuming we have educational institutions that are sufficiently inclusive. And from that viewpoint what I find [?] puzzling in the recent evolution and in [?] the United States, is that if you look at the average income of the parents of Harvard and [?] students, this corresponds to the average income of the top 2% of the U.S. distribution of family income. So, it doesn't mean that you have no student below the top 2, but this means that you have very few students below the top 2; and that those who come from the top 2% are sufficiently high up, the top 2 percent; so that the overall average when you [?] the top 2 percent those who [?] as if you were to take it from your students just from the top 2% of the family distribution [?]. Now I think this is quite far from the meritocratic ideal that we all have in mind. I believe it. And I think this is a major challenge for the United States, and also for every country. Let me say very clearly that I'm certainly not going to tell you that the French university system is a system to follow. I'll be very clear about that. So I think the United States has been very good at producing very efficient top universities, but has been less good at promoting equal access to higher education. The average quality--the bottom 50% of the U.S. population does not quite have the high quality training that one might hope. But I think no country in the world, certainly not in France or nowhere in Europe or Japan has found the perfect system to combine efficiency with equality of access to higher education. So I think this is a major challenge for every country. There is a lot to learn from looking at these comparative data. I think every country, including France and the United States, often pretends to be more meritocratic than they really are. And I think people sometimes just don't look at the data. And again, this is as bad and sometimes worse in France than in the United States. So I am not trying to say-- Russ: The United States has a very large public university system, but studies have shown that it tends to benefit high income people as well. So that's a subsidy that is ultimately I think very misplaced. We also have a very poor education system before college, which I think has handicapped low income people from low income households.

56:37 Russ: We're almost out of time. I want to raise a couple of issues about the American data and get your response. One of the things you ignore, and everybody ignores when they look at the change in the share going to the top 1 or top 10%, say between 1980 and the present where it starts to rise very dramatically in your data, are two things that I'd like to hear you react to. One is: demographics have changed dramatically over that time period. There's an enormous increase in the divorce rate that begins in the 1970s and continues through the 1980s. As a result the number of households rises much more quickly than population. And since the divorce rate is higher among low income households than high income households, you are going to get a rising share to the top 1 or top 10% simply for that demographic reason. Similarly changes in tax laws encourage people to take income in the form of personal income rather than corporate income starting in 1986. So, when I look at your data, the trend, though it looks "frightening," because of the increasing share, some of that is a statistical artifact. Do you agree? Guest: No, I disagree with this statement, because in fact, if anything I think top managers are getting even more nontaxable perks like, you know fancy jet or big officers or fancy cars or beautiful hotels and restaurants today than what they did in the 1960s or 1970s. So the view that there was as much inequality in the 1960s than you have today but that people were getting it through fancy cars where at least today they are just getting cash but they have become very virtuous regarding nontaxable perks and fancy jets, I think this is just wrong. Russ: I'm talking about the increase from 1980, though-- Guest: I think if anything we see this seems to be complementary. This seems to be complementary. In the long run I think you see an increase both in cash compensation and in non-cash perks and benefits. So I think-- Russ: It's not non-cash. It's how I declare it. If I have a small business, it's now, starting in 1986, it's advantageous for tax reasons to call that income rather than corporate profit and take it in the form of capital. So, the labor share artificially rises in the 1980s. Guest: Right, but this you should see it in capital gains a bit later. Because you know when you have a lot of retained earnings within your corporation, at some point you will want to cash capital gains out of that and so we do take into account this through capital gains, which is a big part of the whole picture. I'm not saying that the change in tax law to not matter for how people reap those income. Of course it does matter. But if anything I think the overall trend would look bigger if we could take into account all the nontaxable forms of compensation. Russ: You want to react to that demographic point? Guest: Regarding the demographic point: yeah, I think you are right. I think this can contribute to rising inequality. Also, it's a very tough--this is not really what is really explaining the very big rise in the top share. And also we should not forget that when you have a married couple, sometimes you have a lot of inequality within the family, how money is allocated and who decides how to spend the money. And this is very complicated to look at but there are studies in developing countries and also in developed countries showing that if you really look at how the money is spent within households the poverty rates and inequality indexes can look very, very different. So, in other words, a woman in married couples can be a lot poorer than what it seems if you just divide by 2 the income. Because sometimes the division of poor and the division of-- Russ: Sure. But there are a lot of-- Guest: How you decide what to spend the money is not exactly equal [?] Russ: But there are a lot of households in America living in the highest income areas with two high-earning doctors, lawyers. That's an increasing phenomenon. I don't know whether that gets into the top 1%. Certainly it gets them into the top 10%. Guest: I agree. Yeah, I agree with that. I definitely agree with that.