On the Other Hand…

Scholars have also raised some serious shortcomings with the analysis. No, I don't refer to the Financial Times' Chris Giles's overwrought and insignificant allegations of data errors (What is the world coming to when journalists can levy allegations at serious research without vetting, and yet command instant global attention?). Far more important issues have been raised by Per Krusell of Stockholm University and Tony Smith of Yale, for example, as to whether it is appropriate to assume (as Piketty does in what he calls the "second fundamental rule of capitalism") that capital's share of national income will tend toward the ratio of the savings rate to the growth rate in the long run.

The two economists note that the "fundamental rule" is untenable at one extreme (if growth falls to zero, savings would consume all of GDP) and that it is inconsistent with U.S. experience. They also point to alternative models of economic growth that are more consistent with U.S. experience. Serious related questions have been raised by Summers and others as to whether Piketty is sufficiently sensitive to the role of capital depreciation. Still others have pointed to the reality that inherited wealth is spread over multiple heirs, that heirs do not always invest wisely, and that many wealthy individuals choose to donate the bulk of their wealth to charitable causes rather than leave it to their offspring (thank you, Bill Gates and Warren Buffett).

I would yet raise another concern about Capital…, one that suggests that the evolution of inequality might be even more alarming than Piketty predicts. The focus of the book is on physical capital and financial capital. Human capital is given short shrift. Yet the importance of human capital – the investments that people make in their own productive capacities, just as capitalists invest in plant and equipment – is quite old in economics. In The Wealth of Nations, for example, Adam Smith wrote:

A man educated at the expence of much labour and time to any of those employments which require extraordinary dexterity and skill, may be compared to one of those expensive machines. The work which he learns to perform, it must be expected, over and above the usual wages of common labour, will replace to him the whole expence of his education, with at least the ordinary profits of an equally valuable capital.

In modern economies, the returns to human capital account for the lion's share of national income, and investment in human capital drives economic growth. (See, for example, my May 1999 paper in the American Economic Review: Papers and Proceedings for evidence on the outsized role played by human capital in the U.S. economy, and Paul Romer's 1990 Carnegie-Rochester Conference Series paper on human capital and growth.) Indeed, the categories referred to as labor's share of income and capital's share of income appear crude and antiquated when one can compare the share of income accruing to diverse groups ranging from managers to college graduates to high school dropouts.

A more troubling aspect of the Piketty phenomenon is not about what he might get wrong, but what he sweeps under the rug. While the increased concentration of income among the top 1 percent of Americans has attracted enormous attention in the wake of the American publication of Capital… and the earlier Occupy movement, the rise in income inequality among the bottom 99 percent is arguably a far more important feature of the economic landscape, and one at least as worrisome. Moreover, changes in earnings associated with different levels of education – that is, human capital – have played an outsized role in raising inequality among the bottom 99 percent of Americans.

Consider the following hypothetical calculation. If the top 1 percent's share of income had remained constant at its 1979 level, and all of the increase in share that actually went to the top 1 percent were redistributed to the bottom 99 percent – a feat that might or might not have been achievable without shrinking the total size of the pie – then each family in the bottom 99 percent would have gained about $7,000 in annual income (in today's dollars). That is not an insignificant sum. But contrast it with the magnitude of the income premium associated with educational achievement: The earnings gap between the median household headed by a college graduate and the median household headed by a high school graduate rose by $20,400 between 1979 and 2013 according to my calculations based on the Bureau of Labor Statistics' Current Population Survey. This shift – which took place entirely within the bottom 99 percent – is three times as great as the shift that has taken place from the bottom 99 percent to the top 1 percent in the same time frame.