Inequality and the Rate of Return on Capital: An Institutional Approach to “The Piketty Problem”

Abstract:

In Capital in the Twenty-First Century, Thomas Piketty (2014) explains growing income inequality via the difference between the rate of return on capital and the growth rate of the economy: the “r > g” inequality. Even if it is true that r > g leads to increasing inequality, nearly every school of economic thought predicts that r will fall as the economy grows. Thus, for Capital (2014) to be a comprehensive theory of inequality, a more adequate theory of r is required. I term this the “Piketty Problem.” I offer a solution to this problem from an institutionalist perspective.

Keywords::

• inequality
• Piketty
• institutions

JEL Classification Codes::

• B52
• E25
• P16

Notes

¹ For a longer study of Capital, see Pressman (2016).

² Michl (2016) does note that a choice of technique model with a fossil production function may be able to generate increasing inequality through Marx-biased technical change without restrictive assumptions about the elasticity of substitution between capital and labor. While illuminating, this aside assumes a constant rate of return on capital, rather than explaining it, and thus begs the question.

³ Greenwood (2016) offers an excellent, concise treatment of Institutionalist theories of the wage bargain.

⁴ An objection to this line of reasoning holds that changes in the working rules governing transactions may be more likely to influence the profit share than the profit rate, the latter being the relevant variable for Piketty’s (2014) analysis. However, the two are inevitably related. The profit rate gives the total value of profits relative to the capital stock: $r=\frac{\prod }{K}$. Multiplying by $\frac{Y}{Y}$ gives: $r=\frac{\prod }{Y}\cdot \frac{Y}{K}=\pi u$, where π is the profit share, and $u=\frac{Y}{K}$ is a measure of capacity utilization. For a constant u, increases in the profit share will tend to be associated with increases in the profit rate. However, this may be complicated if u itself depends on the profit share. Further, it is possible that the profit share is itself endogenous to the profit rate, which is what Piketty’s (2014) first fundamental law assumes. The empirical literature on demand and distribution systems suggests that US demand is profit-led—that is $\frac{du}{d\pi }>0$ (Barbosa-Filho and Taylor 2005; Foley and Nikiforos 2012)—which means increases in the profit-share will tend to increase the profit-rate, even when u depends on π. In the case of an endogenous profit share, changes in institutions may impact the rate of profit directly through their effect on expectations, insofar as the value of capital (present and in the future) relies on them as Commons (1924) suggests.

Additional information

Notes on contributors

Luke A Petach

Luke Petach is a PhD Candidate in economics at Colorado State University. His research interests include political economy, economic development, and regional and institutional approaches to income distribution, particularly in the United States. The author would like to thank Christopher Brown, Steven Pressman, and an anonymous referee for their helpful comments and criticisms on early drafts of this article.