Piketty opens his discussion of capital and income by asking:
Does the clash between labour and capital belong to the past, or will it be one of the keys to the 21st century?
That, ladies and gentlemen, is the sound of a thousand Australian leader-writers racing to slam down the book. Piketty’s argument is that the long social peace of the second half of the twentieth century may not last in a low-growth régime in which the share of national income accruing to capital is steadily getting larger. Will we, he asks, see a
return to a political regime which is objectively quite favourable to private capital?
This first section of Piketty’s book is devoted to explaining, in some detail, the concepts of capital, income and economic growth. Much of it will be familiar to economists, although there are several telling points to be made.
Piketty emphasises the ratio of the capital stock to output, rather than necessarily focusing on the capital share of income, which has been the focus of some excellent economic commentary (the ACTU’s Matt Cowgill produced an excellent discussion of capital and labour income shares earlier this year).
To understand these transformations, we will see that the best approach is to analyse the capital stock/output ratio (that is, the ratio of the total capital stock to annual income and production flows) and not just the capital/labour shares (that is the share of income and production flows divided up into labour and capital income), which has been more classically studied in the past, largely due to a lack of adequate data
Piketty’s definition of the capital stock, by the way, includes residential housing, which is usually about half of the total stock.
For what it’s worth, here’s Australia’s capital share of income and capital-stock-to-output ratio, compared to a bunch of other first-world countries (Japan, Germany, the US, France, the UK, Italy and Canada) over the past forty or so years.
In other words, the share of capital in national income has been growing both in Australian and in other rich countries (the exact figure may differ from other estimates because of the way that income earned by the self-employed has been decomposed into ‘labour’ and ‘capital’ income), and the size of capital stocks both here and overseas, expressed as a fraction of our national output, has been growing. Throughout the book, Piketty uses β to denote the capital stock-to-output ratio, so, in Australia, β is just under 6. Piketty says that in developed countries this ratio is usually between 5 and 6, although it is higher than 6 in Japan and under 5 in the US and Germany.
This discussion forms the basis of what Piketty calls the “first fundamental law of capitalism”: that the capital share of income is equal to the average rate of return on capital, times the capital stock-to-income ratio:
α = r x β
where r is the average return on capital and α is the capital share of income. As Piketty points out himself, this is an accounting identity: true by definition. (Trivial to see if you remember that the capital share of income is equal to the average return on capital multiplied by the capital stock, divided by output). The point of an accounting identity in economic analysis is to decompose some phenomenon into interesting bits: in this case, by showing how much the capital share of income has changed because of changes to the return to capital, and how much by growth in the capital stock.
We’ll see in future posts why this particular decomposition is interesting.