That is the question at the heart of Capital in the Twenty-First Century,

by the French economist, Thomas Piketty. One of the most discussed academic books published

since the turn of the century, it analyses the role that capitalism plays in global inequality.

For years most economists have believed that capitalism reduces inequality between the

richest and poorest – in the long run. For example, the Kuznets Curve hypothesis suggested

that inequality rises when countries industrialise – but then falls.

Piketty disagrees.

He claims that capitalism creates greater economic inequality.

The Kuznets Curve was constructed using data relating to wealth and income collected from

the late 19th to the early 20th century. But Piketty benefitted from a whole century of

extra data – right into the early 21st century. Using this wider pool of figures, Piketty

does two things. He argues that Kuznets’s data is misleading, because it was drawn from

what turns out to be a very unusual period of history. And he creates a theory he calls

the ‘central contradiction of capitalism’.

So what is this ‘central contradiction of capitalism’?

Throughout history, the annual rate of return on capital – which means the profits or

the interest you earn from investing your money –usually exceeds the annual growth

rate of the overall economy. Return on capital (or ‘r’) has remained relatively constant

– at around 5% - despite radical changes in who controls the capital – it’s generally

the rich and individuals who inherit it – and whether it’s held as gold, bonds, land or

in an investment portfolio.

In contrast to this, the annual growth of an economy (or ‘g’) has almost always

remained close to zero (it has only, in the last two centuries, reached a level of 1-2%).

There’s not much – short of revolution – that those individuals who rely solely

on labour to earn a living can do to change it.

Let me introduce Jane and Joe.

They both earn $100,000 a year. But Jane also has a $10million inheritance which she invests

annually in the stock market, earning a yearly return of 5%. Joe has no savings.

Let’s see how their incomes evolve.

Both Jane and Joe spend all of their annual salaries. After a year, Joe will have nothing

left over whereas Jane will have made $500,000 from her investments, which she reinvests.

Fast forward ten years…

Joe’s total wealth has grown very little – it depends on whether he is able to negotiate

a raise but – raise or no raise – Jane’s $10million has now grown to be worth more

than $16million – demonstrating Piketty’s argument that the difference in interest between

‘r’ and ‘g’ can lead to widening inequality over time. To avoid this, he proposes a global

tax on wealth that would effectively lower the rate of return on capital.

A more detailed examination can be found in the MACAT analysis.