Who Is Thomas Picketty & What You Can Do To Avoid Becoming a Bad Inequality Statistic – Part 1

Want to show everyone you’re current and knowledgeable?  Not that pretentious, but actually want to read some pretty interesting stuff about how our world got to how it is today?

Either way, putting Thomas Picketty’s bestselling book: Capital in the 21st Century on your coffee table makes a lot of sense.

Picketty (pronounced pique-et-tee with a thick Parisian accent if you want to really piss off all of your friends and be called a know-it-all) has done what most thought impossible.  No, I don’t mean that he has mostly explained the ultra-complex nature of wealth inequality and put forth some logical (if unlikely) fixes to the situation – although he did that as well.

Instead, pique-et-tee (don’t you hate me just a little more now?) managed to make a book about economics a bestseller.  That’s pretty damn difficult.  The Ph.D. from the Paris School of Economics also managed to write a 700+ page book that people are actually talking about (even if they don’t read most of it).  For anyone not named Rowling or Martin that is rarely seen.  Finally, a French dude managed to sell a lot books in the USA – which is probably a sign of the apocalypse.  When one takes all of those points into consideration, it’s pretty tough to ignore that there must be something to this whole inequality thing.

R>G = ?????

Who Is Thomas Picketty & What You Can Do To Avoid Becoming a Bad Inequality StatisticFull disclosure, I did not climb the entire mountain read the entire book.  I did get through about 500 pages of the monster before succumbing to the temptation to read this executive summary instead (an excellent bang for your buck and reading time) and then read some of the more popular reviews about the book.  Despite the fact that some ultra-conservative commentators have picked at the edges of some of the data Picketty used, it should be noted that Picketty has responded to all specific criticisms and there is absolutely nothing out there that factually refutes the statistics put forth in the book, regardless of what you heard someone with a bachelor of arts degree say on talk radio.

Capital does make reference to income inequality and pays attention to the rise of certain salaries at the top end of the scale relative to the rest of us “middle-classers”; however, this isn’t the focus of Picketty’s thrust.

His main goal is to explain that overall wealth inequality (essentially your net worth as opposed to what your paycheque looks like) is rapidly surging around the world and that it will likely only get worse.  He sums up his argument with the simple formula of r>g.  Now I should admit that while I’m a bit of a finance geek that likes to read, I’m by no means qualified to explain the premises Picketty puts forth.  But I feel safe in saying that r>g can basically be boiled down to the idea that going forward (and for most of human history) overall growth in the economy is not split evenly between the people that provide the labour and the people that provide the financial capital.  To simplify it even more, the people that own stuff – land, factories, stocks, patents – will see their bank accounts grow much quicker and at a much faster overall rate than the people that work for a pay cheque and then use that money to live life.

Not All Income Is Created Equal

Regardless of where you stand on income inequality, overall inequality is a bit of a different ball game.  The rationale for people earning a lot of money makes some sense.  Elite performers in their fields such as Warren Buffett, Jay-Z, Lebron James, Oprah, or Ed Clark (CEO of TD Bank – one of Canada’s leading financial minds) deserve to be paid.  There is a debate to be had about how much more than the average person they should make, but at least they achieved their wealth through hard work and overall talent.

Capital points out though, that the really destructive development, is when people can live off of inherited wealth forever.  When being a part of the investor class, with access to trusts, tax havens, special accountants, lobbying powers, and special tax loopholes, means that your descendants get to live off of other people’s talents and work forever, that becomes an issue.  In many ways this isn’t about the “1%” that you see on the news.  This is about the .1% or even .01%.  The five people I outlined above who make a lot of money came from relatively modest means and rose to the top of their professions – they epitomize the idea of social movement and the principle that everyone has a fair shot at making it to the top.  Alternatively, roughly 1/3 of the Forbes 500 is now inherited wealth and that number will only grow with time if Picketty’s thoroughly-researched premises hold true.

Related: Passive Income: How to Get It

Doomed To Repeat History If We Don’t Understand It…

Some other cool stuff in Capital (cool being relative to the fact you are a history and/or finance geek) is how we got to the current place we are at now.  The idea that a middle-class is natural and is something to be expected is without a doubt shattered by Picketty.  The economic rockstar points out some really interesting developments that occurred as a result of WWI and WWII.  Due to all the government borrowing and the really high marginal tax rates that came about as a result (over 90% in the USA for a brief period!) there were a few decades where wealth was destroyed and/or transferred to a middle-class from the few at the top of the food chain.  Before that, the world was an incredibly unequal place – to the tune of the infamous 1% owning like half of a country’s assets!

Anyway, the gist of learning a little about the history of income and wealth inequality is that one can begin to understand the last 30 years or so and why it really shouldn’t surprise us that things are getting more unequal around the world every day.  Because our lives are relatively short through a historian’s eyes, we think of this current period of stagnating wages and growing inequality as a drastic change that is unnatural, when in fact it is really the period we just came out of that is the real outlier or change from the norm.  History’s momentum will inevitably take us back to the early 1900s (and pretty much any other time in recorded history) unless something fairly radical happens to change course (it took two World Wars the first time, just to give you an idea).

Doesn’t this Frenchman Want to Take All of My Money?

Picketty’s proposed solution is a bit extreme at first glance and even he admits it is completely unrealistic given the current political climate around the world.  The idea is not to tax income necessarily (although that might help as well), but instead focus on overall wealth or assets.  A yearly tax on your net worth is basically what Picketty recommends.  So yes, that could mean a tax on the value of your house – BUT  the tax would only be .1% if your net worth was less than about $270,000 USD (or 200K Euros).  On a $200,000 net worth that adds up to $200.  Sure, that’s not a treat to pay, but I don’t think too many people would worry about that $200 when compared to the insanity of the tax system we currently navigate.  On wealth above $6,750,000 USD or so ($5 million Euros) Picketty proposes we take 2% yearly, with a few echelons in between.

Of course in today’s international world if any country tried to do this we’d quickly see an exodus of the rich (taking their much-needed capital with them).  Consequently, the only way this whole thing works is if the vast majority of the world, including all of the 1st world countries, do it at the same time.  Good luck with that.

Related: How to Get More Money Back from your Tax Return 

How Much of a Leg Up Does One Need?

One thing this debate did do for me is reverse my thinking on the idea of an inheritance tax.  Now I know most rich folks will just beat the inheritance tax through loopholes anyway, and I know that for many that money has already been taxed once.  However, if we were to put in a rule where an inheritor were able to inherit $2 million or so before any inheritance tax were paid (so in this hypothetical example, if a couple had 3 children, they could leave $6 million worth of assets behind tax-free) and then use the proceeds from that tax to directly pay down our debt at various levels of government or to repair the damage done to the CPP (no need for committees, large ridiculous government bureaucracies, or waste of any kind) then I think most Canadians would support the idea.  One should get wealthy from hard work and risk-taking,  for providing something of value to society, not from winning the birth lottery.  If you need more than a $2 million head start (you could still get more than that, you would just have to pay a little tax on every dollar from there) in life you’re doing something wrong anyway.  It’s interesting to note that they already have a version of this in the USA.  How is Canada the hippy in this relationship again? 😉

Tune In Next Time…

Originally I had intended to get to some more practical advice concerning the new world that we live in as well, but seeing as how I got a little too in touch with my inner Picketty and rambled on for way too long already, maybe it’s best to pause things here and come back in a couple days with the follow up.

If you want to hear other people’s thoughts on this discussion check out the online clip or podcast from our most recent edition of the Money Mastermind Show!

8 Comments

  1. Phil on July 21, 2014 at 10:44 pm

    Bottom line is if you follow the money flow, you will find the reason it flows the way it does and why it will most likely never change. We as humans, unfortunately, are a greedy bunch and until our societal morals catch-up we are doomed to fail the majority… Knowledge is power, and in a society where knowledge seems to be in decay, well only those who understand how and why it works the way it does will have the power, and hence the control to keep it there to benefit from. Unfortunately most that have control are rewarded for having it, and so will go the cycle as it has for many more years to come, with those with knowledge and financial power, controlling the majority… – Cheers.



  2. Kyle on July 21, 2014 at 11:17 pm

    Has it ever been any different?



  3. Phil on July 21, 2014 at 11:18 pm

    Nope, and never will…



  4. SST on July 22, 2014 at 9:36 pm

    “The idea that a middle-class is natural and is something to be expected is without a doubt shattered by Picketty.”

    This, perhaps more than the the ‘why’ of the growth of wealth of the holders of capital vs. the growth of wealth of labour (which is interesting, albeit not ground-breaking) is the more profound argument of Picketty’s book.

    All the current furor about the “disappearing middle-class” is null and void when you consider economies are merely returning to the mean from an anomalistic spike. Only history will tell if middle-class is the new normal.



  5. Kyle on July 23, 2014 at 12:36 am

    It was quote sobering from a historical perspective SST.

    Just out of curiosity, what path do you think we’ll head down in the whole r>g argument?



  6. SST on July 23, 2014 at 8:02 pm

    I think we’ll return to the mean — r=5%, g=1%.

    r = annual return on capital
    (capital = profit, dividends, rent, interest, etc.)
    g = rate of growth of the economy/annual increase in income or output*

    *(this stat on its own is a very startling punch in face to anyone who does digs into the last 30-40 years of numbers, especially so for our American cousins.)

    Basically the holders of capital used to make profit by building and creating — factories, patents, etc. — eventually some of that profit would be given to the labour portion. But then the holders of capital started monetizing/financializing their capital to make profit (i.e. building nothing), thus almost completely excluding the labour component. Credit card companies are a great example.

    If you look at the timeline of “r>g”, you’ll see that it took until the 1980’s to kick into high gear after the World Wars caused so much wealth havoc. Not sure how much further we can keep feeding off of debt. The last decade gave us a few good examples of what is to come. The holders of real capital –land, businesses, production — will be coming out on top when the chips finally fall, but even they will suffer. Will just have to see how much intervention the government takes to try and save a drowning ideal. Moreover, rather than being an alarmist tome, Capital should be a wake-up call for those with wealth in terms of how to invest in and for the future.

    It’s no wonder Picketty’s extrapolations are causing such a stir, as there are far more middle-class people closer to being poor than rich; there are also far more rich people ($1-$5M range) who are closer to being poor than having unshakable long-lasting wealth.

    As an aside, I think his inheritance tax idea is a bit moot and in direct opposition to his idea that sovereign funds will eventually own the majority of everything, that is, the majority of wealth will face no inheritance tax as it will be owned by the tax man.

    In closing, Picketty states by year 2100 “petroleum rents might well enable the oil states to buy the rest of the planet (or much of it) and to live on the rents of their accumulated capital.” The very reason I invest heavily in oil. It won’t be Nexflix and Facebook stockholders who own the world.



  7. Kyle on July 24, 2014 at 11:48 am

    Interesting. I appreciate the thought you put into your comments. I agree with much of it. You obviously don’t believe that economic realities of “peak oil” (as flawed as that term has become) forcing the economy to transition away from it as a main source of energy then? Do you make anything out of the massive gains in solar technology etc? Netflix and FB are luxury items, and even worse, technology-based luxury items. That will always be pretty volatile territory.

    Given the reality we agree on then, do you think much of the Western middle class will eventually come over to support the more-socialist-than-capitalist-hybrid that Picketty sort of recommends. Like a super-Scandinavia? Or will big media, big money, and our own individualist tendencies continue to push away from that sort of world?



  8. SST on July 24, 2014 at 10:00 pm

    This isn’t just a “Western” issue, but a global one.

    What I can see happening is the Western societies which did enjoy the middle-class phenomenon will continue to do as much politically and economically as they can to save that drowning man. As Picketty says, economists hide behind math in order to “sciencefy” their vocation instead of dealing with all the organic stuff surrounding the matter. Governments, especially backed by the will of the people (and corporations, of course), can stall the inevitable math for a good long while.

    Meanwhile, the entities which never experienced a middle-class boom — China/Asia, Russia, India et al — are growing into their own but don’t have that Western albatross weighing down their decision process.

    Thus the West will be expending resources on preservation, while the rest of the world will be expending resources on growth. The prime example is China going gangbusters in resource uber-rich Africa (and the rest of the world!).

    As much as there is a divergence of R and G wealth, I can also see a divergence of West and non-West wealth. It doesn’t really matter to sovereign wealth how much they pay for any given good, as long as they own it — ownership will become the name of the game and the non-West is buying fast and furious.

    How will this effect the Average Joe? Capital points out that this will be a long, slow slog downward (year 2100, remember) so it might be our great grandchildren who will be faced with greatest costs (i.e. taxes and tariffs of all sorts). In opposition, the great grandchildren in the non-Western nations may be reaping the greatest benefits.

    However, Picketty suggests Canada might be destined for the black side of the ledger. As an oil/petroleum exporter, we can invest the excess income in non-oil assets, thus growing our ownership and, in return, our wealth. So at least we have that on our side! America on the other hand…yikes.

    Capital should definitely not be taken as a written-in-stone guide to anything. Its best quality is perhaps perfect timing: people can still remember the ’08 Crisis but are no longer in over-drive fear mode, now that we are ‘awake’ (or should be!), Capital provides a sober reminder of where we came from, what reality is, and options for future choices.

    Hope this rambling had a point.

    (as a side note, for about a year I’ve been discussing the idea that the middle-class is an historical anomaly, although my thesis was based purely on intuition and general hunches. Very grateful that Picketty spent years doing the all the work for me!)

    re: solar — people much smarter on the matter than I have concluded that solar power is, on almost all levels, a bust. Oil has nothing to fear from solar. I’d be interested if nuclear power started to show some movement.



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