The True Story of Capitalism

What Research Reveals

“A long-held tenet of free market capitalism, is wrong,” writes Eduardo Porter, business reporter for The New York Times. Economists have long held to the belief was that income disparities in a market economy would eventually level out.

That did seem to happen in the mid 20th century, leading the economist Simon Kuznets to postulate a curve of income distribution. The “Kuznets curve,” showed a “widening in the early phases of economic growth . . . becoming stabilized for a while; and then narrowing in the later phases.”

Kuznets get it wrong because he focused on a period when, as Porter put it: “a depression, two world wars and high inflation destroyed a large chunk of the world’s capital stock.” Then, “fast growth after World War II and high taxes on the rich . . . flattened the distribution of income until the 1970s.” Kuznets generalized from these historical anomalies.

Porter noted that his “conclusion provided a huge moral lift to capitalism as the United States faced off with the Soviet Union. It suggested that the market economy could distribute its fruits equitably, without any heavy-handed intervention of the state.”

The Kuznets curve became a tenet of “economic orthodoxy that prevailed throughout the second half of the 20th century.” Holding sway today, “it more or less put an end to economists’ interest in the topic.”

It helped undermine the case for inheritance taxes, progressive income taxes and other ways governments had sought to help those at the lower end of the income scale. Clearly those policies served the interests of the wealthy, but because they were presented as economic laws, not political decisions, they seemed indispensible to managing the economy. As such, they could even be seen as benefitting the poor in the long run. They just had to wait longer.

Now, however, impressive scholarship by the French economist, Thomas Piketty, based on painstaking examination of income tax returns, suggests that “the dynamics of capitalism will not help.” Piketty’s conclusion: “income from wealth usually grows faster than wages.” As a result, “inherited wealth will grow faster than the economy, concentrating more and more into the hands of few.”

Porter concludes: “future inequality in the United States will be driven by two forces. A growing share of national income will go to the owners of capital. Of the remaining labor income, a growing share will also go to the top executives and highly compensated stars at the pinnacle of the earnings scale.” (See, “A Relentless Widening of Disparity in Wealth.”)

Back in the 50’s, Kuznets told investors what they wanted to hear. Piketty is now telling us what we have long suspected. The richest 10 percent of Americans take a larger slice of the economic pie than they did in 1913, at the peak of the Gilded Age.

Porter writes: “Progressive wealth taxes could reduce the after-tax return to capital so that it equaled the rate of economic growth.” But “holders of wealth, hardly a powerless bunch, will oppose any such move, even if that’s what is needed to preserve capitalism against the populist impulses of those left behind.”

My question: Are our minds free to think outside the boxes of what was conventional wisdom for so long, and is still embraced as economic law. How long will it take for Picketty’s discoveries to replace the old norms?