What Piketty Misses

Thomas Piketty's book, Capital in the Twenty-First Century, is a global best seller that has attracted more reviews from academics and public intellectuals than any other economics book in recent memory.

But none of these many reviews point out that the voluminous statistics used by Piketty are of limited relevance for reaching his neo-Marxian conclusion about the inevitability of rising inequality and the collapse of existing market economies. The statistics he uses are snapshots of the distribution of income taken of a population whose composition changes with every picture taken.

What is more relevant to the assessment of future income distribution and the likelihood of the demise of market economies is information that traces the incomes of the same individuals through time. Only in recent years have governments begun to publish this information sporadically. In the United States, one set of data has been authored by the Treasury. In Canada, Statistics Canada has published some data which received virtually no attention. The Fraser Institute published a study using data specifically compiled by the agency at considerable cost.

The Canadian data provides information that surprises many. Out of 100 workers who were in the lowest income quintile in 1990, 87 had moved to higher income quintiles 19 years later, with 21 of them having reached the very top quintile. Income mobility also results in downward movements. Of 100 Canadians in the highest income quintile in 1990, 36 were in lower quintiles 19 years later.

Another important finding of the Fraser Institute data puts a lie to the many reports about the demise of the middle class. The same Canadian families who had inflation-adjusted incomes in the lowest quintile in 1990 had incomes 280 per cent higher by 2009. During the same period, families in the top quintile initially experienced an increase of only 112 per cent. The incomes of the middle three quintiles rose by 153 per cent. The data show that all Canadians have become richer, the poor more so than the rich and the middle class has more than kept pace with the rich.

The income distribution dynamics revealed by these statistics is primarily the result of the life-time pattern of income, which most readers have experienced firsthand. Pay and productivity are low in one’s first job but rise with age and work experience and later decrease with the onset of age-related disabilities and retirement.

The time pattern of incomes of individuals is also caused by short-lived influences on the ability to work, such as illnesses and personal decisions about raising children, further education and changes in life style. In Western market economies, the impact of these events on income is limited through access to social security benefits and private insurance.

High incomes also tend to be earned only for limited periods of time as a result of one-off events like the realization of capital gains and earning performance bonuses. Statistics Canada data show that in recent years, earners in the top one per cent did not have incomes at that level five years earlier. The Forbes data on billionaires shows that only 10 per cent of those on the 1982 list were still on the list in 2012, even after adjustment for inflation over the 30 years.

Most of the extra-ordinary recent growth in the income of top earners, the infamous one per cent, is due to the growth in the market for their services, which has been driven by the introduction of new electronic media, globalization and the growth in incomes of audiences. For example, professional athletes, creative artists and entertainers now reach millions rather than the hundreds who used to fit into arenas or thousand in movie theaters.

The globalization of commerce has increased the size of firms and raised the dollar value of the contributions managers can make to their bottom line. A firm with domestic sales of $100 million can offer a top manager expected to raise sales by one per cent less than it can pay after globalization raised this same firm’s sales to $10 billion. The earnings of Bill Gates and Steve Jobs and their top managers would have been much smaller if their innovations had been sold only in the United States rather than in the entire world.

Piketty errs when he concludes that the rich are getting richer and the poor are getting poorer. Dynamic income statistics show everyone is getting richer, the poor more so than the rich. The bottom line: Piketty’s case for confiscatory income taxes and imposts on wealth to prevent “potentially terrifying” events is simply based on the use of wrong data.