PSE: Wealth Income Ratios

Capital is Back: Wealth Income Ratios in Rich Countries 1700-2010

By Thomas Piketty and Gabriel Zucman, Paris School of Economics, July 26 2013.


This paper addresses what is arguably one the most basic economic questions: how do wealth-income and capital-output ratios evolve in the long run, and why?

Until recently it was difficult to properly address this question, for one simple reason: national accounts were mostly about flows, not stocks. Economists had at their disposal a large body of historical series on flows of output, income and consumption – but limited data on stocks of assets and liabilities. When needed, for example for growth accounting exercises, estimates of capital stocks were typically obtained by cumulating past flows of saving and investment. This is fine for some purposes, but severely limits the set of questions one can ask.

In recent years, the statistical institutes of nearly all developed countries have started publishing retrospective national stock accounts including annual and consistent balance sheets. Following new international guidelines, the balance sheets report on the market value of all the non-financial and financial assets and liabilities held by each sector of the economy (households, government, and corporations) and by the rest of the world. They can be used to measure the stocks of private and national wealth at current market value.

This paper makes use of these new balance sheets in order to establish a number of facts and to analyze whether standard capital accumulation models can account for these facts. We should stress at the outset that we are well aware of the deficiencies of existing balance sheets. In many ways these series are still in their infancy. But they are the best data that we have in order to study wealth accumulation – a question that is so important that we cannot wait for perfect data before we start addressing it, and that has indeed been addressed in the past by many authors using far less data than we presently have. In addition, we feel that the best way for scholars to contribute to future data improvement is to use existing balance sheets in a conceptually coherent manner, so as to better identify their limitations. Our paper, therefore, can also be viewed as an attempt to evaluate the internal consistency of the flow and stock sides of existing national accounts, and to pinpoint the areas in which progress needs to be made.

Our contribution is twofold. First, we put together a new macro-historical data set on wealth and income…. To our knowledge, it is the first international database to include long-run, homogeneous information on national wealth. For the eight largest developed economies in the world – the U.S., Japan, Germany, France, the U.K., Italy, Canada, and Australia – we have official annual series covering the 1970-2010 period. Through to the world wars, there was a lively tradition of national wealth accounting in many countries. By combining numerous historical estimates in a systematic and consistent manner, we are able to extend our series as far back as 1870 (Germany), 1770 (U.S.), and 1700 (U.K. and France). The resulting database provides extensive information on the structure of wealth, saving, and investment. It can be used to study core macroeconomic questions – such as private capital accumulation, the dynamics of the public debt, and patterns in net foreign asset positions – altogether and over unusually long periods of time.

Our second – and most important – contribution is to exploit the database in order to establish a number of new striking results. Looking first at the recent period, we document that wealth-income ratios have been gradually rising in each of the top eight developed countries over the last four decades, from about 200-300% in 1970 to 400-600% in 2010…. Taking a long-run perspective, we find that today’s ratios appear to be returning to the high values observed in Europe in the eighteenth and nineteenth centuries, namely about 600-700%, despite considerable changes in the nature of wealth…. In the U.S., the wealth-income ratio has also followed a U-shaped pattern, but less marked….

In order to understand these dynamics, we provide detailed decompositions of wealth accumulation into volume effects (saving) and relative price effects (real capital gains and losses). The results show that the U-shaped evolution of the European wealth-income ratios can be explained by two main factors. The first is a long-run swing in relative asset prices, itself largely driven by changes in capital policies in the course of the twentieth century. Before World War I, capital markets ran unfettered. A number of anti-capital policies were then put into place, which depressed asset prices through to the 1970s. These policies were gradually lifted from the 1980s on, contributing to an asset price recovery.

The second key explanation for the return of high wealth-income ratios is the slowdown of productivity and population growth. … In short: capital is back because low growth is back. …

Our findings have a number of implications for the future and for policy-making. First, the low wealth-income ratios of the mid-twentieth century were due to very special circumstances. The world wars and anti-capital policies destroyed a large fraction of the world capital stock and reduced the market value of private wealth, which is unlikely to happen again with free markets. By contrast, the logic [of our second key explanation] will in all likelihood matter a great deal in the foreseeable future. … To the extent that growth will ultimately slow everywhere, wealth-income ratios may well ultimately rise in the whole world.

The return of high wealth-income ratios is certainly not bad in itself, but it raises new issues about capital taxation and regulation. Because wealth is always very concentrated (due in particular to the cumulative and multiplicative processes governing wealth inequality dynamics), high [net saving rate divided by income growth rate] implies tha[t] the inequality of wealth, and potentially the inequality of inherited wealth, is likely to play a bigger role for the overall structure of inequality in the twenty first century than it did in the postwar period. This evolution might reinforce the need for progressive capital and inheritance taxation (Piketty, 2011; Piketty and Saez, 2013). If international tax competition prevents this policy change from happening, one cannot exclude the development of a new wave of anti-globalization and anti-capital policies.

Further, … wealth-income ratios can vary a lot between countries. This fact has important implications for financial regulation. With perfect capital markets, large differences in wealth-income ratios potentially imply large net foreign asset positions, which can create political tensions between countries. With imperfect capital markets and home portfolios bias, structurally high wealth-income ratios can contribute to domestic asset price bubbles. According to our computations, the wealth-income ratio reached 700% at the peak of the Japanese bubble of the late 1980s, and 800% in Spain in 2008-2009. Housing and financial bubbles are potentially more devastating when the total stock of wealth amounts to 6-8 years of national income rather than 2-3 years only. The fact that the Japanese and Spanish bubbles are easily identifiable in our dataset also suggests that monitoring wealth-income ratios may help designing appropriate financial and monetary policy. In Japan and Spain, most observers had noticed that asset price indexes were rising fast. But in the absence of well-defined reference points, it is always difficult for policy makers to determine when such evolutions have gone too far and whether they should act. We believe that wealth-income ratios and wealth accumulation decompositions provide useful if imperfect reference points.

Last, our findings shed new light on the long run changes in the nature of wealth, the shape of the production function and the recent rise in capital shares. In the 18th and early 19th century, capital was mostly land…, so that there was limited scope for substituting labor to capital. In the 20th and 21st centuries, by contrast, capital takes many forms, to an extent such that the elasticity of substitution between labor and capital might well be larger than 1. With an elasticity even moderately larger than 1, rising capital-output ratios can generate substantial increases in capital shares, similar to those that have occurred in most rich countries since the 1970s. Looking forward, with low growth and high wealth-income ratios, one cannot exclude a further increase in capital shares.

The paper is organized as follows. Section 2 relates our work to the existing literature. In section 3 we present the conceptual framework and accounting equations used in this research. Section 4 is devoted to the decomposition of wealth accumulation in rich countries over the 1970-2010 period. In section 5, we present decomposition results over a longer period (1870-2010) for a subset of countries (U.S., Germany, France, U.K.). We take an even longer perspective in section 6 in which we discuss the changing nature of wealth in the U.K., France and the U.S. since the 18th century. In section 7, we compare the long-run evolution of capital-output ratios and capital shares in order to discuss the changing nature of technology and the pros and cons of the Cobb-Douglas approximation. Section 8 presents some possible directions for future research. The main sources and concepts are presented in the main text, and we leave the complete methodological details to an extensive online Data Appendix. …

For complete article, see Thomas Piketty and Gabriel Zucman, Paris School of Economics, July 26 2013.

(Emphasis added)