Up Front

Piketty Got It Right (At Least Most of It)

Dany Bahar

In his book, Capital in the 21st Century, the French economist Thomas Piketty describes his hypothesis on why inequality has risen in past decades both across and within countries: The divergence forces are dominating the convergence forces, he claims.

The main divergence force, he asserts, is the return to capital being larger than economic growth rates in most economies (i.e. r>g), creating a “never-ending” cycle where the gap between individuals that inherited wealth and those who didn’t keeps increasing. Natural market forces such as supply and demand are not enough to stabilize the market. Thus his suggested solution is a global tax on wealth with redistributive purposes. 

As for convergence forces, Piketty mentions knowledge diffusion. The spread of knowledge will induce productivity increases in places that are falling behind, generating more economic growth. In Piketty’s own words: “The main forces for convergence are the diffusion of knowledge and investment in training and skills. The law of supply and demand, as well as the mobility of capital and labor, which is a variant of that law, may always tend towards convergence as well, but the influence of this economic law is less powerful than the diffusion of knowledge and skill and is frequently ambiguous or contradictory in its implications. Knowledge and skill diffusion is the key of the overall productivity growth as well as the reduction of inequality both within and between countries.”

Piketty got this part right. It is well known that productivity differences for the most part explain differences in income, and productivity can be fueled by acquiring more and better knowledge. The problem is, however, that knowledge, despite having all the characteristics of a public good, does not behave as such. Its transmission is difficult and its diffusion is slow and geographically localized. 

In fact, in our daily lives, we often struggle to learn new things, just as we struggle no less when we try to teach the things we already know to co-workers, peers or even family members. Imagine the learning/teaching process in an international setting when distances, different languages and cultures complicate things further.

The good news is that knowledge does diffuse, but very slowly and locally. How can we accelerate such processes? With the answer to that question we might begin to reverse the current pattern of growing inequality. Piketty refers to policy recommendations to induce knowledge diffusion by saying: “[…] the principal force for convergence –the diffusion of knowledge– is only partly natural and spontaneous. It also depends in large part on educational policies, access to training and to the acquisition of appropriate skills, and associated institution.”

Yet, we need more than that. We need knowledge to be transferred across borders, and hence, the challenge goes beyond a country’s own institutions or education policies.

Policies that aim to accelerate the international knowledge diffusion process might be more practical than Piketty’s suggestion on implementing a global tax on capital to slow down the “r>g” divergence force. He is technically correct, but implementing a global tax is unlikely to be politically supportable in the short run: Countries can barely agree on trade or environmental global policies, so they are much less likely to agree on global fiscal rules.

By researching the barriers to international knowledge diffusion and ways to overcome them, we can contribute to what Piketty himself suggests is the most important question that should keep economists busy in the years to come: how to reverse the increasing gap in incomes between and within countries?