Piketty begins this chapter by presenting the argument that huge capital investments are likely to produce high returns. Individuals who invest less capital receive less returns. The rate is always as little as 1 percent or 2 percent. The individuals investing huge amounts of capital receive higher returns. The rate is always above 8 percent. The differences in this returns imply that the poor continue remaining in the poverty cycle because of the inability to invest in major sectors to earn better returns (Piketty, 2014). Piketty, also points out that the type of investment also determines the level of returns. Investing in risky assets such as industrial capital (shares stocks) often give larger returns. On another view, returns from the less risky investment such as farmland are low. The rates of returns lie between 3 to 4 percent. Therefore, some people naturally earn interest above average on the investments than others (Dornbusch & Fischer, 2000).
To clearly bring out his point on the division of national income amongst labor and capital, he uses several factors to explain. Using “The notion of pure return on capital” he explains that the differences in the returns in the formal and the informal sectors is a result of lack of attention on the rate of return in the informal sector. The difficulty in measuring the value of labor in the informal sector results in the exclusion from the national accounts. He stipulates that the costs in the informal sector are high during the rapid economic growth because the investors take more time and research analyzing the best portfolio to invest in (Piketty, 2014). The exclusion of the informal sector costs and income in the national accounts results to the inequality in the split of labor and capital. It results to incorrect distribution of income to capital and labor (Snowdon & Vane, 2005).
In figure 6.5 he indicates that there has been a rise in the capital-income share in the two states from 1970. From 2010, the rise has been rapid because the rate of return on capital investment has also increased. It is in agreement with the law of capitalism coined by Piketty that is; the first law of capitalism. I agree with this argument because the explanation given by other scholars also indicate that the increase in capital yields leads to rise in national income (Piketty, 2014).
Piketty, also comments on the view that establishing a stability in the capital-labor split results in a harmonious social order. To bring out this point, Piketty borrows the idea of the Cobb-Douglas model of production. However, he states that the achievement of stability of capital, does not guarantee harmony in the society. The main element of consideration in establishing stability is the need to combine the inequalities in capital ownership and how the income is distributed (Piketty, 2014). Traditional economic studies argue that social order is attained in the society if the society sees that there is fairness in the distributing of income, resources, and wealth. Cases of inequality and unfairness cause social uprising to fight for a share of the national cake (Snowdon & Vane, 2005).
Piketty, also gives an elaborate explanation on the substitution between labor and capital. He does not consider the infinite and zero elasticities of substitution because they have no logical explanation. He focuses on the elasticities between zero and one to explain how it leads to increase or decrease in marginal productivities of capital and labor. The use of elasticity in explaining the effect of changes in the two elements have on each other is very relevant. It borrows from the elementary studies of economic scholars like Cobb-Douglas who give empirical evidence. Piketty’s explanation when the elasticity is one, between one, and zero makes economic sense and it is useful in drawing inferences (Snowdon & Vane, 2005).
Piketty points out that, overtime there has been an increase in the consideration of human skill in production. He states the stability in labor-capital and income split has been attributed to the importance of human skills. There has been an increase in the human skills in the past two centuries showing its contribution to the growth in income (Piketty, 2014). Further, Piketty states that concentration on human skills is important in increasing the capital income but more importantly, the bargaining power shift is the main contributor to this growth. He clearly points out that the growth is related to the power of politics than the market perfections (Snowdon & Vane, 2005).
In conclusion of his book, Piketty states that technology has played a significant role in the growth of economies after the second-world war. However, it is irrational to give it all to caprices of technology because the growth has come along with the growth of knowledge diffusion and productivity (Dornbusch & Fischer, 2000). The two do not only depend on technology but on the contribution of human capital and other elements. The argument should be used to avoid Marx apocalypse prediction and strive to balance the capital contribution process (Piketty, 2014).
Piketty, also states that progress towards achieving technological and economic rationality (perfectly competitive markets) is not a leeway to achieving meritocratic and democratic rationality. However, the two elements (technological and economic rationality) have helped in avoiding the Marxian apocalypse. He finishes by saying that the two have not altered the capital influence on structures or the macroeconomic importance of the relationship between labor and capital in the society (Piketty, 2014).
In consideration of the explanation by Piketty, it has come to my understanding that he confidently states that the share of income going to capital exceeds what goes to labor. He also gives a mathematical explanation for this but I feel the explanation does not consider all factors involved (Piketty, 2014). He assumes that the value for BETA is growing overtime while that of r (rate of return) is stable. Given the uncertainties in the yields of investments, it is not possible to have stable r to conclude the accurate of the information (Piketty, 2014). It has been proven by previous studies that the yields on different portfolios vary according to the riskiness of the investment. However, even if the portfolios have the same degree of riskiness, the yields vary because of the differences in the inherent factors. At no point can the r be constant or stable given the flexibility and unpredictability of events in the economy (Piketty, 2014). The different innovations in the economy have increased productivity that leads to increase in the rate of returns. The development of better methods of predictions on the viability of given portfolios also means the rate of return depends on the accuracy of these predictions affecting the yields (McConnell & Brue, 2005).
Dornbusch, R. & Fischer, S. (2000). Macroeconomics (Fifth ed.). New York: McGraw-Hill. pp. 78–90
McConnell, R. & Brue, L. (2005). Economics. McGraw-Hill Professional.
Snowdon, B. & Vane, R. (2005). Modern macroeconomics: its origins, development and current state. Edward Elgar. p. 61.
Wessels, J. (2000). Economics. Barron’s Educational Series
Piketty, T. (2014). Capital in the twenty fist century. The Belknap Press of Harvard University Press