Finance and Capital in the 21st Century

In Thomas Piketty’s controversial, ambitious, but ultimately flawed book, Capital in the Twenty-First Century, he claims that: (1) the return on capital (r) has exceeded the growth rate of the economy as a whole (g); (2) this relationship (r g) has produced ever-greater concentrations of wealth and income; and (3) raising taxes, especially on capital, is the best way to reduce these inequalities. He concludes with an impassioned plea for economics to aspire to a higher “political, normative and moral purpose,” while lamenting modern efforts to treat it as a science. Because finance is essentially the study of capital and capital markets, this article evaluates Piketty’s claims from the perspective of financial theory, using the scientific method. Is Piketty’s theory of capital internally consistent? Does the data support his hypotheses? What are the policy implications? To briefly preview, I find that his theory of capital confuses cause and effect, the data do not support his hypotheses, and his policy prescriptions would likely prove counter-productive.

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