Consider the two countries portrayed below. In both cases, the lines represent the share of national income earned by the top 1%.
- The graph clearly shows that policy went wrong starting around 1994, allowing the rich to exploit the poor.
- We cannot really tell whether the graph demonstrates generalised good things or bad things; we need to know why the shares changed before assessing anything.
- The graph clearly shows that policy improvements in 1994 stopped the wage compression that was hurting economic growth; we should expect that overall outcomes have improved since then as well.
Thomas Piketty’s (2014) book, Capital in the 21st Century, follows in the tradition of the great classical economists, like Marx and Ricardo, in formulating general laws of capitalism to diagnose and predict the dynamics of inequality. We argue that general economic laws are unhelpful as a guide to understand the past or predict the future, because they ignore the central role of political and economic institutions, as well as the endogenous evolution of technology, in shaping the distribution of resources in society. We use regression evidence to show that the main economic force emphasized in Piketty’s book, the gap between the interest rate and the growth rate, does not appear to explain historical patterns of inequality (especially, the share of income accruing to the upper tail of the distribution). We then use the histories of inequality of South Africa and Sweden to illustrate that inequality dynamics cannot be understood without embedding economic factors in the context of economic and political institutions, and also that the focus on the share of top incomes can give a misleading characterization of the true nature of inequality.
On South Africa, they note:
No clear consensus has yet emerged on the causes of the post-apartheid increase in inequality, but one reason is related to the fact that after the end of apartheid, the artificially compressed income distribution of blacks started widening as some portion of the population started to benefit from new business opportunities, education, and aggressive affirmative action programs (Leibbrandt, Woolard, Finn, and Argent, 2010). Whatever the details of these explanations, it is hard to see the post-1994 rise in the top 1 percent share as representing the demise of a previously egalitarian South Africa.