Inequality & Development
Summary
This document contains an extensive summary of the lectures. The names of the lectures have been
changed slightly to make more sense within this document: in the course itself, lecture 2 is the final
lecture of topic 1 just like in this document. However, rather than continuing to lecture 3 (as can be seen
in the summary) the count restarts at lecture 1 and picks back up at lecture 3 in topic 3. I found this
inconsistent so I changed it to be one continuous flow of lectures.
The guest lectures, pitch session and SDG lecture do not form a part of the exam literature and will
therefore not be covered in this summary.
,Lecture 1 Piketty
This course is divided into 3 separate parts. The first part focusses on inequality, wealth & (human)
development. In this first part, we look at the ideas of Thomas Piketty in great detail. We look at his
theories as well as the application in practice. We focus on inequality, poverty, growth and development
in low and middle income countries, which we will refer to as so-called LMICs. We look at the influence
of population size on economic growth and look at different welfare measurements.
So apparently, Thomas Piketty is an important chap. But who is he? Piketty is a French economist who
wrote the book “Capital in the Twenty-First Century” He gave the course economics of inequality, some
slides of which we will see back in this course as well. The book has been nr. 1 on the Ney York Times
bestseller list, selling 2 million copies. The book is very large and lectures of Piketty himself are sold out
quickly.
The biggest insight and central thesis from Piketty’s work is the fundamental force of divergence: r > g.
In English, this says the annual return on capital (r) is larger than the growth rate of the economy (g).
The latter one determines to which extent earnings grow.
This force is also referred to as Piketty’s Third Fundamental Law of Capitalism: The rate of return on
capital systematically and substantially exceeds the overall growth of income r > g.
As a result, there is increasing inequality between those with and without capital.
Piketty discusses two U-shaped curves:
1. Income inequality in the United States: large at the beginning of last century (1910/20s), went down
during the middle part (40s throughout 80s) but is now back at the original observed levels (00s and
2010s)
2. Capital/Income ratio in Europe: high at the beginning of last century, went down during the middle
part but is now back at the original observed levels. K/Y is now approx. 500-600%
These two curves are mostly unrelated at this stage and involve different economic mechanisms. But:
both could happen everywhere in the future. An important objective of this lecture is to better
understand this kind of long-run evolution.
The third fundamental law of capitalism implies inequality in the economy.
Let’s look at some of the basic concepts in Piketty’s framework:
Basic concepts: Income
- national income Y = domestic output + net foreign factor income (= abroad income)
- Domestic output Yd = Net domestic product (NDP) = GDP – depreciation of capital
- Capital depreciation is about 10% of GDP, but it can be <5% in agrarian societies. Land
depreciates a lot slower in comparison to buildings, equipment and computers.
,- currently, the net foreign factor income is about 0. You can see this by the interest you earn on your
bank account. In most countries, the net inflow of earnings is equal to the outflow.
Basic concepts: Capital
- according to Piketty the words capital and wealth can be used interchangeably
- this is important as it will be done in this course as well
- national wealth (read: capital) is the total market value of everything owned by the residents and
government of a given country at any given point in time, provided that it can be traded at some market.
- the private wealth Wp = non-financial assets + financial assets – financial liabilities, all held by private
individuals or households
- the public capital Wg = non-financial assets + financial asets – financial liabilities, all held by the
government
- national wealth: WN = Wp + Wg
- national wealth WN can also be calculated as domestic capital + net foreign assets: K + NFA
- according to Piketty, national wealth is about 0 right now because assets are about equal to liabilities.
- private wealth accounts for nearly all national wealth, almost everywhere.
-
Basic concepts: capital/income ratio
- how much times the national income is the value of a country’s capital stock?
- denoted by β
- indicates the overall importance of capital in a society
- if the country’s total capital stock is equal to six years of national income, then β = 6 or meaning
600%.
The national wealth Wn is roughly equal to the private wealth W like stated before. W n therefore equals
residential housing + other domestic capital, which is about a 50/50 spread. In general, national wealth
is roughly 500 to 600 % of the national income Y, and therefore the capital/income ratio K/Y or β is
generally between 5 and 6. This is the case in wealthy countries.
according to Piketty, an average person in a wealthy country earns about 30,000 a year and owns
about 180,000 in capital, of which 90k in a dwelling and 90k in savings, bonds, stocks etc.
We have seen the third (and most important) fundamental law of capitalism introduced by Piketty, but
that implies that there are at least two other laws right? What are those laws?
The First fundamental law of capitalism describes the importance of capital in an economy
- the K/Y ratio β is related to the share of income from capital in national income by the following law:
α=rxβ
where:
α = share of income from capital in national income
r = average rate of return on capital
, - reflects the returns to capital over a year in any form as a percentage of the value of the capital
that was used/invested
- the percentage of national income that is income from capital is henceforth determined by how much
capital there is, as well as the average return to capital.
The Second fundamental law of capitalism describes what determines the K/Y ratio β. In the long-run,
the capital/income ratio is related to the savings rate and the growth rate according to the following
formula:
β=s/g
where
s = savings rate
g = growth rate
Piketty saws that in the very long-run, growth slows down and β = s/g. The more you save, the more
capital you accumulate. This is especially true in a slow-growth economy.
The third fundamental law we saw, stating that r>g. This causes increasing inequality between people
with and without capital.
Piketty’s ideas are based on observing historical data. There are two facts that can be pointed out:
1. convergence: poor countries are catching up with wealthier countries
- clear that convergence is happening right now
- unclear when convergence will be fully reached
2. Global growth slowdown in the 21st century: productivity growth is always slow for countries at the
world technological frontier.
- Once the global catch-up process is over, growth might be low everywhere.
- The population also seems to reach a growth nearing zero, maybe even lower than that.
- productivity growth is always slow for countries at the world technological frontier
- some economists are predicting a growth between 1 and 1.5%, but more pessimistic
economists say that growth on the long-run is going to be less than 1%.
- g = n + h where
- n = population growth
- h = productivity growth
- ( g = growth rate)
Piketty’s vision on growth:
- productivity growth is always slow for countries at the world technological frontier. Once global catch-
up process is over, growth might be low everywhere.
- historically, no country at the world technological frontier experienced a growth of per-capita output
exceeding 1.5% over a lengthy period of time.
- only in periods of catching up, growth rates might reach levels of over 3 to 4%
- Piketty assumes long-term per-capita output growth in the wealthy countries of about 1.2% annually
- However, an annual growth rate of the size might mean major social changes
- 1% growth over 30 years means a cumulative growth of over 35%
