Capital in the 21st Century Review: Chapter 4 (part 1 of 3)

Chapter 4 is titled “From Old Europe to the New World.”  It essentially covers the same ground as Chapter 3, which covered Great Britain and France, but looks at three other countries:  Germany, the United States, and Canada.  By examining more than two countries it was easier to grasp which patters are universal versus in which ways have countries genuinely different from one another.

I broke this chapter into two parts.  Each part covers a country and then a new aspect of the capital/income ratio.

Part 1)  Germany and details of the mid-20th Century “shocks” which collapsed the capital/income ratio.

Part 2)  The United States and Canada, plus human slavery and how it affected the capital/income ratio, particularly in the United States.


Thomas Piketty Starts by looking at Germany. germany3 (Note:  the graph starts in 1870 rather than 1700 because 1870 is the date of German unification.)

C21c 4.1

The first thing to notice is that the overall evolution is similar (to Britain & France):  first, agricultural land gave way  in the long run to residential and commercial real estate and industrial and financial capital, and second, the capital/income ratio has grown steadily since World War II and appears to be on its way to regaining the level it had attained prior to the shocks of 1914-1945. (page 141)

19th Century Germany was more similar to France than Britain insofar as farmland remained a substantial fraction of total wealth, though it shrank down to a very small percent as it did elsewhere.

Germany also only owned about half a year’s worth of income of (net) foreign assets ( = (non-German assets owned by Germans) – (German assets owned by foreigners)), which was about half as much overseas assets as did France, and about a quarter as much as Britain.  “The main reason for this is, of course, that Germany had no colonial empire.” (page 141)  However, unlike Britain and France, Germany ran persistent trade surpluses for decades, and finds itself again with about half-a-year’s income worth of foreign assets.

Germany mirrored France in having its public debt effectively wiped out by high inflation, with prices rising 300-fold between 1930 and 1950.  “In regard to public assets, the German case is again similar to the French:  the government took large positions in the banking and industrial sectors 1950-1980, then partially sold off those positions between 1980 and 2000, but substantial holdings remain.

C21C 4.4

German wealth in 2010 is only about 4 times national income, compared to at least 5 times for Britain and France, despite a high German savings rate.  Thomas Piketty spends several pages explaining this apparent paradox:

The first factor…is the low price of real estate in Germany compared to other European countries, which can be explained in part by the fact that the sharp price increases seen everywhere else after 1990 were checked in Germany by the effects of German reunification, which brought a large number of low-cost houses onto the market.  To explain the discrepancy over the long term, however, we would need more durable factors, such as rent control. (page 144)

However, real estate counts for a definitely minority of the difference.  Most of the difference comes from German firms being valued lower on the stock market.  “If, in measuring total private wealth, we used not stock market vaue but book value (obtained by subtracting a firm’s debt from the cumulative value of its investments), the German paradox would disappear:  German private wealth would immediately rise to French and British levels.” (Page 145)

The reason for the lower stock market prices involve the modern German model of capitalism, based on “stakeholder representation.”  In other words, while in most other countries a corporation is governed exclusively by the shareholders and their representatives, in Germany corporate governance involves shareholders, governments, and the workers.  This leads to better wages and more stability than the shareholder-exclusive model, but means profits, and hence stock prices, are lower.

Thomas Piketty adds “Britain, France, and Germany account for more than half of the GDP of Europe and are representative of the entire continent:  Although interesting variations between countries do exist, the overall (“U-shaped over the past 100 years) pattern is the same.” (page 146)


C21C 4.5

Next comes a section on the dramatic events of the early-to-mid 20th Century:  World War 1, inflation, the Great Depression, World War 2, and gradual (or in some cases sudden) decolonization, which caused the Capital/Income ratios to fall from 6.5-to-7 down to around 2.5, or in other words, by almost two-thirds.

Direct destruction by war played a role, but a smaller role than you might think.  It accounts for a bit under 25% of the decline in France, about 1/3 of the total decline in Germany, and under 3% in Britain.

In fact, the budgetary and political shocks of the two wars proved far more destructive to capital than combat itself.  In addition to physical destruction, the main factors that explain the dizzying fall of the capital/income ratio between 1913 and 1950 were on the one hand the collapse of foreign portfolios and the very low savings rate characteristic of the time.  (Together, these two factors, plus physical destruction, explains 2/3 to 3/4 of the drop.) and on the low asset prices that obtained in the new postwar context of mixed ownership and regulations (which accounted for 1/4 to 1/3 of the drop.)

The decline in foreign capital stemmed partially from “expropriations,” such as when the USSR repudicated all foreign debt (much of it owed to French people) amassed under the Tzars.  Another example was Egypt’s nationalization of the Suez Canal.  But the larger factor was “the very low savings rate observed in various European countries between 1914 and 1945, which led British and French (and to a lesser extent German) savers to gradually sell off their foreign assets.  Owing to low growth and repeated recessions, the period 1914-1945 was a dark one for all Europeans but especially for the wealthy, whose income dwindled considerably.” (page 148)

Furthermore, the limited amount of private saving was largely absorbed by public deficits, especialy during the wars…Savers lent massively to their governments, in some cases selling their foreign assets, only to be ultimately expropriated by inflation.

Ultimately, the decline in the capital/income ratio between 1913 and 1950 is the history of Europe’s suicide, and in particular the euthanasia of European capitalists. (page 149)

inflation moster

Thomas Piketty finishes this section by adding that the there was a silver lining here:  this collapse of the capital/income ratio also reflected deliberate policies of European governments to reduce the power of wealth and provide better for their citizens.  For example, rent control made housing more affordable, while reducing the value of a given piece of real estate.  Heavy regulation and taxation of business reduced the value of their stock.  These social(ist) policies accounted for about 1/3 of the fall in the capital/income ratio, with the rest being the result of “volume effects” (low savings rates, loss of foreign assets, destruction).  The partial rollback of these policies in the 1980s and 1990s similarly explain a significant minority of the increase in the capital/income ratio seen during that time.

So a quick-and-dirty way to summarize this all is that for France, the drop in the capital/income ratio  had four roughly-equal-size causes:  direct destruction caused by the World Wars, money borrowed to fight these wars that was then inflated away, other effects such as a generally low savings rate owing to repeated recessions and decolonization, and more socialist national policies making asset ownership less profitable.  In Germany the destruction was somewhat more; in the United Kingdom a lot less.  (And in the United States & Canada essentially zero.)

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