The Economics of Inequality, by Thomas Piketty

Inequality is the hot topic of the moment, not least since the publication in 2013 of Thomas Piketty’s own somewhat Marxist-sounding Capital in the Twenty-First Century. His latest book features a bright red cover and an almost Russian-style font; the anti-capitalist defiance appears evident. However, the notion that you should never judge a book by its cover has never been truer.

Rather than being an anti-capitalist diatribe, this book provides a relatively standard economic account of the causes of inequality and the policy options available to help address it. It is a supplement to (rather than a substitute for) Capital. Its key message is, be warned. While the inequality problem is pressing, we need to stop, look and listen before reacting. We should not even consider further policy responses until we have identified the sources of the problem.

According to one camp, inequality is “efficient”, resulting from individuals possessing different talents, productivities and work ethics, with market rewards differing accordingly. Here, inequality results from the virtuous workings of the free market, from the forces of supply and demand; forces that can change over time, meaning that inequality will not remain stable. The extent to which technological developments substitute for or complement skilled work, and the impact of trade on the demand for skills, are two such forces that economists have argued have acted to increase inequality in the past 30 years.

If one agrees with the free-market way of explaining inequality, then interfering with “market prices”, such as by introducing minimum wages at the bottom or wage ceilings for those at the top, would be inefficient and counterproductive. Higher minimum wages would serve only to reduce the demand for unskilled workers (causing unemployment), while limits on compensation for skilled workers would discourage younger people from becoming “skilled up”, something that should naturally help to lower inequality over time. Of course, this is not to say that inequality should not be actively reduced by government, but rather that this goal should be achieved through the tax and transfer system (such as through tax credits) instead of interfering more directly with the market.

For those with less faith in the market, there is another camp, one in which market failures rather than efficient market signals are responsible for inequality. Examples might be labour market discrimination, for which affirmative action (such as quota systems) would provide redress, and the monopsony power of employers, where workers face a single employer (or cartel of employers), for which the minimum wage can help to limit “exploitation”. Here, directly interfering with the market is precisely the right approach.

This discussion might all seem rather “textbook”, and it appears in a book first published 18 years ago in French and which Piketty admits has not received much updating in this English translation (making Tony Atkinson’s Inequality: What Can be Done? a more worthwhile investment). But it is, nevertheless, eerily well timed for the UK market. Combine the theory with a little knowledge of George Osborne’s recent Budget, and it serves to emphasise a major shift in the British Conservative Party: away from the kinds of inequality-reducing policies associated with the free market view of inequality (including tax credits) and towards those associated with the opposing market failure view of inequality (such as a higher minimum – or “living” – wage).

So, either the Conservatives are detaching themselves from their Thatcherite past and jumping to the Left, or they have come to recognise that inequality is multifaceted. As Piketty himself concludes, it would be “misleading or counterproductive” to see inequality as purely the result of either free market forces or of market failures. The reality is that there is no magic bullet. Inequality demands an eclectic response – and one that breaks through the political boundaries of the past century. The future is, unlike the front cover of this book, a mix of red and blue. The future is purple.

Victoria Bateman is fellow and director of studies in economics at Gonville and Caius College, Cambridge, fellow of the Legatum Institute, London, and author of Markets and Growth in Early Modern Europe (2012).

The Economics of Inequality
By Thomas Piketty, translated by Arthur Goldhammer
Harvard University Press, 160pp, £16.95
ISBN 9780674504806
Published 3 August 2015