Piketty with Chinese Characteristics

HONG KONG – In his bestselling book , Thomas Piketty argues that capitalism aggravates inequality through several mechanisms, all of which are based on the notion that r (the return on capital) falls less quickly than g (growth in income). While debate about Piketty’s work has focused largely on the advanced economies, this fundamental concept fits China’s recent experience, and thus merits closer examination.

Of course, a large share of China’s population has gained from three decades of unprecedentedly rapid . The fixed-capital investments that have formed the basis of China’s growth model largely have benefited the entire economy; infrastructure improvements, for example, have enabled the rural poor to increase their productivity and incomes.

As to almost half of GDP, to as little as a third. The government, recognizing the need to rebalance growth, began to raise the minimum wage in 2011 at nearly double the rate of real GDP growth, ensuring that the average household had more disposable income to spend.

But property prices have risen faster than wages and profits in manufacturing, causing the return on capital for a select few real-estate owners to grow faster than China’s GDP. The same group has also benefited from the leverage implied by strong credit growth. As a result, China’s top 1% income earners are than their counterparts in the rest of the world – and far faster than the average Chinese.

In fact, while the rise of China and other emerging economies has reduced inequality among countries, has risen almost everywhere. The Piketty framework highlights several drivers of this trend.

For starters, by lowering trade and investment barriers, globalization has created a sort of winner-take-all environment, in which the most technologically advanced actors have gained market share through economies of scale. In particular, as the global economy moves toward knowledge-based value creation, a few innovators in global branding, high-technology, and creative industries win big, with the global boom in tech stocks augmenting their gains.

The resulting concentration of revenue, wealth, and power undermines systemic stability by creating too-big-to-fail entities, while hampering smaller players’ ability to compete. The global financial system reinforces this concentration, with negative real interest rates promoting financial repression on household savings. Given that banks prefer lending to larger enterprises and borrowers with collateral, small and medium-size enterprises struggle to gain access to credit and capital.

Another problem is that the low interest rates generated by advanced-country central banks’ unconventional monetary policies have led to the decapitalization of long-term pension funds, thereby reducing the flow of retirement income into the economy. In many emerging economies, including China, widespread fear of insufficient retirement income is fueling high household saving rates.

Economists largely agree that this trend toward inequality is unsustainable, but they differ on how to curb it. Those on the right argue for more market-based innovation to create wealth, while those on the left argue for more state intervention.

In fact, both approaches have a role to play, particularly in China, where the government is pursuing a more market-oriented growth strategy but retains considerable control over many aspects of the economy. China needs to strike a balance between policy-supported stability and market-driven progress.

In particular, policy and institutional factors have led to the underpricing of key resources, generating significant risk. The vast workforce has driven down the price of labor, impeding the transition to a high-income, domestic-consumption-driven growth model. Similarly, failure to account for environmental externalities has contributed to the underpricing of natural resources like coal, fueling excessive resource consumption and creating a serious pollution problem.

Moreover, policies aimed at stabilizing the exchange rate and keeping interest rates low have caused capital and risk to become undervalued in large projects. And local governments’ effort to finance development by selling land to investors at artificially low prices has spurred massive investment in real-estate development, causing property prices to rise at unsustainably high rates. Given property’s role as the main form of collateral for bank loans, financial risk has risen sharply.