LECTURE 9: THE RETURN OF CAPITAL IN THE 21 ST CENTURY Dr. Aidan Regan Email: aidan.regan@ucd.ie Website: www.aidanregan.com Teaching blog: www.capitalistdemocracy.wordpress.com Twitter: @aidan_regan #CapitalUCD
Introduction We will seek to answer 3 questions in this lecture: 1. Why has the capital/income ratio returned to historically high levels? 2. Why is it structurally higher in Europe than the US? 3. What does this suggest about the future?
Explaining higher capital/income ratios 1. Slower growth and higher savings (primarily retained corporate earnings) long-term 2. Privatizations of public wealth since the 1970's short-term 3. Acceleration of real estate and stock market prices since the 1990's short-term
Determinants of β Piketty s 2 nd law of capital is that the capital/income ratio is related to the savings rate and the growth rate. β = s/g β = capital/income ration S = savings rate G = growth rate If a country saves 12% of its national income and it s economy is growing by 2%, β = 600%
Low growth Decreased growth (especially population) and a higher savings rate (households & corporate) is primarily responsible for the comeback of capital And the variation between Europe and USA If growth falls to 1% and the savings rate equals 12% then β= 1200% Conversely if growth increases to 3% and the savings rate equals 12%, what will β equal?
The case of Ireland But does more capital not mean better investment? From 2000-2008 the total capital stock for investment increased from 228bn to 447bn. 72% of the increase went into housing (188bn). Of the 50bn that went into productive investment 75% was coordinated by the public sector, State (33bn) Productive private sector investment made up a meagre 17bn.
β = s/g This gives a good account of structural evolution of capital over the very long-run. It must assumes asset-prices move in tandem with consumer prices. But do they? It also assumes a stable savings rate. It does not explain the political shocks to capital.
Capital since 1970 800% Figure 5.3. Private capital in rich countries, 1970-2010 Value of private capital (% national income) 700% 600% 500% 400% 300% 200% U.S. Germany U.K. Canada Japan France Italy Australia 100% 1970 1975 1980 1985 1990 1995 2000 2005 2010 Private capital is worth between 2 and 3.5 years of national income in rich countries in 1970, and between 4 and 7 years of national income in 2010. Sources and series: see piketty.pse.ens.fr/capital21c.
The comeback The data clearly shows a comeback of private capital (low growth and higher savings = patrimonial capital for Piketty) But note the boom-bust cycles of capital assets The Japanese speculative bubble in the 1990 s The dot-com crash in the US in early 2000 s The property crash in the late 2000 s Do asset prices balance out over the long-run?
Savings since 1970 Table 5.1. Growth rates and saving rates in rich coutries, 1970-2010 Growth rate of national income Growth rate of population Growth rate of per capita national income Private saving (net of depreciation) (% national income) U.S. 2.8% 1.0% 1.8% 7.7% Japan 2.5% 0.5% 2.0% 14.6% Germany 2.0% 0.2% 1.8% 12.2% France 2.2% 0.5% 1.7% 11.1% U.K. 2.2% 0.3% 1.9% 7.3% Italy 1.9% 0.3% 1.6% 15.0% Canada 2.8% 1.1% 1.7% 12.1% Australia 3.2% 1.4% 1.7% 9.9% Saving rates and demographic growth vary a lot within rich countries; growth rates of per capita national income vary much less. Sources: see piketty.pse.ens.fr/capital21c
Two components of saving Private saving (net of depreciation) (% national income) incl. Household net saving incl. Corporate net saving (net retained earnings) U.S. 7.7% Japan 14.6% Germany 12.2% France 11.1% U.K. 7.4% Italy 15.0% Canada 12.1% Australia 9.9% 4.6% 3.1% 60% 40% 6.8% 7.8% 47% 53% 9.4% 2.8% 77% 23% 9.0% 2.1% 81% 19% 2.8% 4.6% 38% 62% 14.6% 0.4% 97% 3% 7.2% 4.9% 60% 40% 5.9% 3.9% 60% 40%
Privatisation Value of capital (% national income) 800% 700% 600% 500% 400% 300% 200% U.S. Germany U.K. Canada Figure 5.5. Private and public capital in rich countries, 1970-2010 Japan France Italy Australia Public capital Private capital 100% 0% -100% 1970 1975 1980 1985 1990 1995 2000 2005 2010 In Italy, private capital rose from 240% to 680% of national income between 1970 and 2010, while public capital dropped from 20% to -70%. Sources and series: see piketty.pse.ens.fr/capital21c.
Privatization The decrease in public wealth equals equals around 1/5 th or one quarter the increase in private wealth. The case of Italy is particularly clear. The wealthy lend to government and buy their assets. At a global level the biggest privatisations took place in the former Soviet Bloc. The public-private capital was completely reversed. Think about the rise of Russian Oligarchs (buying very cheap public assets).
The rebound in asset prices 160% Figure 5.6. Market value and book value of corporations Ratio between market value and book value of corporations 140% 120% 100% U.S. Japan Germany France U.K. Canada 80% 60% 40% 20% 0% 1970 1975 1980 1985 1990 1995 2000 2005 2010 Tobin's Q (i.e. the ratio between market value and book value of corporations) has risen in rich countries since the 1970s-1980s. Sources and series: see piketty.pse.ens.fr/capital21c.
Apple s stock prices
Asset prices The price of capital is shaped by a whole host of unobservable factors. They are not natural. The book value and market value will diverge depending on a countries political and legal institutions. But the rebound in asset prices (stocks and real estate) accounts for between one third and one quarter of the increase in the capital/income ration.
Conclusion The comeback of capital can be explained by β = s/g and complemented by privatisation and rising asset prices. In a world of financial globalization every country is owned by another country to some extent. International cross-national investments are a central characteristic of our contemporary world Particularly in small open economies like Ireland Piketty does say much about the change in the ideological and ideational climate underpinning public policy.
FDI
The future? 800% rivate capital (% national income) Value of pr 700% 600% 500% 400% 300% 200% Observed series Projections (central scenario) 100% 1870 1890 1910 1930 1950 1970 1990 2010 2030 2050 2070 2090 According to simulations (central scenario), the world capital/income ratio could be near to 700% by the end of the 21st century.