The Thomas Piketty Series

3. Three ways in which economic inequality affects the future of the Creative Economy


American sociologist Richard Florida coined the terms Creative Class and Creative Economy as a way to refer to those industries where creativity and innovation are central to their performance. It may be the case that, in general terms, we can extend the argument saying that creativity is central to any business, however, Florida’s notion is not intended to blanket all businesses, but is rather much more concrete: creativity is not about individuals, but about organisations that structure their business around autonomy, tolerance, talent and technology, because in doing so they are able, to develop better products, while having positive effects on their environment (spillovers of their activity that, for instance, enables others to increase their own productivity (think of search engines like Google) or by promoting cultural products (like Wikipedia or Open Data Portals).

From this perspective, the creative economy appears as bearing important differences that distinguish them from established organizational structures (e.g. Taylorism, Fordism, and businesses that practice with military rigor the mantra of minimum cost equals maximum profit). Instead the creative economy is all about rewarding collaboration rather than individual performance, innovators rather than technocrats, autonomy over discipline, etc. We may not be able to draw a line on the sand that divides the creative industries from more traditional ones, yet it is still possible to trace general boundaries:

  • ‘I define the core of the Creative Class to include people in science and engineering, architecture and design, education, arts, music and entertainment, whose economic function is to create new ideas, new technology and/or new creative content. […]
  • All members of the Creative Class—whether they are artists or engineers, musicians or computer scientists, writers or entrepreneurs—share a common creative ethos that values creativity, individuality, difference and merit’ (Florida, 2004, p. 8).


In short, if innovation, creativity and collaboration are core values to your business and your consumers, then your business is part of the creative economy.


Florida's The Rise of the Creative Class 2004



How does income inequality affect the creative economy?

Thomas Piketty’s work on income inequality trends in developed economies tells us that there are forces of convergence and forces of divergence that characterise capitalist growth in the past two hundred years or so: forces that make lower and higher incomes converge—reducing inequality—and forces that make low and higher incomes diverge, resulting in higher inequality.

The forces of divergence that directly affect the creative economy, says Piketty, are two: financial instability and lower investments in cultural capital.

I will now go over each so as to clarify his point.

Financial instability means, on the one hand, that economies are in constant risk of building economic bubbles, that is, in funneling investment flows: putting too much money too quickly into particular markets, leading to situations of overinvestment. The tech bubble of the late 90s is a prime example, although an even better one is of course the 2007 sub-prime crisis that ended in a global financial crisis.

But, why does income inequality produce financial instability?

The reason is that higher income inequality means that a small number of investors are able to influence the direction of a market. This means that they are able to drive people’s future expectations about the type of returns a market can accrue, bringing, in turn, larger investment flows into that market. However, they can also affect the negative expectations of a market, taking investment away from that market.

The second force of divergence mention by Piketty is the general tendency of public capital to decrease. Public capital referring to all those investments (private or public, although mainly public in nature) whose benefits are equally public, at least in the sense of what economists call public goods: we can talk here about schools, public libraries, roads and bridges as well as about the particle accelerator in Switzerland, the Norwegian public fund that manages the country’s oil wealth, the public funding destined to R&D—although the latter is surely the smallest in comparison.

The problem, as you may have already sensed, is that ‘we currently spend far more in interest on the [public] debt than we invest in higher education. [AND] This has been true for a very long time (Piketty, 2013, p. 567).

The reason public capital plays a central role for the Creative Economy is explained by relation that exists, between high cultural capital (e.g. libraries, parks, museums, etc.) and, on the one hand, the entrepreneurial spirit that drives innovation, and on the other, the social atmosphere that rewards autonomy, creativity, collaboration, and so on.    

I said, however, that Piketty identifies too, forces of convergence—forces that bring high and lower incomes closer to each other. This forces not only decrease the levels of inequality, but also result in a number of what economists call positive externalities, that is, public capital can increase the number of well-paid jobs, can allow the middle class to increase their disposable income, can decrease the rates of violent crime and in general have positive economic and social spillovers.

Public capital allows for the three T’s (talent, tolerance and technology) to flourish within social groups, which increase entrepreneurial innovation, at every level of the business. There are a number of ways in which companies can use these three factors as the underpinning of their business model. The next post of the Thomas Piketty series will describe how the three T’s can increase productivity, job satisfaction and general firm performance.

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Written by Daniel Vargas Gómez




2. Competition at the top: is managerial compensation really increasing economic inequality?




Bank bonuses have, since the financial crisis, been at the center of the debate on economic inequality. The public has grown tired of such generous compensation, which is seen as underserved, because of the direct role that the banking sector played in the recent—and in many places—still ongoing crisis. The scandals about Libor rate manipulation and the very recent reports on HSBC hidden Swiss accounts are exemplar about the type of behavior that people take—and rightly so—as unacceptable and as incompatible with huge bonuses.

However, finding such behavior reprehensible may turn the conversation towards a question of professional ethics and morality that are context specific and, therefore, cannot be swiftly use to make any assertions of economic inequality, as an issue that goes beyond individual or sectorial behavior.  The real question must be one that takes into account managerial compensation at large (throughout all sectors): should we see super-salaries as equally outrageous across all industries? And, more concretely, are super-salaries really a contributing factor to rising economic inequality?

Are super-salaries really a contributing factor to rising economic inequality?

The French economist Thomas Piketty takes a close look at the actual evidence in his acclaimed work, Capital in the Twenty-First Century. He explores the changes that the highest incomes from labor have had in recent decades and in particular since the 1980s. What he finds is highly insightful and provides persuasive arguments, based on hard evidence, about the true role that exuberant managerial compensations are really playing.


The figures

Piketty provides clarifying figures, from which a detailed image of the labor inequality landscape emerges. It is important to keep in mind that the following figures focus only on the income that results from people’s work, that is, their salaries and other related compensation, such as bonuses. This distinction is key, because income can also be the result of investments, savings and an array of financial instruments—and taking a close look at this second source of income provides impactful conclusions, without a doubt, but not conclusions on how labor income is contributing to economic inequality.

So,

The upper 10% of the labor income distribution (the best-paid 10%) in developed nations, says Piketty, generally receives between 25–30 percent of total labor income. This means that the best-paid 10% of the population takes home around 25% of all the income that results from salaries, bonuses, etc., within a country.

Is the richest 10%—in the US or the UK—made out of the same people that are in the best-paid 10%?

Not exactly, and this is where it gets interesting. The richest 10% is not made out of the same people as the best-paid 10%, because the richest 10% receives most of its income not from their salaries (their work in any shape or form), but from the capital they owe (from income generated mainly in the financial and real estate markets). To understand this difference in income sources and the role it plays in economic inequality Piketty divides that wealthiest 10% even further, between the richest 1% and the rest (the 9% left). What he finds out is that,

The top 1% receives a much lower proportion of their income through their salary and other forms of work-related compensation, than the rest—than the missing 9%.

In fact the higher up you go—so from the richest 1% to the richest 0,1% and then even higher up to the 0,01%—the less important income from labor becomes.

Now, you may be thinking at this point, ‘so the super-rich don’t earn their money like most people, so why is this important?’

I will tell you that it is important for three reasons:

1.    People, who make most or all of their income, through financial instruments alone (capital income alone), are people who inherited their wealth in the first place (Piketty, 2013). Hence, when we are talking about the richest 1% we are not mainly talking about moguls of innovation like Steve Jobs or Richard Branson, but actually of heirs like the Hiltons or the Kennedys, just to name a couple of exemplar cases.

2.    Capital income, in addition, has been increasing as a percentage of GDP in most developed countries, between 1975-2010, from
  • 22% of GDP to 27% in the US
  • 19% of GDP to 20% in Germany
  • 17% of GDP to 30% in the UK
(Piketty, 2013, p. 222)

This means that capital income has become more and more important in our time, than it has been for the past seventy years, and is set to become even more important in the future. This is important because it means that wealth inheritance has likewise become in the recent decades more and more important.

40-year trend in capital income for developed countries

Source: Piketty, Capital in the Twenty-First Century, p. 222

3. The bottom 50% of wage earners is becoming poorer in comparison to the rest.

·      While they make up 50% of the labor force, they get to keep only 30% of the total income generated from labor—they take virtually nothing of the income generated from capital.
·      When we look at general wealth, the bottom 50% owes less than 5% of a country’s total wealth (US figures).

This is a very worrying trend, because it means that the bottom 50% can never expect to earn any income from capital, because their savings are insignificant—plus they have no inheritance at all—and their income from labor does not allow them to be able to buy into even the less-profitable types of financial instruments; too many in the workforce are stuck with at most a savings account, offering a rate of return that is barely above inflation, and is probably lower than inflation today.

Western societies proudly boast that ancient hierarchies, where last names mattered more than personal ability, have been long left behind: if you work hard and persist, society will compensate you in turn, was the mantra that most of us were born repeating. Believing that hard work is the underpinning of economic success motivates many to study, to want to excel at their jobs, to want to become entrepreneurs, etc., as well as to be trustful of corporations and firms at large.

In a word, living in a society that rewards smart, hard working people, is, for the most part, something that defines our identities and our sense of freedom, and a social virtue that provides the kind of political stability and freedom that is but a myth in too many countries around the globe. It is the increasing difficulty to reach this desirable outcome in the West that makes Piketty’s findings especially worrisome: are we set to return to the old-times, where inheritance determined our place in society? Will our kids be talking about dowries again?


Written by Daniel Vargas Gómez






1. Is technology to blame for economic inequality? 3 ideas in Piketty you need to know to answer this question




Let’s begin with the begging question: Why would technological improvements explain growing economic inequalities in America and elsewhere?

The logic is fairly simple. Technology has a positive impact on the economy as a whole, because it increases productivity, making the production of goods cheaper or more cost effective—workers become more productive and the resources needed to produce goods and services decreases. From this perspective, the issue of income inequality seems foreign and the way it is introduced into the conversation is as follows:

1) By asking about the type of skills needed to be able to use and benefit from technologies—which amounts to asking about the ways in which the presumed gains in productivity come about.

2) By comparing investments in technology with other forms of investment.

How can productivity gains come about if most workers lack the skills to use the available technologies at their disposal?

After raising this question, apologetics of economic inequality hurry to give the following answer: income inequality is the result of having a labor force that is split, between those who possess the right skills and can to take advantage of the technologies available in the 21st century economies and those who lack such skills and find themselves competing for a decreasing number of jobs that don’t require any such skills. In short, this is the story that tells us there is Silicon Valley, on the one hand, with its high-tech innovations and a growing number of millionaires and billionaires. On the other hand, you have the grey old manufacturing sector, which is inefficient and wasteful and that would be symbolized by cities like Detroit in the US or Birmingham or Liverpool in the UK.

Income inequality would, therefore, be a temporary event, whose solution is to motivate people to choose the right professions (ICT related subjects), for, once they do, they will be able to earn the high salaries that those skilled workers at Google have. Is this a feasible story?  What does the evidence tell us?

Thomas Piketty addresses this argument in his Capital in the Twenty-First Century. The evidence, he tells us does not seem to support this theory.

“Over the long run, education and technology are the decisive determinants of wage levels” (Piketty, 2013, pp. 306, 307).

In the short run, however, differences in labour income (in wages) obey directly to three main factors:

1.    Executives have acquired direct influence on their own remuneration and at times even set their own salaries, through direct control over boards of directors—this is a claim supported by Piketty, but also Nobel price winners’ Joseph Stiglitz and Paul Krugman.
2.    Pay for luck: positive changes in a firm’s external conditions (economic growth, prices of raw materials, exchange rates, competitors’ performance) are rewarded as if generated internally—by the leadership and strategic mind-set of upper echelon employees (Piketty, 2013, p. 335).
3.    Decreases of top marginal income tax rates in English speaking countries since the 1980s, was followed by an explosion of very high incomes, which accelerated the growth rate of economic inequality during the last 30 years (Piketty, 2013, p. 335).
4.    The main source of income of the richest 1% is not their wage, that is, income inequality is NOT primarily explained by disparities in wages (Piketty, 2013, p. 280).


Next to these factors, I said too that in comparing investments in technology with other forms of investment, such as investment in real estate property, the former are presumed to accrue higher rewards, because they entail equally high risks. This means, for instance, that someone like Steve Jobs, who made what was back in the early eighties a very risky investment in an incredible innovation (the personal computer) received an equally high reward, when his innovation proved its merit and became very profitable. In comparison, if you or I, who are fearful of risk, prefer, in turn, a safer investment (a savings account for example), it is only logical that we cannot expect high rewards. Under this light, innovations are taken as the philosopher stone of wealth creation, and to a certain extent long run economic growth does depend on innovation (Piketty, 2013, p. 306).

Yet, is it feasible to put the blame of economic inequality on smart investments (high risk, high reward) against lame investments (low risk, low reward)?

Piketty’s answer is that the historical evidence does not suggest this to be the case, even remotely, for a single, yet quite important reason: the rate of return of portfolios increases not as their investment on innovations increases, but rather as the amount of capital invested increases—on average the largest endowments are able to obtain real returns of close to 10 percent a year, while smaller endowments must make do with 5 percent returns (Piketty, 2013, p. 449).

Technology has, no doubt, been fundamental to the economies of the 19th, 20th and 21st centuries and has, to be sure, been disruptive of the ways we used to do things in the past—and it will probably play the same role in the future. The issue of economic inequality, however, cannot be blamed on technological advancement.


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The factish 2015 begins with a knowledge bang. The Thomas Piketty series is an in-depth approach on the economic debate that promises to change the way we understand capitalism forever. In factish-like fashion this series brings you closer to the main aspects of the debate, by maintaining a practical appproach that remains both insightful and relevant. The Thomas Piketty series will challenge your most engrained ideas on how markets work and on the true role that inequality plays for innovators, creative professionals and entrepreneurs. 



Thomas Piketty is a french economist and author of the best-selling Capital in the 21st century, a book that has stirred debate among economists, social scientists and think tanks across the globe. His book has become a magnet for all those interested in understanding the underlying causes of inequality and has led to radically question the optimistic relationship between development and inequality posited by many economists throughout the twentieth century. His ideas on the role that political and fiscal institutions in the historical evolution of income and wealth distribution have will ensure that you never think of markets in the same manner again.