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Li Cheng

Institute of Economics, Chinese Academy of Social Sciences

« Is ‘r-g’ the Main Force of Divergence? A Debate with Data »

As a central but controversial claim in his chef d’oeuvre Capital in the Twenty-first Century, Thomas Piketty (2014) argues that the gap between the rate of return on capital (r) and the rate of economic growth (g) constitutes the ‘main force of divergence’ among social groups (page 27). Nevertheless, confronting this theory with data on capital stock and distributional national accounts of eleven major economies, the current paper provides contrary evidence regarding the above claim: after controlling government spending, saving rate, financial development, openness to globalization, human capital, and other determinants of economic inequality, the ‘r-g’ gap is significantly negatively correlated with the top income/wealth shares in most model settings. The results remain also robust among different regression procedures aimed at dealing with endogeneity and other econometric concerns.

From a theoretical perspective, a tentative explanation for these findings is that the impact of ‘r-g’ on economic inequality depends on the capital/labor elasticity of substitution in, at least, two ways: under some assumptions on saving behavior and income/wealth distribution, on the one hand, higher elasticity of substitution leads to higher capital return, from which the top stratum benefits, in general, more than the bottom one – a mechanism to which Piketty has paid much attention. On the other hand, as demonstrated in de La Grandville (1989), higher elasticity of substitution leads also to higher economic growth – a point largely ignored in existing literature on ‘r-g’ model. Putting together, if the growth effect of elasticity of substitution is sufficiently strong, it is highly possible to observe a negative correlation between ‘r-g’ and measures of economic inequality, as empirically shown in this paper.