Thomas Piketty's Capital in the Twenty-first Century has garnered a lot of attention this past year, as I've noted. One of the many striking things about Piketty's account is the idea that wealth inequality is a process, and a one-way ratchet at that: wealth inevitably concentrates in the hands of a few, gradually and over time. By "gradually," he means a long time: we are headed back to the vast differences in wealth in place at the beginning of the twentieth century, but that process has been slowed by two world wars and the Great Depression, which knocked everybody back, so that the world became more equal. Wealth inequality has not yet, by Piketty's account, recovered from those economic catastrophes.
A slightly different version of Piketty's story has been told before. In The Rise and Decline of Nations, the late economist Mancur Olson described a one-way ratchet of increasing unemployment, stagflation, and the ultimate economic decline of nations. Over time, Olson argues, a country with a stable political environment allows special interest groups to develop. Special interest groups exist only to engage in rent-seeking – the achievement of favorable government policy that secures above-normal rents for members of the special interest group. Why else would members of special interest group pay dues, unless they expect the group to obtain benefits they could not obtain themselves as individuals? Drawing upon Olson's earlier magnum opus, The Logic of Collective Action, how else can one even explain the existence of special interest groups, given the potential for within-group free-riding?
The provocative result of Olson's work is that this decline is almost inevitable. Over time, special interest groups form, they secure enough above-normal wealth, and what is left over is below-normal wealth for everybody else. Once special interest groups gain a foothold, their influence over policy grows, and their gains at the expense of society accumulate. Exceptions to inexorable decline exist, but are uncommon. A large and sudden shock from a trade liberalization might scramble the economic order faster than special interest groups can form or mobilize. Or, disruptive technologies might lead to a creative destruction. But absent such serendipitous shocks, the die is cast.
While Olson is primarily concerned with allocative inefficiency and Piketty with distributive effects, it is striking to notice the parallels of their theses. Both see a one-way ratchet, not a cycle. Both see their stories as mostly inevitable, checked only by random, infrequent, exogenous shocks. But why, save for the few exceptions, should spirals be inevitable? Why can't developed countries stave off the tyranny of special interest groups and periodically re-invent their economic identities? In Piketty-world, why can't the ninety-nine percent rise up in electoral anger and smite down the one percent?
There is one answer for both Olson's and Piketty's puzzles. In both cases, a narrow segment of society – Piketty's one percent and Olson's special interest groups (though there is clearly overlap) – garner above-normal rents, use them to invest in capital, and then use legal rules and institutions to protect that capital. This has the effect of both widening wealth inequality and blocking reform. For Piketty, the missing piece was the use of law to secure outsized rents for the one percent, while for Olson, the missing piece was the use of law to protect capital, developing an elaborate legal super-structure around it to protect it from changes in its legal or economic environment. The legal system is used in Piketty's world to obtain capital and in Olson's world, to protect capital from regulatory interference and reform. Governments at all levels have demonstrated an inclination to use "carrots" instead of "sticks" to achieve policy goals, and the carrots frequently take the form of some capital promotion or protection. Scattered throughout the Internal Revenue Code are carrot-like provisions that lower the cost of private capital or increase the returns to private capital. This two-staged exploitation of the legal system has the dual effects of exacerbating wealth inequalities and grinding legal and economic reform to a halt.