Connecting income to capital growth and potential inequality | Macroeconomics | Khan Academy

We've already talked quite a bit about the idea that if you look, you if you have a market capitalist economy that some, that this will lead hopefully to economic growth. Economic growth, but by definition, a market economy will have some folks who win more and some folks who don't do as well. And it's going to, you're also going to have inequality. Inequality is essentially a fact of life of a market economy, and it's not necessarily something that you just want to turn off because that might also hurt economic growth.

And that actually might make everyone better off because the economic growth on a per capita basis could also be benefiting people who aren't in the top percentile or decile or quartile. Not always, but it could be. But with that thought in the back of our minds, let's actually think a little bit more about inequality and how, and how it's measured and how it can be tied to things like capital and growth of income to capital and returns on capital.

So this right over here, this is from Thomas Piketty's book, and that's what's neat: he's made all of the charts of his book available online right over there. And this shows income inequality in the United States between 1910 and 2010. And what you see here, he measures it by the share of the top decile in national income. So top decile is the top 10.

So this point right over here tells us that in 1910, the top 10% of earners made a little over 40% of the national income. As we go into the late 20s, that approaches 50 percent at the top, that the top 10% of earners were making close to half of the national income. And then, as we go through the Great Depression and especially after World War II, this drops down into the low 30s.

And then from the 1980s to the present, this has crept back up to the high 40% range. So the top decile, the top 10% of earners are making close to half of the national income. And let's just visualize how this happens just numerically. So let's imagine this is your economy in year one. So this is your economy in year one.

And actually, let me copy and paste that; I think that'll be useful. So copy. All right. And let's say that this is the fraction—I'll do it in orange—that is going to the top decile. So let's say it's roughly a third in year one. So this is the fraction that's going to the top decile; this is one-third right over here.

So the way that you have rising—so on this chart, this would be kind of a 33.3, so it would be someplace around here. So we could pretend like where some date in the 60s or 70s, right over here. And now the way that you have this chart moving up, where you have the top decile having a larger and larger share of national income, is if this orange section grows faster than this green section.

So if, for example, this grew by 10 while this grew by 5—by five percent—over time, this orange section is going to take a larger and larger chunk of the green section. Now, as we saw in previous videos, even if this does happen—and this is, by definition, rising inequality—there could be a scenario where the other 90% are still having a bigger pie and, on a per capita basis, still might be able to be better off.

But the focus of this video is not that; the focus of the video is tying this idea to the idea of increasing returns on capital driving this phenomenon, driving income inequality. So as we've seen before, income and wealth are not the same thing, but wealth could be a proxy; the more wealth that you have, you will have more income from that wealth. You will have a return on that capital.

So another way to divide the economy is, instead of thinking of the top 10% of earners and the other 90% of earners, you could think of how much of this income goes to the owners of capital and how much of it goes to the people who provide the labor. So it's more of a labor-capital split versus a 90-10% split.

So here we could think of this section right over here, and I'll just make it different. So let's say this is right over here. This is how much is going to owners of capital—capital to owners of capital—the people who own the buildings, the real estate, the resources—and how much of national income is going to labor. So this right over here is going to labor.

Now, the same—a similar idea is: look, if this blue section—if this blue section grows consistently, grows faster than the green pie, than the green pie, then the percentage of income that goes to capital is going to grow more and more and more. And because, in capitalist market economies, capital is also not evenly distributed, mainly because income is not evenly distributed, because capital is not evenly distributed, that this would essentially lead—this, as more and more income goes to capital—and that capital is disproportionately owned by the upper decile of income or wealth—then you're going to, it's essentially going to drive this phenomenon right over there.

Now, I want to be very clear: this growth right over here—you'll hear the term return on capital in conjunction with Piketty's book, where they compare the return on capital to growth rates—and this growth right over here is not the return on capital. In order to know the return on capital, you have to know how much—you need to know the income that the capital generated, but you also have to know the value of that capital.

And here in this diagram, all I know is the income that the capital generated, but I don't know the value of that capital, so I can't calculate the return on capital. This growth that I'm showing right over here—maybe after a few years, this blue section grows to over here, while the green section, while the pie, has grown something like this.

This growth right over here, you could view this as the growth of income to capital, which isn't something you hear a lot about. But this growth right over here—this growth, maybe this is plus five percent for the total economy; this is the G that's often referred to—this is the total growth of the economy.