Thomas Piketty’s illusory inequality

In his controversial worldwide bestseller Capital in the Twenty-First Century, French economist Thomas Piketty condemns the rise in income inequality. Yet, the statistical data he presents does not necessarily lead to this conclusion.

Indeed, Piketty focuses on the changing distribution of income within the population over time, which allows him, for example, to study the proportion of total income earned by the highest-earning percentile of the population. The problem is that the top one per cent is not made up of the same individuals from one year to the next, and the income of these individuals is not as stable today as that of the average wage earner.

Take the example of Steve Jobs. When he was the CEO of Apple, his annual salary was a single dollar. At the same time, though, he received Apple shares and stock options, which he subsequently turned into income. But executives cannot resell their shares or their stock options before the end of a certain period (the vesting period, which often lasts three years). So even though this henceforth makes up the bulk of their remuneration, they earn no actual income from this equity-based compensation for several years.

Consequently, the income they receive from the sale of these shares will be concentrated in a relatively short period of time. At that point, these upper managers will inflate the inequality statistics, but this just compensates for the fact that their incomes have finally been adjusted upward after several (relatively) lean years.

Could this phenomenon help explain the rise in income inequality? After all, if this lag between the time when equity-based compensation is granted and the realization of the related income had always existed, it would not alter the inequality picture. But this lag is a fairly recent phenomenon, concomitant with the growing role of shares and stock options in executive compensation.

Research by the economist Carola Frydman and her co-authors shows that in the 1950s and 1960s, CEOs were essentially remunerated with fixed salaries and bonuses (also relatively fixed), which represented around 90 per cent of their compensation. Moreover, CEO remuneration was remarkably stable at the time, with little variation from year to year.

The 1980s and 1990s, however, saw a revolution in executive pay, as a result of which stock options became the main component of executive compensation. Salary and bonus came to represent only 40 per cent of CEO pay in the 2000s, the rest being mostly made up of shares and stock options.

In the same way, employees of startups who are paid in pizza and stock options have rather low incomes for a number of years, until they sell their stock options and sometimes become millionaires. Likewise, they contribute substantially to statistical inequality during that year, whereas their average income over a longer period of time is not so high.

Another example is elite athletes, who are paid more today than they were in the past. But let’s not forget that while they earn high incomes in their youth, they do not always earn very much after retirement.

Therefore, the rise in income variability documented by Piketty could simply reflect the fact that incomes are now more variable from one year to the next than they used to be, especially for high-income earners, and not that there has been an increase in income inequality between individuals.

Pierre Chaigneau is an Associate Researcher at the Montreal Economic Institute. The views reflected in this op-ed are his own.

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