Dan Kervick — The Rate of Return on Capital Is Not a Growth Rate

This post is simpler than many of my more recent posts, and is aimed only at clearing up a single popular confusion I have run across from time to time concerning the rate of return on capital, and the role that rate plays in Thomas Piketty’s arguments in Capital in the Twenty-First Century.

Some people, when they first come across Piketty’s claim that the rate of return on capital has been significantly and persistently higher than the rate of growth throughout history, will respond in one of these two fashions:

• That’s crazy! If the rate of return on capital were higher than the growth rate, then capital would inevitably expand faster than the rest of the economy, and would eventually absorb everything.
• That’s horrible! But it explains everything. If the rate of return on capital exceeds the growth rate, that means capitalists are getting rich faster than the rest of us, and the gap between wealthy capitalists and everyone else is expanding.

I suspect both of these responses often spring from a common confusion. The idea seems to be that the rate of return on capital is the rate at which something is growing: perhaps it’s the rate at which either capital itself is growing or the rate at which the income from capital is growing. But the rate of return on capital is not a growth rate.

Rugged Egalitarianism
The Rate of Return on Capital Is Not a Growth Rate
Dan Kervick