Testing Piketty's Hypothesis on the Drivers of Income Inequality: Evidence from Panel VARs with Heterogeneous Dynamics

TL;DR

This paper empirically tests Piketty's hypothesis that the r-g gap drives income inequality using panel VAR models, finding no support and highlighting the importance of other economic dynamics.

Contribution

It provides the first formal empirical test of Piketty's causal chain using panel VARs with heterogeneous dynamics across multiple countries.

Findings

No empirical support for Piketty's r-g hypothesis.

Savings-rate adjustments offset inequality effects.

Diminishing returns to capital influence inequality dynamics.

Abstract

Thomas Piketty's Capital in the Twenty-First Century puts forth a logically consistent explanation for changes in income and wealth inequality patterns. However, while rich in data, the book provides no formal empirical testing for its theorized causal chain. This paper tests the hypothesis that the $r-g$ gap drives income inequality and the increasing capital share of national income. Using panel VAR models with data from 18 advanced economies over 30 years, I find no empirical support for Piketty's predictions. The results suggest that dynamics such as savings-rate adjustments and diminishing returns to capital play critical roles in offsetting the hypothesized effects. These findings challenge the theoretical underpinnings of the growth in inequality and call for alternative explanations.