Welcome Knut (George Grantham) and masaccio

Discussion about Thomas Piketty’s book – Capital in the Twenty-First Century

(Thomas Piketty will not be here, but will participate in a salon later this year)

Knut’s Introduction:

Good afternoon, Pups. As most of you know, we were supposed to have this discussion six weeks ago with Piketty himself, but at the last minute he was overwhelmed by requests for interviews on television (including a stint on the Colbert Report) and just about every major newspaper in the English-speaking world and had to cancel. Jane is hopeful that we can have him on sometime in the future, but for the time being you will have to content yourself with Masaccio and myself. I have e-mailed Thomas to let him know we are doing this, and that he is more than welcome to intervene like Marshall McLuhan in ‘Annie Hall’ to tell me I am talking nonsense. In his absence, please feel free to do so yourself.

Capitalism in the 21st Century has taken the world of professional economics and economic punditry by surprise, and though it is clear from Piketty’s text that he knew exactly what he was doing, the success of the English translation (the French version came out late last fall) probably surprised him as well. As of a couple of weeks ago, it had sold 80,000 copies since coming out at the beginning of March. It has received numberless serious reviews, more than a few hit jobs – the one by Michael Kinsley in this month’s Vanity Fair being the latest—and has upturned the self-referential world of mainstream professional economics, where Piketty’s work, though known, was considered marginal to the main task of turning the world into the realization of its economic model. Capital is therefore more than a report on the trends in wealth and income distribution: it attacks many of the central presumptions that have dominated the practice of economics since the early 1970s. It is arguable that he has written the most important book in economics since Keynes’ General Theory.

Ever since Tjalling Koopman’s essay Measurement Without Theory (1947) mainstream economics has generally held that the proper way to do empirical economics is to start with a theory, work out its empirical implications, and subject them to statistical test. Piketty reverses that procedure. He starts with facts, defines what they are, and attempts to explain them without restricting the explanation to the class of pure economics. The goal is to explain, not to reduce phenomena to outcomes of self-interested behavior, and we know a lot more about why people do what they do than what is in your economist’s philosophy. I hope we can get into some of these issues. However, the first and most important task is to set out what the book actually says.

To summarize a 700-page book in a few paragraphs is to distort it beyond recognition. If you want to find out what’s in it, you are going to have to read it, and I strongly recommend you do so. It is extremely well written, and what other economics book uses Balzac, Jane Austen, Henry James, and Madmen to make serious claims? What follows is a brief selection of points that I hope can serve as a basis for discussion. If you have read the book or even some of its reviews, please feel free to add your own. Here’s my selection of the highlights. I apologize for the length.

1. The Data. This is the Crown Jewel. The data set compiled by Professor Piketty and his collaborators describing the evolution over two centuries of the share of income and wealth in the top decile and centile of their respective distributions is a scientific achievement of the highest order. It makes everything else possible. The data are a game-changer; Piketty’s time series is the first major breakthrough in macroeconomics since the development of the system of National Income Accounts in the 1930s, transformed Keynes’s theoretical propositions from an intriguing idea into an implementable programme. Like that construction, Piketty’s wealth distribution data are a response to a current crisis. The book is an extended commentary on that data. This is fact-based economics. Construction of the data base is an on-going project, and is being extended to less developed economies to see whether the new data reveal common tendencies that can help us understand how and why wealth and income distributions change over time. The term ‘Capital’ misleadingly placed in the title comprises a wider range of assets than reproducible physical means of production; any asset that can be traded and therefore valued at market price, which includes housing, financial assets, intellectual property and Old Masters less any debt (which s of course wealth held by someone else) is what Piketty calls Capital, and what most of us call net wealth. The data describe how that wealth is distributed among individuals between the top 1 percent, 10 percent, the bottom 50 percent and the middle 40 percent. The overwhelming proportion of that wealth has always been owned by the top decile, and in some eras by the top centile. The bottom 50 percent has on average no wealth, and never has.

2. The Trend: The secular trend in the distribution of wealth is driven by a simple dynamic described by the inequality r > g, where r is the rate of return on marketable wealth, and g the rate of growth of national income (GDP less depreciation plus net income from foreign assets. The inequality implies that income generated by capital (including capital gains and losses) grows faster than total income. Since wealth is highly unequally distributed to begin with, the income of wealth-holders in the higher reaches of the distribution (the top decile) necessarily grows faster than average income over a long stretch of time. Wealth inequality rises over time because the wealthy save most of their annual income. This dynamic dominates all other explanations of rising inequality in modern capitalist economies. Wealth becomes more concentrated because wealthy people have more to start with, plough back most of their income into acquiring more assets, both physical and financial, and get higher rates of return on their investments. This dynamic is perfectly general, and it gives a convincing explanation why countries like England and France whose nineteenth-century economic history differed significantly ended up with almost identical levels of inequality on the eve of World War I, when the top decile in both countries owned more than 85 percent of their respective nation’s wealth.

3. Growth in the ratio of wealth to income and growth in inequality are both higher, the lower is the rate of growth of the economy (i.e., the greater is r/g). The average rate of return on wealth over the two hundred years of observation has been 4 to 5 percent, which means most of the action in the ratio r/g has been driven by changes in g. This seems counter intuitive, since we expect economies that grow faster to get rich faster, but we are looking at a ratio here, not the absolute number, and when economies slow down, assuming the saving of people who hold most the wealth holds up, which surely the case, the ratio of wealth to annual income will increase. As developed economies in particular (and the world economy in general) will grow more slowly in the next half century than they did in the last half-century, it follows that the wealth/income ratio will rise and that wealth and income inequality will also rise. Slow growth generally makes the rich relatively richer. This is a fact. As noted above, Capital in the Twenty-First Century is fact-based economics.

4. No plausible economic feedback mechanism exists to reverse the growing inequality of income and wealth generated by the condition r>g; no invisible hand forces income, wealth, and individual opportunity to converge to a more egalitarian state. In particular, there is no observable tendency for r to fall enough relative to g to reverse increasing wealth concentration. Left to its own, the market generates increasing inequality. This poses a conundrum for conventional theory, which predicts that as the stock of capital relative to population rises, its rate of return should decline; but it is a fact that exists whether or not we can explain it by conventional theory. Marxist theorists have noted that the seemingly inexorable march of inequality looks a lot like Marx’s model of accumulating surplus value, but the mechanisms have nothing in common. Marxian accumulation originates in production; Piketty’s in saving out of the positive return to wealth.

5. Wealth and income have experienced periods of lessened inequality, but such periods are associated with major disruptions to the social order, in particular the First and Second World Wars and the Great Depression, which served as hecatombs of wealth in Europe and (to a much smaller degree) the United States. Surprisingly, even in Germany physical destruction of the capital stock during the Second World War accounted for only a small fraction of the total destruction of wealth. The greater part of the loss was owing to taxes on wealth, the (temporary) collapse of market valuations of residential and non-residential property, and inflationary depreciation of the national debt. Although at a stretch one might attribute the world wars and great depressions to high levels of inequality, the concrete links are so loose that it seems best not to rely on these particular mechanisms to restart the inequality clock.

6. Most large individual holdings of wealth are inherited wealth. This seems surprising at first, because we are continually bombarded with stories about people like Bill Gates, Larry Ellison and recently Mark Zuckerberg, whose wealth is not inherited. However, within the centile, or more properly speaking the millentile they inhabit their share of total wealth is small, and of course, their children’s wealth will be entirely inherited, like Paris Hilton’s. Unless the very rich have exceptionally large families, inheritance works to increase the share of total wealth owned by the very wealthy. The income from that wealth is in a real sense as well as in the old-fashioned British tax-law sense, unearned. If the wealth were redistributed, it would still earn the same average return; the income and the standard of living it supports have no justification in ‘social utility.’ In the last quarter century, the richest person in the United States (Bill Gates) and the richest person in France (Lillian Bettencourt) accumulated wealth at exactly the same rate: Bill’s went from $4 to $50 billion; Lillian’s from $2 to $25 billion. The only difference was that Mme Bettencourt inherited her fortune, whereas it can be plausibly claimed that Gates earned his.

7. The facts assembled and reported here have major implications for the social and political development of advanced economies. The most important is that the accumulation of wealth relative to income and growing inequality of that wealth are a feature of societies in which most wealth is privately owned. The crucial question arising from that fact is how much inequality a society can support before it breaks apart. In the pre-modern era, high levels of inequality were rationalized as God’s design of an orderly world. In the words of Governor Winthrop to his fellow passengers on the Arbella in their voyage to New England in 1630, ‘God Almightie in his most holy and wise providence hath soe disposed of the Condicion of mankinde, as in all times some must be rich some poore, some high and eminent in power and dignitie; others mean and in subjection.’ Ever since the American and French Revolutions, Winthrop’s claim has been impossible to sustain (though some continue to try), which means that extremely high levels of inequality can be maintained only if the wealthy succeed in controlling the repressive apparatus of the State (as was the case in some respects in the pre-Civil Rights South) or by implausibly effective propaganda. We do not know how much inequality a society can accept before it explodes (or implodes, as seems to have happen to the later Roman Empire). Legitimacy is not something economists know how to model (and hardly ever think about).

8. If the market cannot undo rising inequality, government must take on the task. Of the alternative method of outright expropriation (the Soviet solution), inflationary destruction of nominal debt (the common capitalist solution), and progressive taxation of income and wealth, which for a time was the American solution, Piketty plumps for the latter on grounds of equity and efficiency. This is not the place to thrash out the details, but he makes a convincing case that there are currently no technical obstacles to reporting individual wealth for purposes of assessment. Because with the exception of real estate, capital is internationally mobile, any tax on wealth effectively requires international cooperation, which as they say in Australia is not bloody likely. But there are no other significant impediments.

As I noted at the start, it is impossible adequately to summarize this book. Non-economists are not likely to appreciate the subtlety of its attack on what currently passes for mainstream economics. Critics like Krugman and Stiglitz have stayed inside that tradition using a discourse that accepts conventional axioms of micro-economic reasoning. On the whole they have not been successful, because in neoclassical economics as in wrestling, every hold has a counter hold, and every counter hold has its counter hold, and so on. The debate is endless. Piketty did an end run around that debate by producing facts that are not vulnerable to theoretical attacks based on the grounds that he cannot explain them by models of constrained optimization. In the end, it doesn’t really matter whether Piketty’s interpretation of those facts (and he readily admits he can be wrong); what matters is the fact of the historical tendency to increasing inequality. I admit to a certain schadenfreude from the deafening silence of Chicago-school economists who have clearly been outflanked!

I said at the beginning that I think this may be the most important book in economics since Keynes’s General Theory. It is important not because it creates a new theoretical view of the economic world, but because, like Columbus, it discovers a new world. It opens a territory for the next generation of economists to explore without being burdened by the theoretical baggage that crippled the last two generations.

 

 [As a courtesy to our guests, please keep comments to the book and be respectful of dissenting opinions.  Please take other conversations to a previous thread. – bev]

Welcome Knut (George Grantham) and masaccio

Discussion about Thomas Piketty’s book – Capital in the Twenty-First Century

(Thomas Piketty will not be here, but will participate in a salon later this year)

Knut’s Introduction:

Good afternoon, Pups. As most of you know, we were supposed to have this discussion six weeks ago with Piketty himself, but at the last minute he was overwhelmed by requests for interviews on television (including a stint on the Colbert Report) and just about every major newspaper in the English-speaking world and had to cancel. Jane is hopeful that we can have him on sometime in the future, but for the time being you will have to content yourself with Masaccio and myself. I have e-mailed Thomas to let him know we are doing this, and that he is more than welcome to intervene like Marshall McLuhan in ‘Annie Hall’ to tell me I am talking nonsense. In his absence, please feel free to do so yourself. (more…)

BevW

BevW