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Perverting Piketty

Perverting Piketty

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I recently wrote about the numerous misconceptions over Thomas Piketty's use and definition of capital in his book Capital in the 21st Century. Sadly, it seems there are a number of other common, equally important mischaracterisations of Piketty's model floating around. Here I will consider 5 of the most widespread and show, using direct quotes from Piketty himself, why they are off the mark. The first 3 are simple errors of interpretation with regards to Piketty's theoretical framework, while the latter 2 are problems with how people have responded to Piketty in general. Although the latter 2 are inevitably more subjective, they are still important for trying to understand and reframe the debate between Piketty and his critics.

1. Lazy rentiers or innovative entrepreneurs?

The claim: Piketty wrongly characterises all capitalists as earning passive returns, and doesn't appreciate entrepreneurial dynamism or the fact that some capitalists lose out.

The reality: Piketty repeatedly distinguishes between the returns to entrepreneurship and the returns to simply owning capital. His major concern is that over time, the latter will dominate the former, as those who were previously entrepreneurs and their heirs begin to live off rents from their accumulated capital.

Piketty begins by pointing out that "a portion of what is called “the income of capital” may be remuneration for “entrepreneurial” labour, and this should no doubt be treated as we treat other forms of labour". He notes the difficulty of separating the two types of income with absolute precision, but argues that the the former inevitably transforms into the latter:

"Capital is never quiet: it is always risk-oriented and entrepreneurial, at least at its inception, yet it always tends to transform itself into rents as it accumulates in large enough amounts—that is its vocation, its logical destination...

...Liliane Bettencourt, who never worked a day in her life, saw her fortune grow exactly as fast as that of Bill Gates, the high-tech pioneer, whose wealth has incidentally continued to grow just as rapidly since he stopped working. Once a fortune is established, the capital grows according to a dynamic of its own, and it can continue to grow at a rapid pace for decades simply because of its size."

It may well be that by shifting from 'entrepreneur' to 'rentier', the very richest get replaced. However, Piketty argues they can still remain wealthy just by investing in a portfolio that yields a modest rate of return.

Piketty actually cautions against overzealous taxation of capital income on the grounds that it "would risk killing the motor of accumulation and thus further reducing the growth rate." He endorses a tax on wealth (which, incidentally, is not 80% but 1-3%) not because he thinks all capital income is unearned, but because such a tax is more likely to target unearned income than a tax on capital income. 

2. 'Fundamental laws' of capitalism?

The claim: Piketty's 'fundamental laws of capitalism' are not fundamental at all.

The reality: Although calling them 'laws' is misleading, at no point does Piketty claim that his laws are inviolable. They are instead tendencies (with the exception of the first law, which is just an accounting identity) which push capital's share of income in a certain direction over time, but can be counteracted by any number of things, and only take hold over a long timespan.

Piketty's second law states that the capital/income ratio equals the savings rate over the rate of growth, or β = s / g. Krussel & Smith (KS) interpret this as a straightforward equality, but Piketty makes it clear this is not the intention:

"...this is an asymptotic law, meaning that it is valid only in the long run: if a country saves a proportion s of its income indefinitely, and if the rate of growth of its national income is g permanently, then its capital/income ratio will tend closer and closer to β = s / g and stabilize at that level. This won’t happen in a day, however: if a country saves a proportion s of its income for only a few years, it will not be enough to achieve a capital/income ratio of β = s / g."

The law is supposed to tell you how the capital/income ratio will change for a given savings rate and growth rate, rather than what its value will be at any one time.

Piketty's "fundamental force for divergence [of income/wealth]" (not sure why this isn't called his third law) states that the rate of return on capital will exceed the rate of growth, increasing inequality over time, or r > g. A common misconception is that 'r' represents some sort of rate of growth for capital, but it actually represents the returns to ownership of capital in a given year. If growth is low, and the returns to capital are high, then accrued wealth from these returns will begin to dominate other income. It is not required that the returns themselves grow for this to happen. Again, Piketty is aware that empirically, r > g "is a contingent historical proposition, which is true in some periods and political contexts and not in others".

What's more, Piketty's version of his third law is not the same as the popular interpretation that seems to be floating around, characterised by Dan Kervick as “r > g, therefore disaster!” For Piketty, r > g  is only a necessary, not a sufficient condition for inequality to increase: if r is "distinctly and persistently" greater than g, this is a "powerful force for a more unequal distribution of wealth". As he makes clear, other things can offset this effect, which leads to me number 3:

3. Savings and accumulation

The claim: Piketty's definition of saving assumes all savings are accrued as capital; once this assumption is relaxed, his model does not necessarily imply that inequality will increase.

The reality: Piketty is well aware that there are many things which offset the savings accrued by capital owners, but his framework implies that inequality can increase despite these things.

For example, KS argue that Piketty does not adequately account for capital depreciation and the difference between net and gross saving. But Piketty's definition of savings already includes depreciation:

"One can also write the law β = s / g with s standing for the total rather than the net rate of saving. In that case the law becomes β = s / (g + δ) (where δ now stands for the rate of depreciation of capital expressed as a percentage of the capital stock)."

Similarly, Larry Summers claims that Piketty "presumes...the returns to wealth are all reinvested", but the latter again makes it clear this need not be the case, and gives a specific historical example where inequality has increased despite a relatively low savings rate:

"the rate of return on capital was significantly higher than the growth rate in France from 1820 to 1913, around 5 percent on average compared with a growth rate of around 1 percent. Income from capital accounted for nearly 40 percent of national income, and it was enough to save one quarter of this to generate a savings rate on the order of 10%. This was sufficient to allow wealth to grow slightly more rapidly than income, so that the concentration of wealth tended upward."

It is not required by Piketty that all the returns to capital go toward increasing the wealth of capitalists; it is merely required that enough is saved for this to happen: depreciation, conspicuous consumption and whatever else may offset accumulation, but inequality can increase nonetheless.

4. Marx reincarnated?

The claim: Piketty's book, or at least his policy prescriptions, are ideologically motivated.

The reality: Nobody is unbiased, and Piketty's ideas are inescapably political and ethical. However, there is an undeniable disparity between Piketty's arguments and the responses of some of his critics: while he is generally careful to draw major conclusions or recommend policies, at least without substantial caveats, the criticisms often take the form of blanket objections based on policy considerations alone.

For example, Tyler Cowen argues that "Piketty’s policy recommendations [a global wealth tax] are more ideological than analytic." Yet Piketty's recommendation for a wealth tax, far from a rallying cry to eat the rich, is largely designed to gather information and promote transparency, which is why Piketty puts it as low as 0.1%. To the extent that the tax is supposed to prevent accumulation, we have already seen that it is largely targeting inherited wealth, which is why Piketty rejects a tax on capital income. In contrast, Cowen sees fit to assert - without citation - that "taxes of that level would surely lower investments in human capital and the creation of new businesses" and that capital owners will "probably" avoid the tax. He also goes on to state that it is "hard to find well-functioning societies based on anything other than strong legal, political, and institutional respect and support for their most successful citizens." These are empty ideological convictions, not substantive critiques of Piketty's recommendations.

Another such example was Piketty's recent Channel 4 debate with Ryan Bourne of the Institute for Economic Affairs. At one point, Piketty argued for a 80% tax on labour income on the grounds that you don't see increases in managerial productivity at very high pay levels, but pointed out that such a tax would be "disastrous" if it were on anything below incomes of $1-2 million. Meanwhile, the best that Bourne could do - aside from referencing the discredited FT critiques and other "work" which supposedly contradicted Piketty's but had no author or title - was wax lyrical about how the industrial revolution was amazing, the poor of today are not poor compared to peasants, etcetera. Piketty replied that Bourne was "absolutely right" (no surprise, since he begins his book by documenting exactly this), and agreed that some degree of inequality was desirable, but said he was concerned that especially high inequality could be lead to a dominance of inherited wealth and hence damage exactly the kind of growth Bourne was praising. Again, we see that Piketty's attempt to make a nuanced point is met only by general ideological convictions. This dynamic is by no means limited to Cowen or Bourne; there are many others examples of these lazy criticisms, some much worse than theirs, and I am not the first to notice it.

5. Piketty belongs to mainstream economics

The claim: Piketty's model is a mainstream economic model.

The reality: Piketty briefly refers to some mainstream models for support, but most of his analysis is either statistical, historical or based on his own framework. His overall disdain for economists is made clear early in the book:

"To put it bluntly, the discipline of economics has yet to get over its childish passion for mathematics and for purely theoretical and often highly ideological speculation at the expense of historical research and collaboration with the other social sciences. Economists are all too often preoccupied with petty mathematical problems of interest only to themselves. This obsession with mathematics is an easy way of acquiring the appearance of scientificity without having to answer the far more complex questions posed by the world we live in. There is one great advantage of being an academic economist in France: here, economists are not highly respected in the academic and intellectual world or by political and financial elites. Hence they must set aside their contempt for other disciplines and their absurd claim to greater scientific legitimacy, despite the fact that they know almost nothing about anything."

This isn't to say Piketty 'belongs' to heterodox economics, either. His book and model stand on their own apart from preexisting schools of thought, and should be (critically) appreciated as such.


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Unlearning Economics

Why would net savings fall as growth falls? And would this necessarily be enough to counterbalance wealth accumulation?

As for the returns on capital - well, I wouldn't call it a "devastating critique"; it's a potential force in the opposing direction to r > g, but one that Piketty discusses, in particular noting that the return on capital doesn't seem to have diminished much below 4-5% historically. Furthermore, the return on capital may well increase domestically because of technological progress or increasing returns to scale - there's no reason to expect it to diminish a priori.

In any case, it's entirely possible for the returns on capital to fall but for capital ownership to become more concentrated, increasing inequality nonetheless. It's also possible for labour income to become more unequal, which, as Piketty notes, it has been doing for some time thanks to the "rise of the supermanager". So there are multiple mechanisms at play.

I discussed some of this in my previous post on Piketty, linked at the top of this article. The Jacobin article 'Piketty's Fair Weather Friends' is also good on this topic.

As for globalisation in general: chapter 12 is focused exclusively on this matter. Surely a global concentration of capital ownership, along with international competition for labour, implies even greater inequality?

You make valid points here except I think re Krussel and Smith. Their point was that Piketty's contention that net savings would hold up while growth slows is wrong. That's actually a crucial and devastating critique, even with the capital/income ratio correctly understood as only trending over the long run towards the long run average savings/growth ratio.

Also you leave the other devastating critique - Piketty misses that overinvestment in capital reduces returns, limiting accumulation.

What Piketty really misses though is globalization. He takes hardly any notice of the huge role that foreign investment and trade have played in the change in trend in inequality within high-income countries over the past four decades. He attempts to diagnose modern advanced economies as if they were closed.

There is one and only one way net savings and returns can hold up as growth slows: if savings are invested abroad somewhere where growth is faster. This is indeed what we have seen very clearly in Japan, and it has also been happening, albeit less obviously, in the US and Western Europe. To write such a a long book warning of a phenomenon visible in Japan today and yet miss the crucial role in it of cross-border investment, was, forgive me, rather daft.

But bringing in globalization radically changes the story, to one of emerging world labor catching up with developed world labor and developed world capital going global. For whatever reason, Piketty prefers to close his eyes to that reality.

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