Among the stack of books to read is Thomas Piketty's Capital in the Twenty-First Century.  I'll hold off on my view until I've finished reading it.  (And there are plenty of other distractions this summer, so it may be a while.)  My reading might be colored by the commentary, of which there has been plenty.  Here are a few reactions, primarily from serious economists.  There are plenty of other serious economists weighing in: good for them taking the time to read and understand.

I start, though, with the populist reading that might have contributed to widespread sales among non-economist readers.  The author is Noel Ortega.
Before the Industrial Revolution, and for most of our human history, economic growth was about 0.1 percent per year. But during and after the rapid industrialization of the global north, growth increased to a then-staggering 1.5 percent in Western Europe and the United States. By the 1950s and 1970s, growth rates began to accelerate in the rest of the world. While the United States hovered just below 2 percent, Africa’s growth rates caught up with America’s, while rates in Europe and Asia reached upwards of 4 percent.

But as Marx observed in the 19th century, economic growth did little to reduce inequality. In fact, as Piketty demonstrates, wealth has grown ever more concentrated in the hands of the few, even as the pie has gotten bigger.
Yes, and that's the fundamental problem of political economy. Reduced to Arthur Okun language, it's the tradeoff between equality and efficiency. Or, taking the longer view, it's about improving the condition of ordinary people, such that even the most desperate American enjoys better health and a better material condition than a medieval prince.

Somewhere in the populist perspective, though, is a tension between improving the material condition of the poor, and running out of stuff.
The traditional approach to inequality is to bring down those at the top while raising up those at the bottom. But to what level should we bring people, considering our finite planet?

Do we want everyone to live a mythical American middle-class lifestyle? Where every family of four lives in a two-car-garage home with a TV in every room, and every family member has a smart phone, tablet, and computer? Where they take a vacation to the other side of the globe once a year, and send their children away to a university and buy them a car when they are of age?
To Mr Ortega, there is thus a second tradeoff.
Piketty is right that our political economy favors the growth of inequality, and that inequality in turn poisons our politics. But while we should aspire to create a society that shares its prosperity, we need to address a much bigger gap than the one between rich and poor. We need to address the gap between what’s demanded by our planet and what’s demanded by our economy.

At the center of the rapidly growing New Economy Movement are ecological balance, shared prosperity, and real democracy. If we can’t find a way to build all three, then the only economy worth measuring is the number of days we have left.
That's where neoclassical growth theory comes in.  Fortuitously, The New Republic enlisted Robert Solow to review Piketty.
For example, if the rate of return is 5 percent a year and the stock of capital is six years worth of national income, income from capital will be 30 percent of national income, and so income from work will be the remaining 70 percent. At last, after all this preparation, we are beginning to talk about inequality, and in two distinct senses. First, we have arrived at the functional distribution of income — the split between income from work and income from wealth. Second, it is always the case that wealth is more highly concentrated among the rich than income from labor (although recent American history looks rather odd in this respect); and this being so, the larger the share of income from wealth, the more unequal the distribution of income among persons is likely to be. It is this inequality across persons that matters most for good or ill in a society.

This is often not well understood, and may be worth a brief digression. The labor share of national income is arithmetically the same thing as the real wage divided by the productivity of labor. Would you rather live in a society in which the real wage was rising rapidly but the labor share was falling (because productivity was increasing even faster), or one in which the real wage was stagnating, along with productivity, so the labor share was unchanging? The first is surely better on narrowly economic grounds: you eat your wage, not your share of national income. But there could be political and social advantages to the second option. If a small class of owners of wealth — and it is small — comes to collect a growing share of the national income, it is likely to dominate the society in other ways as well. This dichotomy need not arise, but it is good to be clear.
Professor Solow contributed to the theory of balanced economic growth, as evidenced by the invocation of the capital and labor share: in a balanced growth equilibrium, these are constant, but in a growing economy, that small class of owners can collect a growing share of the national income.  But perhaps life is messier than a balanced growth equilibrium, and out-of-equilibrium incentives to equilibrium matter.
There is no logical necessity for the rate of return to exceed the growth rate: a society or the individuals in it can decide to save and to invest so much that they (and the law of diminishing returns) drive the rate of return below the long-term growth rate, whatever that happens to be. It is known that this possible state of affairs is socially perverse in the sense that letting the stock of capital diminish until the rate of return falls back to equality with the growth rate would allow for a permanently higher level of consumption per person, and thus for a better social state. But there is no invisible hand to steer a market economy away from this perversity. Yet it has been avoided, probably because historical growth rates have been low and capital has been scarce. We can take it as normal that the rate of return on capital exceeds the underlying growth rate.
And thus Professor Piketty's now-famous r > g becomes a new stylized fact.  But don't throw out your growth theory, not yet.
Suppose it has reached a “steady state” when the capital-income ratio has stabilized. Those whose income comes entirely from work can expect their wages and incomes to be rising about as fast as productivity is increasing through technological progress. That is a little less than the overall growth rate, which also includes the rate of population increase. Now imagine someone whose income comes entirely from accumulated wealth. He or she earns r percent a year. (I am ignoring taxes, but not for long.) If she is very wealthy, she is likely to consume only a small fraction of her income. The rest is saved and accumulated, and her wealth will increase by almost r percent each year, and so will her income. If you leave $100 in a bank account paying 3 percent interest, your balance will increase by 3 percent each year.

This is Piketty’s main point, and his new and powerful contribution to an old topic: as long as the rate of return exceeds the rate of growth, the income and wealth of the rich will grow faster than the typical income from work. (There seems to be no offsetting tendency for the aggregate share of capital to shrink; the tendency may be slightly in the opposite direction.) This interpretation of the observed trend toward increasing inequality, and especially the phenomenon of the 1 percent, is not rooted in any failure of economic institutions; it rests primarily on the ability of the economy to absorb increasing amounts of capital without a substantial fall in the rate of return. This may be good news for the economy as a whole, but it is not good news for equity within the economy.

We need a name for this process for future reference. I will call it the “rich-get-richer dynamic.” The mechanism is a little more complicated than Piketty’s book lets on. There is some saving from labor income, and thus some accumulation of capital in the hands of wage and salary earners. The return on this wealth has to be taken into account. Still, given the small initial wealth and the relatively low saving rate below the top group, as well as the fact that small savings earn a relatively low rate of return, calculation shows that this mechanism is not capable of offsetting the forecast of widening inequality.

There is yet another, also rather dark, implication of this account of underlying trends. If already existing agglomerations of wealth tend to grow faster than incomes from work, it is likely that the role of inherited wealth in society will increase relative to that of recently earned and therefore more merit-based fortunes.
And we have yet to introduce factor-augmenting technical change or resource constraints that might limit either increases in income from work, or returns on capital.

Never a shortage of interesting questions.  Or perspectives.  Foreign Affairs retains Tyler Cowen, who offers an interesting twist on Paul Samuelson's quip about Karl Marx being a minor post-Ricardian.
Piketty, in a way, has updated the work of the British economist David Ricardo, who, in the early nineteenth century, identified the power of what he termed “rent,” which he defined as the income earned from taking advantage of the difference in value between more and less productive lands. In Ricardo’s model, rent -- the one kind of income that did not suffer from diminishing returns -- swallowed up almost everything else, which is why Ricardo feared that landlords would come to dominate the economy.

Of course, since Ricardo’s time, the relative economic importance of land has plummeted, and his fear now seems misplaced. During the twentieth century, other economists, such as Friedrich Hayek and the other thinkers who belonged to the so-called Austrian School, understood that it is almost impossible to predict which factors of production will provide the most robust returns, since future economic outcomes will depend on the dynamic and essentially unforeseeable opportunities created by future entrepreneurs. In this sense, Piketty is like a modern-day Ricardo, betting too much on the significance of one asset in the long run: namely, the kind of sophisticated equity capital that the wealthy happen to hold today.

Piketty’s concern about inherited wealth also seems misplaced. Far from creating a stagnant class of rentiers, growing capital wealth has allowed for the fairly dynamic circulation of financial elites. Today, the Rockefeller, Carnegie, and Ford family fortunes are quite dispersed, and the benefactors of those estates hardly run the United States, or even rival Bill Gates or Warren Buffett in the financial rankings. Gates’ heirs will probably inherit billions, but in all likelihood, their fortunes will also be surpassed by those of future innovators and tycoons, most of whom will not come from millionaire families.
Democracy Journal brings in Lawrence Summers, who characterizes the book as an important first word on a challenging topic, yet suggests there is room for further research.
Economists universally believe in the law of diminishing returns. As capital accumulates, the incremental return on an additional unit of capital declines. The crucial question goes to what is technically referred to as the elasticity of substitution. With 1 percent more capital and the same amount of everything else, does the return to a unit of capital relative to a unit of labor decline by more or less than 1 percent? If, as Piketty assumes, it declines by less than 1 percent, the share of income going to capital rises. If, on the other hand, it declines by more than 1 percent, the share of capital falls.

Economists have tried forever to estimate elasticities of substitution with many types of data, but there are many statistical problems. Piketty argues that the economic literature supports his assumption that returns diminish slowly (in technical parlance, that the elasticity of substitution is greater than 1), and so capital’s share rises with capital accumulation. But I think he misreads the literature by conflating gross and net returns to capital. It is plausible that as the capital stock grows, the increment of output produced declines slowly, but there can be no question that depreciation increases proportionally. And it is the return net of depreciation that is relevant for capital accumulation. I know of no study suggesting that measuring output in net terms, the elasticity of substitution is greater than 1, and I know of quite a few suggesting the contrary.
And yet, owners of capital are getting richer.  But understanding that dynamic takes work.  Dissent engages James Galbraith to elaborate.  Aggregation is necessarily perilous, and Professor Galbraith might send some future dissertators to the stacks.
But the argument of the critics was not about Keynes, or fluctuations. It was about the concept of physical capital and whether profit can be derived from a production function. In desperate summary, the case was three-fold. First: one cannot add up the values of capital objects to get a common quantity without a prior rate of interest, which (since it is prior) must come from the financial and not the physical world. Second, if the actual interest rate is a financial variable, varying for financial reasons, the physical interpretation of a dollar-valued capital stock is meaningless. Third, a more subtle point: as the rate of interest falls, there is no systematic tendency to adopt a more “capital-intensive” technology, as the neoclassical model supposed.

In short, the Cambridge critique made meaningless the claim that richer countries got that way by using “more” capital. In fact, richer countries often use less apparent capital; they have a larger share of services in their output and of labor in their exports—the “Leontief paradox.” Instead, these countries became rich—as Pasinetti later argued—by learning, by improving technique, by installing infrastructure, with education, and—as I have argued—by implementing thoroughgoing regulation and social insurance. None of this has any necessary relation to Solow’s physical concept of capital, and still less to a measure of the capitalization of wealth in financial markets.
And thus, understanding the dynamics of capital accumulation, or wealth concentration, might be much more work than simply noting the presence of either.

There's plenty more out there: start with the Marginal Revolution collection if you'd like.

I close, for now, with a commendation of Professor Solow for stating a gripe I have long held with contemporary publishing practices.  "I call down a painful pox on publishers who put the footnotes at the end of the book instead of the bottom of the page where they belong, thus making sure that readers like me will skip many of them." Indeed.

No comments: