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Wednesday, August 13, 2014

Understanding Piketty, part 1

Thomas Piketty's (CV) Capital in the Twenty-First Century is the most important book on economics published in this century. The book has made a huge splash, and drawn the ire of conservatives, for its straightforward argument that recent increases in inequality in numerous countries are likely to rise to unprecedented heights unless governments can reach democratically based solutions to this problem.

As I mentioned previously, the book's success is built on a mountain of data that a multinational team of researchers has been compiling for 10 years, the World Top Incomes Database, as well as long-term wealth records dating back to 1790 in the case of France. Piketty, in fact, has been working on inequality issues for 20 years. As he remarks in the book, until the creation of these datasets, debate on inequality was a "dialogue of the deaf" with precious few facts to back up anyone's arguments. A lot of this work has been taking place out of sight of most pundits, as Piketty's early books and papers are published in French, with the exception of the reasonably well-known papers he co-authored with Emmanuel Saez on U.S. inequality.

Most notably, there has been only one significant challenge to Piketty's data, and it was easily swatted down. Chris Giles of the Financial Times claimed that wealth inequality in the United Kingdom had declined since 1980, not risen as given in Piketty's book. But Giles made the error of taking survey-based wealth data (which sharply underestimates the wealth of the rich) and splicing it on to much more accurate estate tax-based data, to get a declining share of wealth for the top 10% and the top 1%. As Piketty says in his response:
Also note that a 44% wealth share for the top 10% (and a 12.5% wealth share for the top 1%, according to the FT) would mean that Britain is currently one the most egalitarian countries in history in terms of wealth distribution; in particular this would mean that Britain is a lot more equal that Sweden, and in fact a lot more equal than what Sweden has ever been (including in the 1980s). This does not look particularly plausible.
Obviously I agree with Piketty, but don't take my word for it. According to Eurostat, the Gini index for income inequality (which runs from 0 to 1, but is often multiplied by 100, as here; higher is more unequal) in 2012 was 32.8 for the United Kingdom versus 24.8 for Sweden. (For comparison, the United States was at 45.0 in 2007, according to the CIA World Factbook.) Combine that with the fact that wealth is more unevenly distributed than income in every country, and it is impossible for U.K. wealth to be more equally distributed than Sweden's is today, let alone at its most equal point in the 1980s. Moreover, according to Piketty's data on Sweden, which Giles does not dispute, the top 10% there owned just a tad under 60% of wealth, and the top 1% fully 20% of wealth, in 2010 (Figure 10.4, p. 345).

So what does all this new data show? First of all, the data show that the optimistic post-war notion that inequality had been solved for good was an illusion. As Piketty points out, economist Simon Kuznets had posited that as countries developed from very poor to very rich, as their GDP per capita increased, countries became more unequal at low levels of income (think China today). However, after a certain tipping point was reached, as countries raised their per capita GDP, their income distribution would become more equal. This was based on what Kuznets saw in the 1950s, a situation where income inequality was indeed declining in the industrialized countries. Many people expected that as more countries developed, they would pass the tipping point, and income inequality would decline in more and more countries. Alas, since 1980, we have seen a resurgence of inequality in the wealthy countries, turning the second half of Kuznets' story into a "fairy tale."

According to Piketty, the reasons we saw a sharp decline in wealth inequality in the wealthy countries from 1910 to 1980 are that there were substantial destructions of capital in the two World Wars, plus high taxes levied on the wealthy to finance the wars, which could not be paid for otherwise. Then, after World War II, there were very rapid growth rates possible as the various countries played catch-up to get back to their pre-war growth trends.

This brings us to a second major point of Piketty's book. He argues that the relationship between the rate of return on investments (r) and the country's growth rate (g) is a critical determinant of how concentrated wealth becomes in a society. If r exceeds g, over time capital ownership becomes more concentrated and society less equal. In all probability, developed countries can only expect to see growth, after inflation, of 1% to 1.5% per year. Of course, China and some other developing countries are growing more rapidly, but as they reach the technological frontier, their growth will slow. Meanwhile, the return on investment is more on the order of 4-5% annually. Thus, for industrialized countries, there is considerable danger that the wealth will become significantly more concentrated, and Piketty considers it obvious that high inequality is dangerous to democracy.

Alas, it's late; I have to stop for the night (but not at Hotel California). I'll have more to say very soon.

Cross-posted at Angry Bear.


  1. It seems that there can be no argument with the "if r > g" argument. That's simple mathematics. If return exceeds growth, then the extra must come from somewhere else -- those not investing. So the investors/savers (as a class -- individual result will vary) will win and the spenders will lose.

    "Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds nought and six, result misery."

    But this inequality is completely voluntary. People freely and willingly give their money to wealthy in return for what they provide in return -- goods and services. People get rich (and stay rich) by providing goods and services that people want and prices they are willing to pay. Those actors are rich whom people will pay to see act. Those baseball players are rich whom people will pay to see play. The computer wizards are rich whom people will pay for the programs they created.

  2. "If r exceeds g, over time capital ownership becomes more concentrated and society less equal."

    This is so oversimplified that it is a wonder anyone can take it seriously. One could very much argue that real wealth inequality is at the lowest level in human history. Wealth is the goods and services available in a society. And there are more goods and services available to the masses today than ever before, which means that the absolute wealth gap is at the lowest point it has ever been. Go another one-hundred years and think about what goods and services will be available, and how much differences in standards of living between rich and poor will have been reduced. Look at how it has been reduced today versus one-hundred years ago.

    That is the kind of inequality that counts with regards to whether we become pre-revolutionary Russia. Relative wealth inequality is what Piketty seems to focus on, and that is a pretty meaningless form. He confuses it with being absolute wealth inequality (the kind I described).

    He speaks of the "income inequality" gap and the "wealth inequality" gap, completely oversimplifying the two. One could very much argue that there is no such thing as income inequality. That would be like talking about height inequality or what percent of society carries around X% of "society's weight." It'd be meaningless. The same applies with regards to things like so-called income inequality.

    There is also a confusing of what are statistical brackets with being fixed classes of people. For example, if the poorest 20% hold a smaller proportion of the total wealth today, so what? For one, the pie has grown a lot larger, so in terms of the absolute wealth level, the bottom 20% enjoy much greater wealth now than they used to, even if they hold a smaller overall percentage of the new pie.

    Two, statistics such as "the bottom 20%" are just that, statistics. They do not give any representation of the actual flesh-and-blood humans beings that make up society, and how well individual people are able to improve their lives in society is what counts the most.

    Thus instead of looking at so-called wealth and income inequality, we need to look at the prevalence of goods and services to the masses and how often people are able to improve their economic livelihoods. Doing this however would show society to be far less unequal than people like Piketty are claiming, and if anything, much more equal than ever before.

    If anything, adherence to Piketty's proposed tax policies will create the very type of society he loathes, one in which a small elite contro lthe majority of wealth, because there will be little to no competition for them to worry about. Everyone will be more equally poor, as opposed to modern societies such as the United States where everyone is more equally a form of rich. Note that it isn't the United States where people riot over things so much as the supposedly more equal nations such as France.

    Note also that the time periods in which inequality was supposedly skyrocketing in the United States are remembered as being among the best times economically in this country: 1980s post 1981-1982 recession, 1990s, and the 2000s prior to late 2008. Reagan was re-elected in a landslide and everyone talks about the wonderful Clinton years. Yet according to people of Piketty's point-of-view, these were horrible periods for the middle-class.