Why I am not persuaded by Thomas Piketty’s argument
My Foreign Affairs review is here. (Open up “New private window” in Firefox, if need be.) I won’t attempt to cover all of the review, but rather will rephrase a few of my points for MR readers, in slightly different terminology:
1. If the rate of return remains higher than the growth rate of the economy, wages are likely to rise and quite a bit. You can find a wonky version of that idea here from Matt Rognlie. But it suffices to apply common sense, namely that capital accumulation bids up wages. Piketty suggests we are headed back to something resembling the 19th century. Well, that was a pretty good time for the average working person in Western Europe, especially once we get past the first part of that century, which had lots of war and a still-incomplete industrial revolution.
Since we today have had some wage stagnation, perhaps it does not feel that kind of favorable outcome is what we will get and many commentators are trading off this mood. But also realize the (risk-adjusted) return on capital hasn’t been that high lately and it has been falling for decades. This combination of variables — low returns and stagnant wages — does not refute Piketty but it doesn’t exactly fit into his mold either.
2. The crude seven-word version of Piketty’s argument is “rates of return on capital won’t diminish.” Is that really such a powerful forecast? I say over the next fifty or one hundred years we don’t have a very good sense of which factors will show diminishing returns and which will not. It is hard enough to make predictions of trend over a twenty-year time horizon. NB: At many points in the Piketty book he seeks to have it both ways: loads of caveats, but then he falls back into the basic model, and he and his defenders cite the caveats when it is convenient.
3. Piketty’s reasons why rates of return on capital won’t diminish are fairly specific and restricted to only a small share of capital. He cites advanced financial management techniques of the very wealthy and also investing abroad in emerging economies. Neither of these covers most capital, and thus capital returns as a whole may not be so robust. Nor is it obvious that either technique will prove especially successful over the next few decades or longer. Again, is there any particular reason to think either of these factors will outrace the basic logic of diminishing returns, or for that matter EMH, relative to other factor returns that is? They might, to be sure. They also might underperform. In any case this is pure speculation and Piketty’s entire argument depends upon it.
4. The actual increases in income inequality we observe are mostly about labor income, not capital income. They don’t fit easily into Piketty’s story and arguably they don’t fit into the story at all.
5. Piketty converts the entrepreneur into the rentier. To the extent capital reaps high returns, it is by assuming risk (over the broad sweep of history real rates on T-Bills are hardly impressive). Yet the concept of risk hardly plays a role in the major arguments of this book. Once you introduce risk, the long-run fate of capital returns again becomes far from certain. In fact the entire book ought to be about risk but instead we get the rentier.
Overall, the main argument is based on two (false) claims. First, that capital returns will be high and non-diminishing, relative to other factors, and sufficiently certain to support the r > g story as a dominant account of economic history looking forward. Second, that this can happen without significant increases in real wages.
Addendum: Still, it is a very important book and you should read and study it! But I’m not convinced by the main arguments, and the positive reviews I have read worsen rather than alleviate my anxieties. I’ll cover the policy and politics of this book in a separate post. Do read my review itself, which has much more than what is in this blog post.