*Capital in the 21st Century*

Many of you have been asking me about the forthcoming Thomas Piketty book.  I am writing a 2500-word review of it for…elsewhere…so mum’s the word until then.  For now I’ll just say it is a book to buy, read, and indeed study.  Here is one good piece on the book from The Economist.  It’s already a splendid year for the published word.


Branko Milanovic´s review of the book is very good.

Just what we needed: More soft Marxist theories.

In reading The Economist's review, it was hard to distinguish the author's views from the reviewer's, but if they thought that they were building a case for "soft Marxism", they actually ended up doing the opposite.

Piketty starts with two so-called "fundamental laws" of capitalism. The first is an accounting identity: capital’s share of income is equal to the rate of return on capital multiplied by the total stock of wealth as a share of GDP. The second "law" is a rule of thumb: over long periods the capital stock, as a percentage of national income, should approach the ratio of the national-savings rate to the economic growth rate. I am still trying to derive this one, but intuitively it makes sense that when a nation saves more, its capital stock will rise.

This second law suggests that, steady GDP growth along with sufficiently high income to allow a nation to save will naturally lead to a high ratio of capital to GDP. In contrast, if a nation encounters economic hardship --- say from a Depression or war --- that makes it difficult to save (and indeed even destroys capital), then capital-to-GDP will fall. Thus, a high capital-to-GDP indicates past economic success and a low ratio indicates past calamity. That's the left graph shown in the blue box of the review. Think of the lifecycle of an individual: if an individual earns a high enough income to save, then the individual's wealth-to-income ratio will start from near zero and grow over time. However, if the individual encounters some catastrophe that requires drawing down savings, then wealth-to-income will fall. When the individual recovers and starts saving again, then wealth-to-income will again start rising.

Combined with the first law, if capital-to-GDP is growing, then capital's share of income will also rise, *even if return on capital is steady*. So, rising capital-to-GDP and rising capital share of income are *not* indicators that capital owners are being increasingly "favored" over labor in any sense. Rather, it arises naturally anytime a nation has a period of high, sustained GDP, uninterrupted by economic calamity such as Depression or war. (One will note from the graph on the right in the review that return on capital has been pretty steady at about 5% since 1700 and is even forecast to *decline* to 4% during the rest of the century, despite the inequalitistas' insistence that the playing field is being tilted increasingly in favor of capital.)

A corollary is that if one tries to enact policies that decrease capital-to-GDP or capital share of income, then there are two possible outcomes: either the policies will fail or, worse, the policies will succeed, worse because success means that one would have induced an economic calamity sufficiently large to substantially reduce savings or destroy capital. (I am assuming constant GDP growth here, i.e., for any given rate of GDP growth, neither capital-to-GDP nor capital's share of income tell us anything particularly important about economic "fairness", inequality, etc.)

That doesn't seem to be the conclusion reached by the author/reviewer, however. Perhaps, that is the problem with starting from some pre-determined conclusion that capital growth is some ominous thing that needs to be stopped.

Politics of hate needn't be concerned with petty things like results.

I think it is different. Even in your model where almost everybody saves something sometimes in the future it is necessary that capital income will be vastly larger than labor income. So you end up in a society where your position is determined by how rich the family you were born (or married) is - not on your merit of what you can actually do.

But I think the most important critique (at lest from reading the review by Branko Milanovic) is that the return on capital is "constant" and independent on the capital stock or technological rate of growth. This is quite strange. If it is so then the most sane policy would be for every country to create sovereign wealth fund and funnel taxes (hopefully gathered from rich) there. So you sort-of hijack the system by having government as the most "rich" person who rides this wave of inequality.

I sense something fishy here but I reserve further comments until I actually read the book.

I hope your review includes "highfalutin claptrap and sophistry with the sole purpose of justifying theft from some people's wallets to benefit others beholden to the takers."

When someone creates net new wealth through enterprising use of capital, he already serves the interests of others when he pays for their services or provides output for payment. Calculating a notional return that would induce investment is folly, for the capitalist faces grave uncertainty in the outcome and their gain in wealth is proportional to the good it has done. If wealth increases, the rate of return must fall unless new technology squeezes more wealth out of fewer resources. This enhances human existence and shouldn't be discouraged.

Bottom line is that an extra dollar of newly created wealth in Bill Gates' pocket does me no harm, and likely does demonstrable benefit for me. It is none of anyone's business what is in Gates' wallet, both from the standpoint of privacy and property rights. The review by Milanovic removes all doubt about the connection of the ideas of this book and Marxism, and we should be justly repelled as much.

Shorter Willitts:

That books some bullshit.

That's what I said. :)

What should taxes pay for and who should pay for them, in your opinion?

Taxes should pay for the provision of public goods and the remediation of other market failures. That's it.

And before anyone proffers some stupid example of a not-public good, a public good is nonrival in consumption and nonexcludable.

As for who pays, we should have a proportional income tax with a generous exemption for basic needs and few other deductions. We absolutely cannot balance our budget without taxes over a broad base, and that means the middle 90% of income earners.

I agree with Willitts. Marxists and their friends will get a rise out of this book, but it's trivial. The rich have always got about the same proportion of wealth; it just fluctuates within a range of 30% (low) to 50% (high), and presently the top 1% of households own almost 40% of the nation's wealth (full disclaimer: I am in the 1%, hard for some of you to believe, I know, but there it is). This ratio seems to hold, from what I've seen in the literature, more or less throughout history and across cultures. Look even at the GINI coefficients and note the relative closeness between Brazil and Denmark. What is magnified is the fact you have outliers so that you'll have a billionaire in Brazil (like the fallen magnate E. Batista) that you maybe won't find in Denmark (oops, there are 5 billionaires in Denmark says Wikipedia, but they keep a low profile!), or rather the gap between billionaire and pauper is greater in Brazil, so the perception that there are super-rich in Brazil is magnified.

Income disparity is a moral issue, not a logical issue, akin to "inside trading". What harm is inside trading? None, logically. If Bill Gates makes another $10B and it trickles down so a poor person makes an extra 1 cent, the poor should logically be grateful. By analogy, If you sold to an insider, it makes no more difference than selling to a random Joe, since you would have sold anyway. But supposedly it discourages the 'small investor' (balderdash, but that's the conventional mythology; the fact the Philippines is corrupt does not discourage me from being here, for example, and there are many more like me). Likewise, the fact that I am in the 1% should not discourage anybody, but make them strive to be more like me. It actually reminds me of the "optimal (for society) income tax bracket structure" that I once saw: it was not a Laffer Curve but a F(x) = 1/x curve (hyperbola), regressive, so the poor and middle class pay more tax. The theory was: to the extent people are incentive-ized by taxes, they will work harder to get out of their tax bracket by making more money. This will result in more GDP for society as everybody strives to get rich. Logically, this tax bracket would maybe not collect the most money short term, but long term it would (if people are motivated by taxes, and I'm not sure they really are) by increasing GDP.

'or rather the gap between billionaire and pauper is greater in Brazil'

Actually, the existence of a real middle class is what is noticeable in Denmark. That, and the fact it is a monarchy.

And as a note - Denmak's 2012 GINI number was 28.1, while Brazil's was 59.1, which makes this statement 'Look even at the GINI coefficients and note the relative closeness between Brazil and Denmark' pretty amusing.

The US has a shrinking middle class because a growing share of our population either have no skills of measurable worth or the skills they have are WORTHLESS. Those same people are simply unwilling or disqualified from doing jobs that illegal aliens gratefully perform. I'd gladly allow more eager immigrants in if we could pass our trash back to the socialist states the immigrants came from.

I'm pretty darn sure China & India wouldn't mind your trash at all. What's a few million on a billion plus baseline population. They won't even notice. :)

PS. The "unwilling to" I understand. But what's the "disqualified from" bit?

I love it, Willits, when people are reduced to little more than their "job skills." Pretty sure there's more to it than that.

At any rate, you're wrong on the merits. The US has a shrinking middle class because less-developed countries are...well, developing.

The jobs you think Americans are "simply unwilling or disqualified from doing" are no less necessary and are still being done. Just in other countries at a lower cost.

Agree with Herb - people are more than the skills they bring to the economic table. Robots and smart machines are here - millions of people around the globe aren't able to keep up. Figuring out how to keep everything going without resorting to TC's beantopia will be the major issue of the 2020s. As an aside, most stock pickets and mutual funds are worse than useless as they destroy client money when compared to index funds and ETFs.

>Income disparity is a moral issue, not a logical issue, akin to “inside trading”. What harm is inside trading? None, logically

Are you for real? I don't know if you understand the distinction here.

>The theory was: to the extent people are incentive-ized by taxes, they will work harder to get out of their tax bracket by making more money

In what universe are the poor not already incentivized to "work harder" and "make more money"? Is this satire?

@Phill--"Are you for real?" - seems you are more questions than answers; try refuting me instead of questioning. "In what universe are the poor not already incentivized to “work harder” and “make more money”? Is this satire?" - in the marginal universe, you do know about marginal analysis, don't you? And I did add the disclaimer I don't think people respond much to tax brackets. You're dismissed.

The marginal utility on every dollar diminishes, but is still immense when you make under $20,000. Double that if you have a child. Adjust per local cost of living.

All of my elders have experienced crushing poverty. Having grown up somewhat poor and later on experienced being merely flat broke, I have no place for morality plays that relate income to "hard work". It's an absurd, infantilizing premise that yields cruel and inhumane conclusions.

The problem with insider trading is the same as steroids in MLB. You penalize the honest players and investors. An answer is to make insider trading and steroids permissible so the playing fields are level but you would see fewer retail investors if you threw the doors open to insider trading. Big money would simply bribe their way into alpha by hiring insiders around the globe.

Should universities give tenure only on the condition that new professors continue their drug regime until retirement?

Milanovic on Piketty: "It envisages a future of relatively slow growth with the rising share of capital incomes, and widening income inequality. This tendency could be checked only by worldwide taxation of capital."

In other words, the hoarders will be swimming in their money like Scrooge McDuck unless the goverment puts it (and them) to work. We've heard this song before.

So then it must be true

Isn't this uh, roughly what Tyler has been saying for quite a while now as well?

Isn't this inline with "secular stagnation"?

I swear I've read something like this on interfluidity as well.

The main difference seems that people disagree on what should be done about this.


Speaking of new currencies we need, can we get a swimmable one already?

French thinker condemns capitalism.

French thinker, who has published the following title, condemns capitalism. Why, color me surprised.

"Vive la gauche américaine ! : Chroniques 1998-2004"

Mild surprise: Why is Tyler Cowen reviewing it?

Bigger surprise: Why is Harvard University Press publishing it?

Surely anything that causes the commentators on MR to collectively crap their pants simultaneously is something worth reading.

That is why we love Steve Sailor so much. But then it doesn't look to me like Mr Piketty isremotely like Steve Sailor.

So Much For Spelling Names

LOL, agreed

Since he got his PHD at age 22, Picketty has spent the last 20 years collecting data about wealth inequality.
He is the only one in the world to have such data and to have worked on it.
Which means that we should be careful before condemning him because we don't like, as anybody else, taxes.

Actually that is why we should be careful believing him. When other people have reproduced his results, then we can trust his views. At the moment he looks a bit like a crank.

Pierre, I am neither criticizing his intelligence, his data, or his method of analysis. To me, income inequality is a fictional phenomenon - not that it doesn't exist but that it is entirely meaningless.

I could claim that the cash held by the rich is cleaner and crisper than the cash held by the poor for the same denomination of bill. The poor always get stuck with the dirty money which is less liquid because some people won't take it. The rich get their crisp bills because...insert fallacious Marxist arguments.

I could gather a mountain of data on Cash Cleanliness, analyze it with the latest and best techniques, and achieve undeniably significant results.

And despite all that brilliant rigorous analysis, I have still told you nothing of any economic consequence. But the poor...millions of them...might truly be persuaded by this nonsense to form protest groups and demand cash exchange programs or free money laundry services.

This phenomenon might be of some consequence in Somalia, but it means absolutely nothing here. So all that highfalutin sophistry is a waste of precious oxygen.

I'm not so sure. What about resentment? Jealousy? Unrest.

A lot of happiness could very well be based on a relative standard. No one's saying you have to shoot for wacky communist style equality but acknowledging that extreme levels of inequality might cause problems doesn't sound unreasonable. Whether there are suitable interventions is another question but that shouldn't stop us from acknowledging the problem itself.

You think there is more resentment for Bill Gates if he has 60B than if he has 30B?


And Bill Gates only has one vote, while the unwashed, resentful masses who want to rob Peter to pay Paul have more than one vote (though they rarely vote).

Interesting times we live in: I suggest if you an afford it, get a second passport like me, and keep some of your assets in separate countries to keep the taxman at bay. Unless we go to a worldwide registration of property, and/or your ex or your family get pissed at you and turn you in (all the more reason to keep them in the dark as well, to a degree) you're safe if you diversify worldwide, if you can afford it.

Views on wealth inequality are really dependent on wether you believe in natural law or not.
Is my level of wealth determined by arbitrary social rules, or do I deserve it, no matter what?
I tend to believe that when Bill Gates goes from 30B to 60B in 5 years, while doing basically nothing, when the vast majority of hard working people have stagnant income, it might suggest that we are facing a market failure.
At least I am interested in listening to what economists have to say on this matter.

Excellent advice, Ray. Might I also recommend a "Survival Seed" package. Dozens of non-hybrid seeds in its own patented container, a perfect addition to anyone's go bag. Only two easy payments of $49.95.

(And one complicated one.)

You think there is more resentment for Bill Gates if he has 60B than if he has 30B?

At the margins? Certainly

>To me, income inequality is a fictional phenomenon – not that it doesn’t exist but that it is entirely meaningless.

This is a kind of pointless statement. By that measure, virtually everything to do with the economy is a "fictional phenomenon". We're just naming things we measure. Not every description of emergent phenomena is actually going to provide a 1:1 mapping.

Lots of people are having to do smaller portions of the real resources of the economy than they used to a generation ago. That's something we've measured. That's inequality. Your argument however hinges on the notion that inequality isn't bad and thus doesn't exist and that's just silly.

At the end of the day, wealth is a political right granted by society - a collective fiction just like "money", or "the freedom of speech", and if we're finding that vast inequality is harming the ability of most people to exercise their political rights then maybe we need to change the fiction of wealth a little bit.

Isn't extreme inequality bad because it leads to less consumption? When Gates goes from 30b to 60b based on the price of Microsoft the effect on the economy is nil. But if Gates converts the gains to cash and spends the cash on medical supplies and food for the poor there is a positive effect on the economy. Bloomberg only owns one phone but if his money was split up among 1000s of paupers then Verizon would get 1000s more customers. They may even need to hire people to service the customers. Rich people sitting on securities doesn't help the economy.

>Rich people sitting on securities doesn’t help the economy.

All capital is put to use.

How do rich people sitting on paper assets contribute to the economy? Is the theory that cash deposits get lent out by commercial banks? Didn't the London Whale gamble away billions of dollars of bank deposits? Didn't JPM set up units to trade with investor deposits instead of loaning said deposits out to businesses?

What about this example -

You sell video games. You can sell into two markets. Market A = 100mil people with a median family income of $50K and a low standard deviation of income distribution. Market B = 100mil people with a median income of $7K but a high standard deviation of income distribution. In fact, market B has a city of 10mil people and each family in that city has $1mil+ liquid net worth.

I would prefer to sell video games into the first market. Ultimately, if income inequality keeps trending and the 15% pull completely away from the 85% then some businesses will fail due to a lack of customers - which is kind of what we're seeing with JC Penney, Sears, Macy's, etc. If the 85% can't afford what the economy is capable of producing then we get business failure. At least that's what this non-economist thinks.

All capital is put to use, but where?

Super-rich people have enough power to facilitate some change. This may be very good.

I like the fact that Elon Musk has enough wealth to start private spaceflight companies.

In the world where this amount of wealth were only held by state entities, you would still have ossified
NASA as the putative leader of that market.

What justification remains for fractional reserve banking if the wealth to income ratio is increasing and expected to continue to increase? Scrap fractional reserve / maturity mismatched banking and let middle class savers get the full value of their saving. There is one advantage the poor have over the rich - they are younger in general. Give them the benefit of the same.

In the long run we are all dead. From the comment in The Economist, Piketty finds that there is a natural rate of return on capital. In the long run. Unfortunately, in the short run the rate of return is unstable, fluctuating up and down as the economy booms and busts, with long periods of stable return (e.g., post-WWII through the 1970s) being the aberration. Are we doomed to short run economic instability? Will our future be more like the late 19th century and early 20th century boom and bust cycle? Is the cure for instability worse than the disease itself? My view is that excessive concentrations of income and capital (i.e., inequality) are self-correcting, as the rate of return falls and risk rises in response, at some point resulting in a financial collapse and a precipitous drop in the value of capital. It's only through intervention by government that the drop can be mitigated, which preserves inequality for another financial collapse anther day, unless and until government loses the political will to intervene.

So is the part of the book dealing with excess returns to capital any different than what was laid out in Triumph of the Optimists? The book Neiderhoffer raves about.

The focus on the U-shaped curve of inequality overtime is definitely reminiscent of Kuznets. Societies start off as relatively equal (equally poor). When an exogenous change unleashes economic forces, at this initial state there are still high returns to capital accumulation (r>g). This is the upward slope of the u-curve: inequality rises as capitalists grow faster than the general economy. Once diminishing returns set in, fundamental innovation becomes more important, driving unequal gains to discrete innovators rather than a horizontal class of high-savers, who are now making simply the growth rate (r=g). This is when the U-curve has peaked and begins sloping down. This is what we see in the developing work: industrial revolutions increased inequality; inequality peaks and begins to decline as we bump against the technological frontier. Then globalization begins. All of a sudden there are new r>g opportunities for first world capitalists. Capital is internationally mobile while labour is trapped by borders. Labour continues to make returns at the rate of g while first world capital makes emerging market rates of r. Worse, labour may make <g among certain low skill groups who experience factor price equalization. Open economies imply this trend will carry on until the global economy gets to the frontier. And we're many decades away from that.

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