Month: April 2014

Believe it or not, there is an article on wealth and inequality in the United States, with a reasonably good and accurately calibrated model.  It is authored by Ana Castaneda, Javier Dıaz-Gimenez and Jose-Vıctor Rıos-Rull, and it was published in the Journal of Political Economy in 2003.

I find the conclusion a good place to start:

…we provide a theory of earnings and wealth inequality, based on the optimal choices of households with identical and standard preferences, that accounts for the U.S. earnings and wealth inequality almost exactly. We show that uninsured idiosyncratic earnings risk, retirement, altruism, and government transfers to retired households are essential ingredients of our theory, since they allow us to replicate the observed earnings to wealth ratios of both the rich and the poor households simultaneously. We also show that calibrating the earnings process directly is a must if we want our model economies to replicate the observed distributions of earnings and wealth in sufficient detail.

Here is the abstract:

We show that a theory of earnings and wealth inequality based on the optimal choices of ex-ante identical households who face uninsured idiosyncratic shocks to their endowments of efficiency labor units accounts for the U.S. earnings and wealth inequality almost exactly. Relative to previous work, we make three major changes to the way in which this basic theory is implemented:

(i) we mix the main features of the dynastic and the life-cycle abstractions, that is, we assume that our households are altruistic, and that they go through the life-cycle stages of working-age and of retirement;

(ii) we model explicitly some of the quantitative properties of the U.S. social security system; and

(iii) we calibrate our model economies to the Lorenz curves of U.S. earnings and wealth as reported by the 1992 Survey of Consumer Finances. Furthermore, our theory succeeds in accounting for the observed earnings and wealth inequality in spite of the disincentives created by the mildly progressive U.S. income and estate tax systems, that are additional explicit features of our model economies.

In other words we already have a theory which does quite well in explaining U.S. wealth inequality, and it isn’t based on the total centrality of a comparison of r and g, as you find in Piketty.  And no one in the current debates is citing this piece, Piketty included.  From the main results, note this:

We find that abolishing estate taxation brings about an increase in steady-state output of 0.35 percent and an increase in the steady-state stock of capital of 0.87 percent. Along every other dimension, the differences between the benchmark and the No EstateTax model economies are negligible. If anything, we find that abolishing estate taxation brings about a very small increase in wealth inequality [emphasis added]. Specifically, the Gini index of wealth increases from 0.79 to 0.80, and the share of total wealth owned by the top quintile increases from 81.97 percent to 82.33 percent.

We conjecture that the main reason that justifies these findings is that, given the demographics of our model economy, the role played by the estate tax rate in determining the after-tax rate of return of the economy is quantitatively very small.

I don’t hear this point brought up very much these days.

An ungated pdf is here, and for the pointer I thank Tony Smith.  You should by the way also read the Krusell and Smith paper, which deals with similar topics.  See this survey too.

So much of the current Piketty debate is simply forgetting that…science exists and has already offered a wide range of insights on these topics, as well as having rendered some of the more extreme claims unlikely.  In addition to what I offered Sunday, via Tony Smith here are a few additional links:

1. Huggett: http://www9.georgetown.edu/faculty/mh5/research/jedc1993.pdf

2. Aiyagari: http://www.minneapolisfed.org/research/WP/WP502.pdf

3. Heathcote et al: http://www.jonathanheathcote.com/HSV_AR.pdf

Update: Piketty did cite the main piece discussed here in 2010.

Here is one good part of a consistently good and interesting review:

Most of the analysis in the book is more about accounting than economics. Piketty takes nearly everything as exogenous then divides things arithmetically. His ubiquitous r > g heuristic takes both sides of the inequality as given for almost the entire book. Lines like “the richest 10 percent appropriate three-quarters of the growth” (297) enable lazy readers to avoid thinking about what actually determines income. Language about “appropriation” suggests that we live in an endowment economy, as does the claim that post-World War I wealth inequality fell “so low that nearly half the population were able to acquire some measure of wealth” (350). Endogeneity, anyone? Taking income as exogenous leads to other large problems with inference, such as the claim that “meritocratic extremism can thus lead to a race between supermanagers and rentiers, to the detriment of those who are neither” (417). Piketty does not consider the possibility that this race results in more income than otherwise, nor does he consider the notion that an increase in the bargaining power of elite executives could actually come at the expense of capital owners rather than workers. I’m not making an argument for either here; I’m simply suggesting that Piketty’s ideological quips don’t deserve the certainty with which he delivers them. Models with endowment economies have their purposes, but a 600-page book should be able to relax such strict assumptions. His criticisms of mathematical economics (32, 574) are not surprising given that he relies so heavily on assumptions and mechanisms that would be highly vulnerable to criticism if they were forced into the transparency of a formal model.

Hat tip goes to Angus.

Here is one bit:

Market-oriented economies that learn to live with inequality will reap the rewards: More domestic capital for workers to use on their jobs, more foreign capital flowing in to a country perceived as a safe investment, and a political and cultural system that can spend its time on topics other than the 1 percent. Market-oriented economies that instead follow Piketty’s preferred path—taxing capital heavily, preferably through international consortiums so the taxes are harder to evade—will end up with less domestic and foreign capital, fewer lenders willing to fund new housing projects, fewer new office buildings, and a cultural system focused on who has more and who has less.

…The Boston University economist Christophe Chamley and the Stanford economist Kenneth Judd came up independently with what we might call the Chamley-Judd Redistribution Impossibility Theorem: Any tax on capital is a bad idea in the long run, and that the overwhelming effect of a capital tax is to lower wages. A capital tax is such a bad idea that even if workers and capitalists really were two entirely separate groups of people—if workers could only eat their wages and capitalists just lived off of their interest like a bunch of trust-funders—it would still be impossible to permanently tax capitalists, hand the tax revenues to workers, and make the workers better off.

And:

…One lesson of this story is that it’s good to be patient. So let’s start training ourselves and our children to delay gratification, to forego that great sound system on the new car, to eat at home a little more often.

The full review is here.