Monday, April 21, 2014

My Amazon Review of Thomas Piketty's, "Capital in the Twenty-First Century"

Thomas Piketty has written a big data-driven book and an important book about the growing unequal distribution of wealth and income in advanced capitalist societies. However, never once does he mention in his 685 pages why rising inequality matters. For Piketty it is a given. Although Piketty is not a Marxist he wears his social democratic identity on his sleeve with such a statement as “the evil genie of capitalism will be put back in its bottle.” (P.350)  To him the 1914-1970 period where income inequality was on the wane was a brief hiatus between the Gilded Age and Belle Époque of 1890-1910 to what he perceives as the new gilded age of today. After all from 1970 to 2010 the share of income going to the top 1% of the income distribution increased from 9% to 19.8% in the United States.

What interests Picketty is what a Marxist would describe as the laws of motion of capitalist society. For Picketty it is the concept that the pure return of capital (r) is greater the overall economic growth rate (g).  He demonstrates that the pre-tax real return on capital is roughly constant approximating 5% and in most cases economic growth is well below that. For him there is no falling rate of profit.

In order for capital to grow faster than income both the tax rate on capital income (dividends, capital gains, interest and rents) and the propensity to save has to be low. Otherwise the retained return on capital would fall to or below the growth rate in the economy. Thus as long as the retained return is above the growth rate of the economy the capital/income ratio increases faster than the economy and the share of income derived from capital rises. And here is the punchline because capital is more concentrated than wage income; income inequality has to rise over time. This notion explains English and French inequality, but unfortunately it is not a good explanation for what has happened in the U.S. where the labor income of the top 1% has exploded.

Returning to the history, income inequality significantly declined from 1914-1950 and then stabilized for another 20 years. Why did this happen?  Answer: two very destructive wars and a depression. Simply put capital (and millions of lives) was destroyed and the income from it disappeared. Along the way tax rates sky rocketed and growth collapsed. Similarly during the Great Recession of 2008-09 inequality was reduced as stock prices and real estate values crashed. Unfortunately the collateral damage on the average worker was far greater than it was for the owners of capital. Witness the more than complete recovery in stock prices and wages for the top 1% post-2009 while average wages have stagnated. The cure was far worse than the disease.

Although Picketty denies it, the laws of motion in the United States differ from Europe. Here as Picketty notes we have witnessed the rise of the super-manager who has captured an increasing portion of labor income. The share of wages going to the top 1% increased from 5.1% in 1970 to 10.9% in 2010 accounting for half the gain in their total income share over that time period. I would argue the wage share gain is far greater than that because in the late 20th Century and in recent year’s human capital is monetized into financial capital. The return to Bill Gates’, Mark Zuckerberg’s, Sergey Brin’s  human capital  comes not only from their salaries and the ordinary income that comes from the exercise of stock options, but also from their initial ownership positions in the companies they founded. For example according to the Forbes 400 list the wealth of such corporate founders amounts to $72 billion for Microsoft’s Bill Gates, $41 billion for Oracle’s Larry Ellison, $27 billion for Amazon’s Jeff Bezos, $25 billion for Google’s Larry Page, $19 billion for Facebook’s Mark Zuckerberg and $7 billion for Tesla’s Elon Musk. Is this the 19th Century wealth of an Andrew Carnegie or a John D. Rockefeller whose assets were tied up physical plant? I think not. In the new world of capitalism intellectual property is valued more highly than physical capital.

Moreover Picketty’s 19th century view of capital is the role of real estate in national wealth. Real estate holdings accounted for more than 60% of French capital, more than 50% of British capital and more than 40% of U.S. capital. True it not the landed wealth of the 18th century, but it is the 21st century urban version of it.  This is important because if Picketty is really serious about equalizing the distribution of wealth he would advocate a radical reduction in the planning constraints that artificially increase real estate values in the great urban centers of New York, London, Paris, Los Angeles, San Francisco and Washington, D.C. It would be far more beneficial to do that than to impose income tax rates of from 60% -80% on the top 10% and the progressive wealth tax he advocates. While higher tax rates on capital would arguably reduce economic growth, an easing of planning constraints would increase it. I know Picketty would argue that the post war economy grew rapidly in during the postwar era in regime of high tax rates. That is true, but much of the growth came from a recovery from the depression and World War II. Recall that, although high, the tax burden dropped from its war time peaks.

All told Thomas Picketty has written a book that is and will continue to be much discussed. It should be the subject of serious debate and readers should note that the book is not an all-encompassing treatment of inequality. He ignores the role of assortative mating at the top where, for example an investment banker marries a corporate lawyer, and the role of single-parent households at the bottom of the income distribution. But any economist who quotes Jane Austen and Honore de Balzac has to have a lot going for him.

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