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.

For the amazon URL see:

Friday, April 4, 2014

"There Will be Growth in the Spring....and Beyond," UCLA Anderson Forecast, March 2014

The weather played havoc with the economy in the
first quarter. In a mirror image of the balmy winter of 2012
where unusually warm temperatures temporarily enhanced
economic activity, near record cold weather suppressed it.2
As a result of this year’s polar vortex the states of Illinois, Indiana,
Iowa, Michigan, Minnesota, Missouri, Oklahoma and
Wisconsin experienced among their twelve coldest winters
in the past 119 years. (See Figure 1) The cold weather was
exacerbated by unusually heavy snow falls across the Great
Lakes and into the Northeast. Interestingly, while the middle
of the country was freezing, California was experiencing a
drought along with its warmest winter in recorded history.
Indeed the entire southwest from Texas to California was
experiencing severe drought condition.

Simply put, the seasonal factors the Bureau of Labor
Statistics uses are incapable of fully accounting for extreme
weather conditions. In order to highlight the impact
of weather in January and February of 2012, we note that
payroll employment growth averaged, as initially reported a
robust gain of 256,000 jobs. 2 In contrast, this year job gains
were a far more modest 152,000 for the first two months. As
a result, we expect that first quarter real GDP growth will
come in a sub-par 1.4% annualized rate.

Nevertheless as our title suggests, there will be growth
in the spring as such weather affected activities as factory
production, automobile sales and the construction rebound
from their winter lows leading to real GDP growth of about
3%. Furthermore, as we have argued previously, we continue
to believe that the economy is poised to remain on a 3% or so
growth path through 2016 buoyed by increased housing and
business investments along with gains in consumer spending.
(See Figure 2) In this environment we can visualize the
economy creating between 200,000-250,000 jobs a month
with the unemployment rate dropping to 5.4% by late 2016.
(See Figures 3 and 4) To be sure, total payroll employment
will surpass the prior 2007 peak, but the economy will
remain well below its pre-Great Recession growth path.

Modest Inflation Ahead

While inflation has been quiescent for most of the post-
2009 recovery period, it is about to experience an uptick.
Specifically, we forecast that the core consumer price index
will increase from 1.8% in 2013 to 2.5% in 2016. (See Figure
5) Because of increases in domestic energy production, the
increase in headline inflation will be somewhat more muted.
Admittedly, food prices might pose an upside risk should
drought conditions in the Southwest and political uncertainty
in the Ukrainian breadbasket persist.

As we have written elsewhere, the increase in inflation
will come from the shelter and healthcare components
of price indices. 3 Both measures are now running at a 2.5%
rate along with a general increase in wages. To be sure,
for most Americans, the increase in wages will be most
welcome, but for those wary of inflation it will be signaling
a cautionary yellow light. Specifically, we are forecasting
total compensation per hour to increase by 2.4%, 3.5% and
4% in 2014, 2015 and 2016, respectively, compared to a very
low increase of 1.6% in 2013.

Fed Policy: From Taper to Modest Tightening

The Federal Reserve’s long experiments with zero
interest rates and quantitative easing are slowly coming
to an end. We anticipate that the monthly $85 billion bond
buying program, now down to $55 billion, known as quantitative
easing will be all but wound down by September.

Although most market participants do not expect the Fed
to actually begin to raise rates by mid-2015 at the earliest
and a few anticipate that it will wait until 2016, we believe
that the first overt tightening will begin in the first quarter
of 2015. (See Figure 7) Our view was strengthened at Fed
Chair Yellen’s recent news conference where she defined
“considerable period” as approximating six months as the
time between the end of tapering and the beginning of overt
tightening. Thereafter, we forecast that the Federal Funds
rate will rise, to use “Fedspeak”, at measured pace reaching
3% by the end of 2016. In essence, the “Yellen Fed” will be
very much like the “Bernanke Fed.”

Why? Under the Fed’s dual mandate to maintain
maximum employment and price stability there would be
little intellectual justification for continuing a zero interest
rate policy with a 6% and falling unemployment rate and a
2.5% core inflation run rate in the first quarter of 2015. We
are aware that the Fed’s official inflation target variable are
the core and overall price deflators for personal consumption
expenditures in the GDP accounts will be running somewhat
below the consumer price indices. But at that time, there will
be little doubt as to where they will be heading.

In this environment, long-term interest rates will begin
to normalize. We would not be surprised to see 10-Year U.S.
Treasury rates exceeding 3.7% by yearend and be above
4% thereafter. We would also point out that relative to the
2%-2.5% inflation rate, both the real Fed Funds rate and the
10-year treasury yield would still be well below pre-2007
levels. Our short-term interest rate forecast is broadly consistent
with the higher end of published consensus beliefs of
the open market committee after the March meeting.

Sources of Growth: Housing, Business Investment
and Consumption

As we have noted for the past several years, we believe
that housing construction is in a period of sustained, albeit
moderate recovery. After bottoming at below 600,000 units
a year in 2010, housing starts recovered to 931,000 units
in 2013 and are expected to exceed 1.2 million units this
year and approach 1.5 million units in 2015. (See Figure
8) Thereafter, housing activity is expected to plateau in the
1.4-1.5 million unit range as mortgage rates in excess of
6% exact their toll. As we have noted on many occasions,
multi-family construction will account for about 30% of
overall starts as it has in recent years, up from the 20% that
has characterized the prior decades.

Meantime, investment in business equipment and
software along with nonresidential construction will begin
to experience a sustained pickup. (See Figures 9 and 10)
Real equipment and software spending, which increased at
a very tepid 3.1% in 2013, will likely increase by 6% this
year and 10% next year. The improvement in nonresidential
construction will be even more dramatic where that sector
will rebound from a meager 1.4% growth rate in 2013 to
5.2% this year and 11% by 2016.

The rebound in corporate spending will be caused by
the need to replace aging capital equipment, accelerating
global growth, reduced domestic political uncertainty, the
on-going energy renaissance in the U.S. and “most importantly”
in the words BofA Merrill Lynch, the stock market is
no longer rewarding share buybacks.4 Put bluntly, instead of
spending big bucks on financial engineering, American companies
will step up their spending on physical engineering.

Along with increases in business spending, the long
suffering U.S. consumer will begin to spend more robustly.
The increase in spending will be driven by the improved
employment and wage picture, a very big deal, along with
the $10 trillion increase in wealth that took place in 2013.
Yes, a bull market on Wall Street is largely concentrated
in the upper income brackets, but that is where half the
purchasing power is. Furthermore, last year’s rise in stock
prices will take some of the pressure off the fiscal stress
facing most defined benefit pension plans and individual
retirement accounts. As a result, real consumer spending
gains are expected to approach 3% in 2015 and 2016 well
above the 2% recorded in 2013. (See Figure 11) Even with
the increases in consumer spending we envision the saving
rate after modestly declining in 2014 to 4.3% will be well
above 5% by 2016.


There will be growth in the spring. The economy will
shake-off the weather induced weakness and begin to grow
at a 3% growth track bringing with it rising employment
and wage gains. Growth will be led by housing, business
investment and the consumer. Along the way inflation will
modestly increase causing the Fed to begin increasing rates
in early 2015 and longer-term interest rates will begin to
normalize. Not great, but what’s not to like.

1. With apologies to Chance the Gardener in “Being There” (United Artists, 1979).
2. See Shulman, David, “Curb Your Enthusiasm,” UCLA Anderson Forecast, March 2012.
3. See Shulman, David, “The Inflation to Come in Housing, Healthcare and Wages,” Ziman Economic Letter, January 2014.
4. See “The cap-X factor,” BofA Merrill Lynch Global Research, 11 March 2014.