Capital and destiny

It is with some trepidation that I offer my review of Thomas Piketty’s [amazon_link id=”067443000X” target=”_blank” ]Capital in the 21st Century[/amazon_link], as so much has been written, almost all of it verging on the adulatory. Of course it’s an important book – who could disagree with that when almost everybody in my world is talking about it, and it has cemented the question of inequality of income and wealth on the economic policy agenda? The book has obviously plugged into the zeitgeist. It has some flaws too.

[amazon_image id=”067443000X” link=”true” target=”_blank” size=”medium” ]Capital in the Twenty-First Century[/amazon_image]

Piketty’s construction of a long-run multi-country World Top Incomes Database for income and wealth, along with Emmanuel Saez and Anthony Atkinson,’ is a magnificent achievement. As the book notes several times, the data – constructed from a range of sources including tax records – are likely to understate the very highest fortunes and incomes because of the failure to declare everything. The assembly of these statistics has helped put inequality at the centre of economic debate.

[amazon_link id=”067443000X” target=”_blank” ]Capital in the 21st Century[/amazon_link] concentrates on wealth and on the share of capital’s income in total national income. ‘Capital’ is defined as marketable assets, at their market price, including land, houses, shares and other financial instruments (but not for example bridges or factories). James Galbraith’s review of the book was critical of the definition. I think Galbraith is right to pick away at the data used and what the definitions actually mean.

Setting this aside, Piketty shows that the income share of (marketed financial) capital (at market values) declined substantially in the second half of the 20th century but is now climbing again. His argument is that this increase is a near-inexorable trend. The mid-20th century decline was essentially the result of Depression and war, or in other words, the massive destruction of assets and social dislocation; and the capital share stayed low for some decades because economic growth was unusually high, which – he argues – will no longer be the case. Specifically, population growth has slowed or turned negative, and Piketty is clearly gloomy about the prospect of productivity growth.

It’s clear that many readers have taken this argument as a given without concerning themselves about how it adds up. It is based on two equations (the only two in the book), which are asserted rather than given a clear rationale. I couldn’t work out the reasoning until I found Piketty’s lecture notes. So this is my explanation of the lecture notes.

One equation says that the share of capital in national income (α) is defined as the rate of return on capital (r) times the ratio of the capital stock to income (β). This is an accounting identity – it is how the concepts are defined and the figures calculated. If the capital stock is six times a year’s national income, and the rate of return on capital is 5%, the capital share is 30%. Historically, the rate of return on capital has been in the range 3-6%, which for that size of capital stock implies a capital share of 18% to 36% a year of national income, roughly one fifth to one third. Again, in the historical figures, the capital income ratio has typically been 5 or 6.

The second equation, which drives his argument about the upward trend in capital’s share, is a ‘steady state’ condition: when the economy settles down in a stable way in the very long run, at its long-term potential growth rate, the ratio of capital stock to income equals the savings rate (s) divided by the growth rate (g) – in other words, in the unchanging steady state, the ratio of the annual changes in capital growth (saving) and in income growth is the same as the ratio of the capital stock to the level of income.

This is not made all that clear in the book, but putting the two together, the capital share will tend to rise when the rate of return on capital is greater than the growth rate, assuming the saving rate does not decline to offset the impact of r > g. Piketty notes that in the long term data set, this inequality happens to have held: “The inequality r > g is a contingent historical proposition, which is true in some periods and political contexts and not in others.” The exception was the latter part of the 20th century.

This simple algebra based on an accounting identity and a balanced growth rule are the basis of the book’s argument – which has been pounced on by commentators – of an almost inexorable upward trend in the capital share. I am sceptical about the economy ever reaching the balanced growth state, although perhaps this is a useful tool for thinking about direction of travel, and I’m also doubtful that the saving rate would not adjust should the capital share in national grow ever-bigger. I also wish Piketty had spent more time discussing the rate of return on capital – both how it is constructed in the data set and what determines it – as the book treats it as a given at 4-5%. As Barry Eichengreen pointed out in a recent Project Syndicate article, there are some puzzles in saving and interest rate data, and real interest rates have been declining for 30 years. They are only one element of the rate of return series Piketty considers, but at 2-3%, this real interest rate is not too far above the potential growth rate of the major OECD economies. This takes us back to James Galbraith’s point about the definitions: is marketable capital consisting mainly of financial assets the right definition to plug into a balanced growth model?

I would like to have had more practical explanation of the data used in the book in general, as some of the charts are surprising. For instance, the charts suggest the housing stock in France is a bigger share of national income, and has grown faster, than in the UK. (As an aside, the charts are terrible – very hard to decipher, a decade on the x-axis given the same space as a half century or 60 years, multiple lines of equal weight with clashing symbols, much chart junk, Australia classed as ‘Anglo-Saxon’ when it looks like Germany in the data – I hope they all get redrawn for future editions.)

Of course I’m nit-picking by complaining about the impression of an inexorable trend towards an ever-greater capital share created by Piketty’s reliance on a growth model, because there is a deeper truth – as he puts it: “The inequality r > g in one sense implies that the past tends to devour the future: wealth originating in the past automatically grows more rapidly, even without labour, than wealth stemming from work, which can be saved.” In order for an economy to grow at all, the future must win the struggle against the past. But of course there have been several episodes when that has been the case – not just the aftermath of World War 2, highlighted in the book, but also much of the Victorian era, and the early Industrail Revolution (even though the charts here show r well in excess of g during those years too).

Still, the sense of inevitability or otherwise does matter. Piketty’s policy proposal is a global wealth tax. He’s acknowledged how unrealistic this is, but says it’s important to change the intellectual climate. True, but how about also debating the rigged markets in finance and the corporate legal framework that have contributed so significantly to the growth in very high incomes, which are quickly turned into new wealth? What about income and inheritance taxes? And rather than treating savings, the return on capital and the growth rate as givens, isn’t it worth thinking about what determines them, and what actually determines causality in the book’s simple algebra.

I’m glad [amazon_link id=”067443000X” target=”_blank” ]Capital in the 21st Century[/amazon_link] has succeeded in drawing such attention to inequality of wealth as well as incomes, and to our new era of patrimonial capitalism. (Another sobering illustration of this is Greg Clark’s recent book, [amazon_link id=”0691162549″ target=”_blank” ]The Son Also Rises[/amazon_link].) It’s just a bit of a shame it does so in such a deterministic – and therefore disempowering – way.

Nevertheless, pretty much every review I’ve read has raved about the book! Here are Paul Krugman, Branko Milanovic, John Cassidy, The Economist. No doubt there will be many more positive reviews to come.

Thinking about capital

It’s clear that I’m one of the slowest readers of Thomas Piketty’s [amazon_link id=”067443000X” target=”_blank” ]Capital in the 21st Century [/amazon_link]around – only a bit over half way through, when other reviews are pouring out. Most are adulatory; Paul Krugman’s in the New York Review of Books the latest (Why We’re In a New Gilded Age). The problem is the size of the book – I do most of my reading while travelling, and just can’t read long e-books, as nothing sticks.

Anyway, the process got me ferreting about in my old books looking for earlier work on wealth and inheritance, so this morning I was browsing through J.A.Hobson’s [amazon_link id=”1440087180″ target=”_blank” ]The Science of Wealth[/amazon_link] (1911) and Josiah Wedgwood’s [amazon_link id=”1245803719″ target=”_blank” ]The Economics of Inheritance[/amazon_link] (1929).

Here is Hobson on ‘unproductive surplus’:

“The plain facts of modern business show that capital like land can get a share of unproductive surplus. But while land takes its surplus by natural scarcity, capital takes its surplus by making itself scare ie. by artificially restricting the flow of free capital into certain channels of employment. These restrictions, whether maintained by securing advantages of of raw materials, power or situation, by tariffs or other State aid, by trade agreements or combinations, all signify checks upon the free entry of capital into a trade which is thus enabled to secure a scarcity rate of interest for a limited supply.”

He immediately identifies the banking industry as a key locus of unproductive surplus. No change there, then.

Wedgwood has a fascinating chapter on inheritance in which he uses probate records to trace the extent to which large fortunes are passed down the generations. The chapter sets out to test the assertion that most fortunes are self-made and quickly dissipated; “from clogs to clogs in three generations,” in the northern saying. The exercise reported in the book does not support this and in fact is entirely consistent with the results of another truly important recent book, Greg Clark’s [amazon_link id=”0691162549″ target=”_blank” ]The Son Also Rises[/amazon_link]. Wedgwood writes:

“The fortunes of the different branches were largely pre-determined by the economic position of the family at least five generations back and in to some extent by that of ancestors nine generations back.”

What Clark’s book establishes is that ‘patrimonial capitalism’ (in Piketty’s terminology) never really went away even in seemingly egalitarian societies like Scandinavia – around the world and over many different periods, advantage is passed on down the generations, and social mobility has never been all that great.

With hindsight, ignoring wealth and inheritance for a generation or two looks like another of the blind spots of 20th century economics. Even without finishing [amazon_link id=”067443000X” target=”_blank” ]Capital in the 21st Century[/amazon_link] (and I have some reservations about it), it is clear that Piketty, and his colleagues Emmanuel Saez and Tony Atkinson, have done us a great service in their careful collection of income and wealth inequality data. This VoxEUexplainer of the database is a good place to start.

[amazon_image id=”067443000X” link=”true” target=”_blank” size=”medium” ]Capital in the Twenty-First Century[/amazon_image]  [amazon_image id=”1245803719″ link=”true” target=”_blank” size=”medium” ]The Economics Of Inheritance[/amazon_image]  [amazon_image id=”1440087180″ link=”true” target=”_blank” size=”medium” ]The Science of Wealth (Classic Reprint)[/amazon_image]  [amazon_image id=”0691162549″ link=”true” target=”_blank” size=”medium” ]The Son Also Rises: Surnames and the History of Social Mobility (The Princeton Economic History of the Western World)[/amazon_image]

A footnote: Hobson’s book has a wise note about the role of economics, concerning whether or not its conception of prosperity is too narrow, when what really matters is love, joy, meaning etc: “John Ruskin and some other prophets of this wider wealth have denied the validity and the utility of the narrower Political Economy.  … Other students of society have also questioned the validity of separating the study of economic processes from that of other social processes and making of them a ‘science’ of industry. This criticism, in so far as it has a point, is applicable to all scientific specialism. The whole world of phenomena is a unity of intimately connected parts, and every breaking off of any section for separate study is of necessity an act of mutilation. But such separate studies are essential to intellectual progress, and the mutilation is not fatal to their use, provided the subject of special study is not treated as a completely rounded whole.” It’s healthy for economists to engage in interdisciplinary work as a reminder of this point. There are still too many of my fellow economists who’re dismissive of other social sciences.

Capital in the 19th century

During the mid-late 1970s era of high inflation, I was a teenager growing up in a household with two parents who worked, but not in jobs with unions that could deliver inflation-beating wage increases, and whose small savings were held in a building society account. Rising food and energy prices made things tough. Marked as we all our by personal experience, I’ve ever since believed inflation to be harmful for people on relatively low incomes, tending to mean declining real earnings and negative returns on savings.

The early section of Piketty’s [amazon_link id=”067443000X” target=”_blank” ]Capital in the 21st Century[/amazon_link] has given me pause for thought. He contrasts the Victorian and Edwardian era of stable prices and rentier wealth (in the form of land and then government bonds) with the post-1920s era of declining importance in inherited wealth. He writes:

“Capital is never quiet: it is always risk-oriented and entrepreneurial, at least at its inception, yet it always tends to transform itself into rents as it accumulates in large enough amounts.” (p115-116)

The point of accumulation is to build up enough to stop working, whether at the scale of a character in an Austen or [amazon_link id=”0140440178″ target=”_blank” ]Balzac novel[/amazon_link], or at the scale of a colonial power like France or Britain.

What changed with the onset of the violent 20th century was inflation. In the 19th century, when governments built up war debts, rentier classes bought the government bonds and could live securely on the repayments. “In the 20th century, a totally different view of public debt emerged, based on the conviction that debt could serve as an instrument of policy aimed at raising public spending and redistributing wealth for the benefit of the least well-off members of society. The difference between these two views is fairly simple: in the 19th century, lenders were handsomely reimbursed, thereby increasing private wealth; in the 20th century, debt was drowned by inflation and repaid with money of decreasing value.” (p132)

France inflated far more dramatically than the UK in the period 1913-1950, and French public debt dropped from 80% to 30% of national income over that period. The UK had a colossal 200% of GDP debt in 1950, but made up for it with inflation in the 1950s and especially the 1970s. In both cases, though, inflation was the means of expropriating the rentier classes and, Piketty argues, one of the key reasons the 20th century bucked the tendency of capitalism to create and enhance entrenched wealth inequality. So this is obviously a different perspective on inflation from my teenage perception.

I was chatting about this to Professor Dieter Helm, who chairs the UK’s Natural Capital Committee and is writing a book about valuing natural capital (which will be a must-read when it’s out). He pointed out that the shift towards an inflationary regime coincided with a generational rebellion against the Victorian emphasis on thrift and investment for the future, in favour of consumption and the present. In Britain, the Bloomsbury Group – including Keynes – exemplified this; see for example Michael Holroyd’s tome on [amazon_link id=”0099332914″ target=”_blank” ]Lytton Strachey[/amazon_link].

[amazon_image id=”1845951832″ link=”true” target=”_blank” size=”medium” ]Lytton Strachey: The New Biography[/amazon_image]

This all makes one wonder about the next few decades – I’d bet on a return to inflation and expropriation of the bond-holding classes (pensioners?), even though the pressing concern is deflation. But this is a bet, not a forecast. Besides, the future the Victorians built is the one we’re still living off, the infrastructure and institutions. Anybody who cares about sustainability (in its broadest sense) must surely be thinking in terms of tilting the balance away from consumption and towards investment. Towards capital, in fact, which makes its distribution all the more important.

What role for reason?

There’s an interesting review by Molly Worthen of a new book by George Marsden, [amazon_link id=”B00IHGVPG2″ target=”_blank” ]The Twilight of the American Enlightenment: The 1950s and the Crisis of Liberal Belief[/amazon_link]. I suspect the review is more interesting than its subject – at least, I’m not really tempted to read a book aiming to persuade me that faith-based arguments ought to have the same status in public policy debate as reason-based arguments.

I’m more interested in the Walter Lippmann book mentioned in Prof Worthen’s review, [amazon_link id=”B00E3255JW” target=”_blank” ]Essays in the Public Philosophy[/amazon_link], having read his [amazon_link id=”1440047510″ target=”_blank” ]Liberty and the News[/amazon_link] relatively recently. It sounds like it prefigures Daniel Bell’s [amazon_link id=”B00BR5IEZ0″ target=”_blank” ]Cultural Contradictions of Capitalism[/amazon_link]. Does the individualist, market system undermine the social norms and values that make it work? How does the application of reason to public policy questions sit with the role of emotion and belief in our modern democracies? And – a new question as we learn more and more from cognitive science – are we kidding ourselves about the role of reason anyway?

[amazon_image id=”B00IHGVPG2″ link=”true” target=”_blank” size=”medium” ]The Twilight of the American Enlightenment: The 1950s and the Crisis of Liberal Belief[/amazon_image]

[amazon_image id=”B00BR5IEZ0″ link=”true” target=”_blank” size=”medium” ]The Cultural Contradictions Of Capitalism: 20th Anniversary Edition by Bell, Daniel Anniversary Edition [Paperback(1996)][/amazon_image]

In related reading, Richard Marshall of 3AM Magazine has an interview with philosopher Jeremy Sheamur about Popper and Hayek. I was intrigued by the suggestion that Hayek thought of markets as institutions, albeit organic rather than designed – very far from the received wisdom of markets as a free-for-all, a view of course often attributed to Hayek.

The book of the interviews, [amazon_link id=”0199969531″ target=”_blank” ]Philosophy at 3am[/amazon_link], is due out soon. One to look forward to.

[amazon_image id=”0199969531″ link=”true” target=”_blank” size=”medium” ]Philosophy at 3:AM: Questions and Answers with 25 Top Philosophers[/amazon_image]

21st century capitalism – discontents but no defenders

Thomas Piketty’s [amazon_link id=”067443000X” target=”_blank” ]Capital in the 21st Century[/amazon_link] is all over the blogs and magazines in the US but Amazon UK is tantalising me by sending successive emails saying the shipping date over here has been delayed. It now won’t reach Enlightenment Towers until mid-April.

[amazon_image id=”067443000X” link=”true” target=”_blank” size=”medium” ]Capital in the Twenty-First Century[/amazon_image]

Meanwhile, there are other serious attacks on 21st century capitalism to divert the reader so inclined. I see that David Harvey’s [amazon_link id=”B00IOLFGBK” target=”_blank” ]Seventeen Contradictions and the End of Capitalism[/amazon_link] is available now. I just read George Packer’s [amazon_link id=”0571251293″ target=”_blank” ]The Unwinding[/amazon_link], an epic account of the devastation of the American working class. And I’ve started Greg Clark’s [amazon_link id=”0691162549″ target=”_blank” ]The Son Also Rises[/amazon_link], whose introduction got the hairs on the back of my neck to rise because of its radical implications for how we think about social mobility – we’ll see if the rest of the book delivers on that promise.

[amazon_image id=”B00IOLFGBK” link=”true” target=”_blank” size=”medium” ]Seventeen Contradictions and the End of Capitalism[/amazon_image]   [amazon_image id=”0571251293″ link=”true” target=”_blank” size=”medium” ]The Unwinding: Thirty Years of American Decline[/amazon_image]   [amazon_image id=”0691162549″ link=”true” target=”_blank” size=”medium” ]The Son Also Rises: Surnames and the History of Social Mobility (The Princeton Economic History of the Western World)[/amazon_image]

All of which raises the question – who, if anybody, is writing convincingly and interestingly in defence of 21st century capitalism? At the moment I can’t bring any books that would serve this purpose to mind, even in the technology literature where you’d most expect to find them. There are of course some optimists, like Charles Kenny in [amazon_link id=”0465064736″ target=”_blank” ]The Upside of Down[/amazon_link], but that’s not quite the same thing as a rousing defence of the system. Any nominations?