Understanding Piketty, part 5 (conclusion)

Thomas Piketty’s Capital in the Twenty-First Century is the first book to make a data-driven examination of economic inequality. Based on hundreds of years worth of data, it attempts to determine the long-term trends in inequality and the social and political consequences that follow from them.

In this final post, I want to highlight the most important points of the book, including a few I have not yet discussed. Beyond that, I want to consider parts of the book that are perhaps a bit less persuasive.

First of all, the data has been almost unchallenged. The one person who claimed substantial flaws in it, Chris Giles of the Financial Times, is road kill.

Second, three major results emerge from the data bringing dearly-held economists’ views into question. A) There is no Kuznets Curve: Developed countries do not keep getting more equal; rather, the data show that they have become less equal since about 1980. B) There is no fixed share for capital and labor income, as assumed by the Cobb-Douglas production function: Capital’s share of national income has risen since 1975. C) Franco Modigliani’s view that most savings was for retirement, not inheritance, is wrong. Depending on the country, no more than 20% of private wealth is in the form of annuitized wealth that ends at death.

Third, the big theoretical payoff is that some economists’ happy stories about how everyone earns their marginal productivity are simply incorrect. These bedtime stories may make the rich feel like their high incomes and wealth are deserved. The fact of the matter, though, is that high incomes are not the result of merit but of bargaining power. The increase of capital mobility since the 1970s is one element in disciplining labor, while the reduction in the top income tax rate gave top corporate executives more incentive to push for large wage increases and exploit the large uncertainty regarding their individual contribution to corporate success.

Fourth and most obviously, r>g* is no historical necessity, but it has held true virtually everywhere for all of human history. As long as it is true, there is a tendency for inequality to worsen.

Moving on to aspects of the book I have not previously covered, one discussion that stood out was Piketty’s discussion of the weakness of measures of gross domestic product (p. 92). In particular, he notes that there are no good quality measures for adjusting GDP:

For example, if a private health insurance system costs more than a public system but does not yield truly superior quality (as a comparison of the United States and Europe suggests), then GDP will be artificially overvalued in countries that rely mainly on private insurance.

Parenthetically, it seems to me that any high-cost low-quality system would overstate GDP, whether it’s private or public. But the point to remember is that we are talking big bucks here: if the United States were spending merely what the #2 country (Netherlands, in terms of percent of GDP) does, we would be spending almost $1 trillion less, so presumably this means U.S. GDP is overstated by $1 trillion. That’s still a lot of money!

As I discussed before, Piketty advocates a global annual tax on wealth as the solution to the problem of inequality. However, he relegates an alternative global tax, on financial transactions, to a single paragraph plus a single footnote. He claims that an FTT would “dry up” “high frequency transactions,” and for that reason would not raise much revenue. Of course, this would depend on which transactions are taxed (James Tobin had originally proposed taxing foreign exchange transactions) and what the tax rate is. A balance can be struck between “throwing sand in the wheels,” as Tobin described it, and raising revenue. Contra Piketty, I don’t think it is something that can be rejected out of hand, and I plan to discuss an FTT more fully in the future.

So what’s wrong with the book? Honestly, not much. I mentioned before that I wasn’t fully persuaded by Piketty’s evidence that bigger fortunes necessarily earn higher rates of return. However, this is not a big issue, especially as the claim does seem fairly plausible.

At times, however, Piketty’s political arguments seem almost ad hoc. He attributes (p. 509) the rise of Reaganism and Thatcherism in part to a feeling people had that other countries were catching up to them. He presents no evidence for this claim, which does not strike me as particularly plausible. Similarly, he lectures the leaders of large EU countries (p. 523) for their failure to align taxation among the Member States, rejecting their leaders’ point that EU institutions (unanimity is required for changes affecting direct taxation) and other Member States (read: Ireland) can block fiscal coordination indefinitely. But it’s true! It’s right there in the Treaty! So he’s a little too glib about politics for my tastes; but then, I’m a political scientist, so perhaps I’m not the most neutral of sources.

Bottom line: You’ve already bought the book, so take it off the coffee table and read it! It may take you a few weeks, or a few months, but you’ll be glad you did.

* r>g means that the rate of return on investment, r, is greater than an economy’s growth rate, g.

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