David R. Henderson  

Robert Solow on Piketty

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According to Solow, if Piketty gets his way, real wages will stagnate.

My copy of Thomas Piketty's Capital in the Twenty-First Century finally arrived and now I face a tradeoff between reading it and reading many reviews of it. I'm tending towards the former, but one big exception I make is for Robert Solow. I met him in 1972 and we had about a 30 to 40-minute conversation. Although I saw him speak at American Economics Association meetings a number of times after that, we never spoke one on one until sometime in the early 2000s, when we were both staying at the Stanford Park Hotel in Menlo Park, he for a meeting at Stanford and me for a talk I was giving at Hoover. I said "Hi" to him and told him that he might not remember me but I had talked to him years earlier and my name is David Henderson. "I know," he said, with a slight grin. I was pleasantly surprised.

Anyway, the point is that although one of Solow's articles disappointed me in a big way and could reasonably be described as trash-talking, when I see anything written by him, I tend to read it. He is one of the best writers in economics, not just in the sense that he writes well--many economists do--but also in the sense that he explains difficult concepts clearly. In that sense, he reminds me of Paul Krugman in the 1990s and Armen Alchian for most of his career. All three understand that you can have rigor in words.

Although I don't agree with Solow's political views, I do think his review of Piketty is analytically nice. One paragraph stood out. It's one of the most important paragraphs in the piece, but Solow doesn't highlight it in his conclusion. So it's conceivable that many people will miss it. He writes:

This is often not well understood, and may be worth a brief digression. The labor share of national income is arithmetically the same thing as the real wage divided by the productivity of labor. Would you rather live in a society in which the real wage was rising rapidly but the labor share was falling (because productivity was increasing even faster), or one in which the real wage was stagnating, along with productivity, so the labor share was unchanging? The first is surely better on narrowly economic grounds: you eat your wage, not your share of national income. But there could be political and social advantages to the second option. If a small class of owners of wealth--and it is small--comes to collect a growing share of the national income, it is likely to dominate the society in other ways as well. This dichotomy need not arise, but it is good to be clear.

In other words, as Solow sees it, if Piketty is right about both the fact that inequality is rising and about the reason for the rise--the rising share of national income that goes to capital--the result will be higher real wages, and, as Solow says, you don't eat your share of income, you eat your wages. So if this rising share of income that goes to capital is reversed, workers will suffer with either wages that are rising more slowly or wages that are actually stagnating.

Solow doesn't totally tip his hand about which he prefers, but he seems to prefer the latter--limiting the share of capital and settling for slower growth or even stagnation of real wages. He never tells us why. The closest he comes to an explanation is in the paragraph above, and elsewhere in the piece where he writes, "If the ownership of wealth in fact becomes even more concentrated during the rest of the twenty-first century, the outlook is pretty bleak unless you have a taste for oligarchy."

I don't like oligarchy either. But wouldn't the best way to prevent most of its bad effects be to reduce, not increase, the power of government and thus the power of the oligarchy to get its way?

UPDATE: Former Econlog blogger Arnold Kling covers much of the same ground here.


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COMMENTS (15 to date)
Pajser writes:

You eat your wage, not your share of national income. Only if there are no important scarce resources. If some important resources are scarce, I might have billions of dolars, but those who have trillions will outcompete me and I'll starve ... with lot of 'gadgets.'

But wouldn't be the best (...) to reduce (...) the power of government and thus the power of the oligarchy? If Piketty is right, i.e. the rate of return on wealth (r) is greater than the rate of growth (g) then wealthy people do not need help of the government to control increasingly more of scarce resources.

David R. Henderson writes:

@Pajser,
Only if there are no important scarce resources. If some important resources are scarce, I might have billions of dolars, but those who have trillions will outcompete me and I'll starve ... with lot of 'gadgets.'
All important resources, except air, are scarce. Re starving, I don’t think you understand what a real wage is. With a higher real wage, you have more to eat, not less.
If Piketty is right, i.e. the rate of return on wealth (r) is greater than the rate of growth (g) then wealthy people do not need help of the government to control increasingly more of scarce resources.
Even better. So Solow shouldn’t worry.

Hazel Meade writes:

Isn't the danger of oligarchy essentially that they will rig markets to maintain and increase their power?

Why are we afraid of corporate overlords, if not because we think they will use their status to screw over smaller competitors and prevent new market entrants?

And in that case, isn't the remedy to bar the government from doing such things? It seems to me that if you are worried about oligarchy, you should be even more adamantly in favor of a free market.

You should be demanding that the government dismantle any and all regulations that favor any business over any other.

Hazel Meade writes:

I should be a bit more clear....

Isn't the worry about oligarchy that they will use their political power to rig markets - and thereby increase their share of income even more, or make their share entrenched.

And if that's what you are worried about, you should be demanding deregulation, precisely so that new market entrants can challenge just such an oligarchy. You should be trying to make it as easy as possible to topple Steve Jobs (Or Warren Buffet, or David Koch) off his perch.

Pajser writes:

With a higher real wage, you have more to eat, not less. Not necessarily. With higher real wage, I can buy more of something - but not necessarily more of all important resources. The simplest case is land. If my real wage increased 10 times, and other people's real wage increased 100 times, I'll be able to buy less land than before. Am I right?

David R. Henderson writes:

@Pajser,
If my real wage increased 10 times, and other people's real wage increased 100 times, I'll be able to buy less land than before. Am I right?
Probably. It would depend on what they chose to spend their money on. To say that real wages increase is not to say that relative prices remain unchanged: it’s to say that wages rise relative to the cost of a large basket of goods and services. So the odds are that you would have more to eat.

Pajser writes:

So, even if my wealth grows - if the wealth of elite grows faster, there will be tendency that I lose access to relatively scarce goods. It is very interesting.

Hazel, as far as I understood Piketty, he is afraid of loss of the values and that democracy can collapse if inequalities are great.

ThomasH writes:

I think the important thing here is to think marginally. At high levels of inequality and low levels of mitigation, the growth - inequality trade off may be very low or non existent (a carbon tax that replaces the payroll tax, copyright reform, shifting from business taxes to progressive consumption taxes for examples). Eventually the costs of anti-inequality policies would rise and the benefits of further reductions in inequality would fall to some politically agreed equilibrium.

Tom West writes:

But wouldn't the best way to prevent most of its bad effects be to reduce, not increase, the power of government and thus the power of the oligarchy to get its way?

Depends on whether you assume government as a competitor to oligarchy or a vehicle for it.

If they're a competitor, then shrinking government eventually removes the ability to restrain oligarchs. Laws don't matter when nobody dares assert them and the media trumpets only the oligarch's line.

Of course, in the first world, we're a long way away from any business rivaling government power. Odd that in many ways, a government significantly more powerful than any one individual or group is almost a requirement for first world status.

Do history provide any examples of government-rivaling economic powers that didn't *become* the government within a generation?

TallDave writes:

If a small class of owners of wealth--and it is small--comes to collect a growing share of the national income, it is likely to dominate the society in other ways as well. This dichotomy need not arise, but it is good to be clear.

This argument is profoundly unsound. The distribution of wealth in a free economy is a function of the voluntary decisions of its participants. The propensity to engage in transactions that maximize value dictates that whatever the final distribution looks like, it is optimized. To say "this other distribution would be better than the one the markets gives us" is just another fatal conceit.

In any event in a free-market economy there is far too much turnover in wealth for his concern to matter very much. Rentseeking is a problem of government corruption, not of a particular income distribution.

TallDave writes:

So, even if my wealth grows - if the wealth of elite grows faster, there will be tendency that I lose access to relatively scarce goods.

Exactly the opposite. Your access to all goods and services will increase. Consumption faces rapidly diminishing marginal returns.

BMan writes:

So it sounds like Piketty's proposal, at the broad level where his analysis proceeds, would likely be what we call a Pareto disimprovement. Everybody is materially worse off, but more equal. If so, then that's a pretty honest statement of the policy preferences of many on the left. But pretty unattractive to an economist.

praxis22 writes:

Strange there is no link to Solow's review:
http://www.newrepublic.com/article/117429/capital-twenty-first-century-thomas-piketty-reviewed

But I'm guessing the title:

"Thomas Piketty Is Right Everything you need to know about 'Capital in the Twenty-First Century'"

Had a lot to do with that, this is his conclusion:

"Piketty writes as if a tax on wealth might sometime soon have political viability in Europe, where there is already some experience with capital levies. I have no opinion about that. On this side of the Atlantic, there would seem to be no serious prospect of such an outcome. We are politically unable to preserve even an estate tax with real bite. If we could, that would be a reasonable place to start, not to mention a more steeply progressive income tax that did not favor income from capital as the current system does. But the built-in tendency for the top to outpace everyone else will not yield to minor patches. Wouldn’t it be interesting if the United States were to become the land of the free, the home of the brave, and the last refuge of increasing inequality at the top (and perhaps also at the bottom)? Would that work for you?"

So the nostrum of "reduce, not increase, the power of government and thus the power of the oligarchy to get its way?" seems like rote repetition of conventional wisdom, (in Galbraith's original sense.)

I've not read the book myself to be clear, but I've read most of the conversation surrounding the book. I've yet to see anyone who disagreed that it was an important work, that should be read by all economists, and even Piketty himself says he doesn't think his "solution" is at all realistic. I've seen two of his speeches in English where he says as much, but otherwise, without a solution the outcome is bleak.

If you actually believe in liberty & freedom, then you want representative government, one with rules, and law, and restrictions on capital, etc. This is Martin Wolf's point about why the West succeeded in the main, because of strong institutions, property rights, and the rule of law. Because the land of the Oligarchs is Russia, and it's telling that they are leaving as they don't like living there either. Just as the real money is looking to leave China & Burma/Myanmar too.

Unfettered capitalism, and minimal government is not a solution to the problem of unfettered capitalism and inherited wealth. This goes back to Hobbes,

"no arts; no letters; no society; and which is worst of all, continual fear, and danger of violent death; and the life of man, solitary, poor, nasty, brutish, and short."
That part at least nobody is arguing with.

RPLong writes:

I remember reading something from Scott Sumner in which he claimed that macroeconomics just behaved differently than microeconomics. I was so skeptical of that! I totally rejected it.

But I have to walk back on that now. Piketty's idea (the idea that r > g --> greater inequality) is the clearest example I can imagine of something that definitely holds true at the microeconomic level (e.g. for a single firm or a single industry), but not at the macroeconomic level. Greater investments in capital imply that employment will increase among producers of capital. At least some of that new work has to be done by human beings. At some point, prices will reflect this fact.

talldave2 writes:

Apropos.

We treat the physical results of capitalism as though they were an inevitability. In 1955, no captain of industry, prince, or potentate could buy a car as good as a Toyota Camry, to say nothing of a 2014 Mustang, the quintessential American Everyman’s car. But who notices the marvel that is a Toyota Camry? In the 1980s, no chairman of the board, president, or prime minister could buy a computer as good as the cheapest one for sale today at Best Buy. In the 1950s, American millionaires did not have access to the quality and variety of food consumed by Americans of relatively modest means today, and the average middle-class household spent a much larger share of its income buying far inferior groceries. Between 1973 and 2008, the average size of an American house increased by more than 50 percent, even as the average number of people living in it declined. Things like swimming pools and air conditioning went from being extravagances for tycoons and movie stars to being common or near-universal. In his heyday, Howard Hughes didn’t have as good a television as you do, and the children of millionaires for generations died from diseases that for your children are at most an inconvenience. As the first 199,746 or so years of human history show, there is no force of nature ensuring that radical material progress happens as it has for the past 250 years. Technological progress does not drive capitalism; capitalism drives technological progress — and most other kinds of progress, too.

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