David R. Henderson  

Henderson on Piketty, Part 2

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In Piketty's view, if someone's share of wealth stays constant, he cannot be better off, even if wealth has increased.

Yesterday I highlighted the opening of my lengthy published review of Thomas Piketty's Capital in the Twenty-First Century. Here's the next episode.

In my view, a steady increase in well-being for the vast majority of the world's inhabitants, as well as the policies necessary to achieve that, are what should be central to economic analysis. But Piketty chooses to put inequality front and center, and so be it. He states his conclusion up front:

When the rate of return on capital significantly exceeds the growth rate of the economy (as it did through much of history until the nineteenth century and as is likely to be the case again in the twenty-first century), then it logically follows that inherited wealth grows faster than output and income.

The reasoning is fairly straightforward: Assume that someone who owns capital earns an average annual real return of 5 percent and that the rate of growth of the economy is 3 percent. If the owner of capital can live on 1 percentage point of the annual return, his wealth will grow at 4 percent per year, which is higher than the economy's growth rate. We need only one more assumption: that the capital owner has only one son or daughter who, in turn, will live on that 1 percentage point per year. QED
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In short, Piketty's conclusion follows logically, but only if we include assumptions about the number of heirs and their spending discipline. But if, for example, each wealthy person has three heirs who dissipate the wealth, those heirs will leave little to their heirs. So, based on just Piketty's skimpy assumptions, his claim does not follow logically. He, unfortunately, starts out by overstating his case. He could be right empirically, though, and he presents evidence for the growing share of income earned by owners of capital, much of which they inherited.

We are still left with the question: "So what?" Imagine--as Piketty has convinced me seems at least plausible--that the share of income going to owners of capital could rise over time, which means that the share of income going to labor would fall. Would that mean that laborers are worse off? Not at all. In fact, they are likely to be better off. Unfortunately, many people who read the book, especially those who are not economists, could easily miss this point for two reasons: (1) Piketty's emphasis on income shares rather than on real income; and (2) his misleading language. We would expect an emphasis on shares rather than real income from someone who believes that inequality of wealth and income, rather than improvements in standards of living, is "at the center of economic analysis."

What compounds the misleading impression is Piketty's misleading language. For example, in discussing his country, France, he writes, "Probate records also enable us to observe that the decrease in the upper decile's share of national wealth in the twentieth century benefited the middle 40 percent of the population exclusively." But as he well knows, French wealth per capita grew enormously in the 20th century, and so the decline in share of the wealthiest does not imply an absolute decline in wealth. Moreover, even if the wealthiest French people had lost wealth in absolute terms, the higher share of the people below them is not sufficient evidence that the wealthiest group's decline benefited the middle 40 percent. The middle 40 percent could have done better simply because of their own savings and investments.

Piketty's misleading explanation of the French case above is not an isolated weakness. Throughout the book, he writes as if he thinks that wealth is zero-sum and, thus, that increases in various groups' wealth must come at the expense of others. Writing about early 19th-century France, for example, he refers to a "transfer of 10 percent of national income to capital." But a look at his Figure 6.1, on which he bases this claim, shows no such transfer. All it shows is that the share of income going to capital rose. Similarly, in discussing the United States in the late 20th century, he calls an increase in the income share of the top 10 percent an "internal transfer between social groups." Never mind that on the very same page, he admits that income for the bottom 90 percent slowly grew over that same period.

Or consider Piketty's statement about the United States and France: "And the poorer half of the population are as poor today as they were in the past, with barely 5 percent of total wealth, just as in 1910." That is nonsense. If the poor have the same percentage of wealth as they had in 1910, they are much richer because wealth is much greater, as Piketty well knows. Here, he has gone beyond misleading language into actual error.


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COMMENTS (7 to date)
Pajser writes:

If Piketty's, goal is equality, I think it is strange, even odd, that he doesn't consider socialism seriously. He wrote

    "By abolishing private ownership of the means of production, including land and buildings as well as industrial, financial, and business capital (other than a few individual plots of land and small cooperatives), the Soviet experiment simultaneously eliminated all private returns on capital. ... Unfortunately for the people caught up in these totalitarian experiments, the problem was that private property and the market economy do not serve solely to ensure the domination of capital over those who have nothing to sell but their labor power. They also play a useful role in coordinating the actions of millions of individuals, and it is not so easy to do without them. The human disasters caused by Soviet- style centralized planning illustrate this quite clearly." (p. 531)
I can agree. But "It is not easy to do without them" is not really good enough. Piketty implies, but doesn't openly claim that it is impossible - or unrealistically hard - to do without market and private property. And really, it is not. USSR GDP/capita in period 1917-1989 increased from 750 to 7100 international 1990 Geary Khamis dollars. On average, it progressed faster than developed capitalist countries (USA: 5200->23000, W. Europe: 3300->15800) and faster than average of capitalist countries that had less than 2000 dollars GDP/capita in 1917 (I have data for 15 such countries): 1100->6800.
andy writes:

Pajser, I remember an article reviewing past editions of Sameulson's book. I quite liked how in an edition ~ 1989 it included more or less what you are saying. In the next edition there was something like 'economic indicators from these countries are being questioned' and in the next edition this disappeared altogether.

If you try to find something about the countries and the transition to capitalism, you will easily find out that these GDP numbers do not make any sense.

Hugh writes:

Professor Henderson,

I have just finished reading your Piketty review: I agreed with almost everything you wrote, but I feel you have not given enough weight to Piketty's approach to entitlements.

In the US the entitlement deficit has gone from zero in 1934 to gigantic 80 years later. This deficit represents an equal and opposite asset in the hands of all those enrolled in the various entitlement schemes: these are overwhelmingly middle class employees/retirees with middle class incomes.

If we correct Piketty's wealth figures by adding the Net Present Value of these benefits to the wealth of the beneficiaries we will find that a good part of the wealth gap disappears.

The existence of the deficits shows that payroll taxes have been inadequate in funding the entitlements, and the burden of making good the deficit will presumably fall on those paying income taxes (the top 50%). There will thus be a huge redistribution from the top 50% to the bottom half, which is most probably already underway.

Piketty's Policy proposals are thus based on erroneous figures, and are anyway moot as redistribution is already baked in the cake.

David R. Henderson writes:

@Hugh,
You’re right. I totally left that out. My mistake of omission. Thanks for pointing it out.
Best,
DRH

ThomasH writes:

I do not see a contradiction in holding both:

1. An increase in the income of "the poor" accompanied by an even larger increase in the income of "the rich" is a Good Thing. The last few hundred years have been swell and capitalism is one of the reasons they have been swell

2. In some times and places there may be arguments for some policies that result in transferring income from "the rich" to "the poor" if the mechanism of the transfer does not reduce the incomes of "the rich" "too much" with "too much" defined by how much "the rich" substitute leisure for market income and present for future consumption.

As a practical matter, I think we are in one of those times and places.

ThomasH writes:

I do not see a contradiction in holding both:

1. An increase in the income of "the poor" accompanied by an even larger increase in the income of "the rich" is a Good Thing. The last few hundred years have been swell and capitalism is one of the reasons they have been swell

2. In some times and places there may be arguments for some policies that result in transferring income from "the rich" to "the poor" if the mechanism of the transfer does not reduce the incomes of "the rich" "too much" with "too much" defined by how much "the rich" substitute leisure for market income and present for future consumption.

As a practical matter, I think we are in one of those times and places.

Thomas Sewell writes:

Much of this boils down to the perennial leftist "argument" that you hear from news stories whenever they announce income share statistics.

In a nutshell, it's something along the lines of:
If we define the poor as the bottom 10% of income earners, then X years ago, we had 10% poor. Now, we still have 10% poor and they're still the bottom 10% of income earners, therefore no progress has been made for the poor.

Completely ignoring that "the poor" are all different people now and that the results depend on our definition of who "the poor" are.

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