I'm starting to work on a paper that I'll give at the APEE (Association for Private Enterprise Education) meetings in Cancun in April. The working title for the paper, although I might change it when it comes time to submit to a journal, is "Economic Inequality: When and How Does It Matter?"
One of the first things on my agenda was to read Deirdre McCloskey's 50+ (!) page review of Piketty's Capital in the 21st Century. Many people in the blogosphere and on Facebook have talked about it and, on April 14, 2014, our own guest blogger, Alberto Mingardi, presciently wrote "my ideal candidate [for a review of Piketty] would be Deirdre McCloskey.
Although I'm a big fan of McCloskey qua economist and I'm a fan of her writing, I'm not as big a fan of her writing as many of my free-market friends--I have in mind Pete Boettke in particular--are. I sometimes find myself saying, when reading McCloskey, "Quit being so cute and get to the point." So when I saw that the review was over 50 pages long, I thought, "OMG, there she goes again."
I was wrong.
McCloskey's review is a masterpiece. She beautifully weaves together economic history, simple price theory, basic moral philosophy, and history of economic thought. Whereas I had mentally put aside an hour to read and think, it took only about 20 minutes. I highly recommend it.
Yet in fact his own capta, his own things-ingeniously-seized by his research, as he candidly admits without allowing the admission to relieve his pessimism, suggest that only in Canada, the U.S., and the U.K. has the inequality of income increased much, and only recently. "In continental Europe and Japan, income inequality today remains far lower than it was at the beginning of the twentieth century and in fact has not changed much since 1945" (p. 321, and Figure 9.6). Look, for example, at page 323, Figure 9.7, the top decile's share of income, 1900-2010 for the U.S.A., the U.K., Germany, France, and Sweden. In all those countries r > g. Indeed, it has been so, with very rare exceptions, since the beginning of time. Yet after the redistributions of the welfare state were accomplished, by 1970, inequality of income did not much rise in Germany, France, and Sweden. In other words, Piketty's fears were not confirmed anywhere 1910 to 1980, nor anywhere in the long run at any time before 1800, nor anywhere in Continental Europe and Japan since World War II, and only recently, a little, in the United States, the United Kingdom, and Canada (Canada, by the way, is never brought into his tests).
The inconsequence of Piketty's argument, in truth, is to be expected from the frailties of its declared sources. Start by adopting a theory by a great economist, Ricardo, which has failed entirely as a prediction. Landlords did not engorge the national product, contrary to what Ricardo confidently predicted. Indeed the share of land rents in national (and world) income fell heavily nearly from the moment Ricardo claimed it would steadily rise. The outcome resembles that from Malthus, whose prediction of population overwhelming the food supply was falsified nearly from the moment he claimed it would happen.
Incidentally, this same point about land rents was one I made in my criticism of Tyler Cowen's book, The Great Stagnation.
The Pyramid (How the Rich Innovators Get Only a Small Fraction of the Value they Create)
The economist William Nordhaus has calculated that the inventors and entrepreneurs nowadays earn in profit only 2 percent of the social value of their inventions. If you are Sam Walton the 2 percent gives you personally a great deal of money from introducing bar codes into stocking of supermarket shelves. But 98 percent at the cost of 2 percent is nonetheless a pretty good deal for the rest of us. The gain from macadamized roads or vulcanized rubber, then modern universities, structural concrete, and the airplane, has enriched even the poorest among us.
Piketty's Failure to Count Human Capital
For example--a big flaw, this one--Piketty's definition of wealth does not include human capital, owned by the workers, which has grown in rich countries to be the main source of income, when it is combined with the immense accumulation since 1800 of capital in knowledge and social habits, owned by everyone with access to them. Therefore his laboriously assembled charts of the (merely physical and private) capital/output ratio are erroneous. They have excluded one of the main forms of capital in the modern world. . . . He asserts mysteriously on page 46 that there are "many reasons for excluding human capital from our definition of capital." But he offers only one: "human capital cannot be owned by any other person." Yet human capital is owned precisely by the worker herself. Piketty does not explain why self-ownership à la Locke without permitting alienation is not ownership. If I own and operate improved land, and the law prevents its alienation (as some collectivist laws do), why is it not capital? Certainly, human capital is "capital": it accumulates through abstention from consumption, it depreciates, it earns a market-determined rate of return, it can be made obsolete by creative destruction.
Elementary Economic Error
"To be sure, there exists in principle a quite simple economic mechanism that should restore equilibrium to the process [in this case the process of rising prices of oil or urban land leading to a Ricardian Apocalypse]: the mechanism of supply and demand. If the supply of any good is insufficient, and its price is too high, then demand for that good should decrease, which would lead to a decline in its price." The (English) words I italicize clearly mix up movement along a demand curve with movement of the entire curve, a first-term error at university.
I caught this too, when I read Piketty, but I didn't mention it in my review because I failed to see the enormity of the mistake that this one elementary mistake of Piketty's led to. But McCloskey does see it. See what she does with it, on pages 91-93.
There are other things I didn't highlight: some of them because that would make this overly long post even longer and others because I noted the problem in my review.