David R. Henderson  

McCloskey on Piketty

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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.

Some highlights:

The Data

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).

Lousy Predictions
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.




COMMENTS (17 to date)
Ray Lopez writes:

http://marginalrevolution.com/marginalrevolution/2014/11/deirdre-mccloskey-has-a-55-page-review-essay-on-piketty.html

See the mention of my name and my views. Me, myself and I. I will not repeat my entire 724 word review of McCloskey's review, except to point out: "Neither author [Potter, McCloskey] attempts to rebut two key points by Piketty ...point #1: it is UNDISPUTED that r > g .... McCloskey says that anyway most wealth is going to be dissipated by spendthrift heirs, but, that’s ignoring the issue. Key Point #2: Further, neither Potter nor McCloskey address a point that Piketty realizes: wealth is not absolute, but relative. It matter not that due to capitalism that the worldwide poor living on less than $1 a day have decreased over the last generation. The only thing that matters to anybody is that their neighbor is richer than them.

Unlearning writes:
She what she does with it, on pages 91-93.

What exactly does she do with it? All I see is a lot of tedious wordsmithery. How exactly is this point central to Piketty's overarching thesis - hell, how is it even central to that section?

[I should also note that I think she is being uncharitable. From her French translation it would seem he had it right initially.]

Unlearning writes:

Sorry for the double comment, but on your 'the data quote':

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.

1. r > g concerns wealth, not income inequality

2. She seems to be saying that after social democratic policies were implemented, inequality didn't increase. Well, duh. Piketty is arguing for social democratic institutions to counter income inequality. How does her point refute his argument?

Paul Marks writes:

Yes, Piketty either blames capitalism for things that have not happened at all, or for things that are actually the result of the government backed credit-money expansion of recent years.

Roger writes:

Ray,

This is a response to your comments on the attached link.

"It matter not that due to capitalism that the worldwide poor living on less than $1 a day have decreased over the last generation. The only thing that matters to anybody is that their neighbor is richer than them."

Huh? It matters a lot that my family is not suffering from malnutrition, and that we can afford medical care, relatively clean heat and shoes to get us through the winter and education. How can you say poverty doesn't matter?

"A corollary of this is that people don’t think logically when it comes to income, they think in terms of ‘fairness’. Give one person $100000 as a gift, and give his neighbor $10, and the neighbor will hate both you and the $100k recipient. "

Agreed. Luckily most income in modern economies is earned. It is not gifted by some perverse jealousy inducing demon. I have very little if any envy toward any billionaire achieving her fortune by producing value for fellow humans. Indeed, in an ideal world there would be substantially more billionaires and even trillionaires creating wealth in a positive sum manner. Nor would I resent their kids (though I do think inheritance taxes are a better way of paying for public goods than most revenue sources.)

I do however resent anyone achieving so much as a nickel via zero or negative sum rent seeking activity. It isn't success I resent. It is how someone goes about achieving it.

"if it’s true that wealth is not absolute but relative, then I see class warfare increasing"

I disagree in so many ways. First, class warfare has always been a boogie man. Any realistic interpretation of competition would illustrate that people within a class compete substantially more with others in their class rather than those outside. My competition wasn't my employer -- indeed the relationship I had with my employers was always by definition overwhelmingly cooperative. I "competed" with fellow applicants and employees.

Second. Do read James Payne's book "A History of Violence". He has a chapter or two on class warfare, civil war, riots and such. The long term trends are overwhelmingly positive (declining).

Third, as even you allude, most real world envy isn't aimed at billionaires and rock stars. It is aimed at my next door neighbor, coworker or brother in law. Our evolved sense of fairness is clearly aimed at monitoring those we really are competing with for social status as opposed to those the "class baiters" wish we would compete with (my first point)

Which leads to the most important point. Ever notice how it is the same people crying out "inequality!" and "unfairness!" from every roof top who seem to walk into the coffee shop afterward and warn the rest of us about the restless masses? Seems beyond disingenuous to me. If you really are concerned about class strife, please quit manufacturing, exaggerating and propagandizing it. Seriously.

Tyler Kubik writes:

Ray,

it is UNDISPUTED that r > g .... McCloskey says that anyway most wealth is going to be dissipated by spendthrift heirs, but, that’s ignoring the issue.

Is it really ignoring the issue? r > g only has the significance Piketty wants it to have if holders of capital tend to be consistent over time, i.e. his claims about inequality and inane policy conclusions. So, you're saying, essentially, that McCloskey is taking issue with the claim that holders of capital are consistent over time. How is that irrelevant?

Cnuut writes:
It matter not that due to capitalism that the worldwide poor living on less than $1 a day have decreased over the last generation. The only thing that matters to anybody is that their neighbor is richer than them.

This is a-priori false as my neighbours 'richness' does not matter to me; am I the only one? Perhaps basing your epistemology on jealousy is not a good idea. Perhaps it is even immoral.

Dallas writes:

It seems that this whole r > g discussion is HUH! type nonsense.

With "g" being net growth as a sum of growing and dying firms and organizations it is an average that includes the destruction half of creative/destruction. The "r" term is from current investments moving to the creative half of the pair with little/no investment going into the decaying half, where capital is being depreciated and written off. The delay times between the start of destruction and elimination of the firm, while the capital depreciation is flowing into the creative "r", while the decay is counted in "g" will always make r>g. DUH!

It seems that by definition of the terms we can't have r < g, if "g" is measured on a per capita basis. Per-capita basis for "g" is the only rational basis as that is what is relevant to the citizen.

On a total basis for "g", we can have r < g by massive migration of people increasing "g", while creating more of the same and no creative/destruction with zip "r". That may not be a very long lived society with no creative/destruction to increase the pie.

[broken html fixed. Use ampersand-lt-semicolon for less-than symbol in html. See FAQ. --Econlib Ed.]

Tim C writes:

George Reisman and Phillip W. Magness have also cogently refuted Piketty on their sites.

Daniel Kuehn writes:

^ I like this a lot, Dallas.

It's not any kind of proof because the denominators are different for the two of course. The denominator of r is K and the denominator of g is Y. So the standard dynamic inefficiency explanation for why r > g is stronger in that sense. But I really like the sort of intuition in your comment.

r > g is a great psuedo-Turing test for Piketty critics. Anyone that treats r > g as some kind of crazy idea is clearly not even familiar with undergraduate macro and can safely be ignored in the discussion. As Mankiw, Acemoglu, Piketty, myself if I should be so bold, and many others have pointed out r > g is not the controversial claim at all. The controversial claim is what r > g does or does not imply about inequality.

Lliam writes:

I've started reading McCloskey's piece. I was hoping to be able to recommend it to Piketty fans. However, while she is at pains to be nice about Piketty, it seems she's going out of her way to be dismissive about the left in general. Accordingly, the piece seems to have much more polemic than pursuasive value.

Roger McKinney writes:

McCloskey is one of my favorite economists and does an excellent job debunking Piketty. A couple more points:

Inequality in the US began to rise not long after the implementation of Johnson's "Great Society" socialist leap forward. Inequality has continued to grow in the US even as the US has become more socialist. Piketty fixates on Reagan's tax cuts of the top marginal rates, but completely ignores that along with the cuts in top marginal rates Reagan eliminated many tax deductions and so did not change effective tax rates. Federal tax income as a percent of gdp has grown since 1980, not fallen. And state, county and city taxes have increased as well.

Then in his second term Reagan passed the largest tax increase in US history at the time. Then Bush I and Clinton in turn each achieved largest in history tax increases.

Piketty seems to have drunk the Kool Aid mixed by the socialist media that says the US has experienced Wild West style capitalism since 1980. How do FDR's and Johnson's massive socialism, three consecutive tax increases, each in its turn the largest in US history, as well as the Federal Register growing by 70,000 pages per year, constitute anything remotely like capitalism or free markets?

Finally, Piketty admits in his book that the conventional measure of inequality, the GINI coefficient, failed to help him make his case so he had to invent a new measure, his r > g. Torturing the data until it confesses to agreement with your point should have been the first criticism of Piketty.

David R. Henderson writes:

@Dallas and Daniel Kuehn,
I’m not sure why you’re raising the r greater than g point here. I didn’t challenge that, and none of the quotes I used from McCloskey challenges that. Indeed, in my own review of Piketty, I took it as given that r is greater than g and pointed out that you need some more strong assumptions to show that that alone will lead over time to more inequality of wealth.

David R. Henderson writes:

@Lliam,
I would not recommend McCloskey’s review to Piketty fans either, or, at least, I would not recommend it to most of them. The tone doesn’t work. I would, however, recommend my review to them.

Ray Lopez writes:

@Roger - I think you misread me in your first paragraph. The key point is: "local is the yokel" (nobody really cares about starving Africans, except around Xmas time). As for the rest of your post, I think you are not representative but enlightened. I've lived in three countries outside the USA for more than a year, and I see class warfare a distinct possibility in the USA.

@Tyler Kubik - "Is it really ignoring the issue? r > g only has the significance Piketty wants it to have if holders of capital tend to be consistent over time, i.e. his claims about inequality and inane policy conclusions. So, you're saying, essentially, that McCloskey is taking issue with the claim that holders of capital are consistent over time. How is that irrelevant? " - Yes, it's ignoring the issue. In Scandinavian countries and in Marxist ideology it's not that the Rockefeller family is in the 1% for generations (your point) but rather, that there is a 1% class to begin with. Full disclosure: I'm in the 1% and could care less about the working class, as long as I don't run over them in my Mercedes. But I'm just making the argument that Piketty makes and McCloskey ignores. Oh, btw, in Sweden Gregory Clark and others find that in fact the 1% persists longer than commonly believed, based on surnames, but this is beside my point. Classes, in and of themselves, are bad, even with mobility between classes. This is traditional socialist thinking (Horatio Alger would not agree, and it's un-American, but very Continental I posit).

Daniel Kuehn writes:

David -
I think we are responding to Ray and Unlearning. Ray is referencing what he sees as a weakness in McCloskey's argument and Unlearning is referring to the use of r > g to talk about inequality in the section you've quoted under "The Data". I was just reacting to Dallas's comment and then thinking about r > g more broadly.

David R. Henderson writes:

@Daniel Kuehn,
OK. Thanks for clarifying.

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