Piketty, the New Marx

The parallels between Marx and Piketty are quite obvious.  Both men are trying to grapple with the endgame of unfettered capitalism.  The big difference here is that Piketty has data and a century of violent and turbulent experiments in economic systems behind him and Marx mostly just had ambiguous models rarely compared with facts from which he jumped to conclusions.  That in some cases Marx was approximately correct does not change the fact that Piketty’s empirical approach is much preferred.

Now I turn to what Piketty has to say about the future of inequality.  As I said inequality of wealth is reaching its historic Belle Epoque levels and labor income inequality is at historic highs.  Given this backdrop Piketty introduces the simple inequality r>g, with r the rate of return on capital and g the total growth rate.  If this inequality holds then inequality of wealth will continue to grow.  This follows because if I reinvest all my wealth then my wealth increases by r, but the total economy only grew by g, and so a larger amount of the economic pie is now mine.  The larger the discrepancy, the faster a few people come to own everything.

You can’t argue with the logic of this inequality, so instead Piketty’s critics question whether this inequality will hold for much longer.  Now my first order response is yes.  There are two things keeping this inequality true: first growth is slowing and second the rate of return seems fairly constant.

Growth has been slowing in the developed countries for awhile now due to lower population and productivity growth and developing countries will likely end their catch-up growth soon and reduce their birth rate.  Thus, we expect g to be lower in the future.

As Piketty shows, the rate of return on capital, r, has been a fairly constant 4-5% for much of human civilization.  But even on the shorter, more relevant time scale of post-WW2 this is approximately correct despite huge changes in the C/I ratio.  Or more specifically, the C/I ratio was 2-3 after WW2 in Europe and has now doubled to 4-6 and yet if anything, the rate of return on capital has increased from those dark days of war and triumphant social democracy.  Yet, simple supply and demand should tell you that if the amount of capital increases then, all other things being equal, its price, r, should go down.

We can put this more concretely by following Brad DeLong’s model.  He posits a warranted rate of return, r*, of g+w where w is the wedge, a fudge factor to encapsulate war, taxes, nationalization, stupidity, etc. that would raise the price of capital.  The actual rate of return is then r=ρ(C/I)^(-λ) where ρ is the efficacy of capital in influencing politics and society to its benefit and λ describes how r varies with C/I.  If it is unity then they follow each other in lockstep and nothing of the wealth accumulation Piketty prognosticates can happen.  Instead we need a λ<1 so that increases in C/I do not cause a commensurate decrease in r.

Now as I already stated r has been remarkably constant over the last half century despite a doubling in C/I.  This requires a mixture of a λ less than one and a ρ that has increased.  Now it is conceivable that increases in ρ explain the entire effect and I would not discount such an idea.  After all it is in actuality a function of the C/I ratio.  As capital increases we would expect its influence to increase as well.  If this dependence goes as (C/I)^(λ)  then it would also stabilize r and Piketty’s increasing inequality would come into play.

I think more worrying is the empirical result from Piketty that the wealthiest investors also get the highest rates of return.  If the global average is 4-5%, then Harvard and people on the Forbes list of wealthiest people are getting 10% or more and it seems to decrease as you get less rich.  This is at odds with standard economic theory that says every investor should get the marginal product of a unit of capital, that everyone’s rate of return should be the same.  That the rate of return is an increasing function of your existing capital means that existing inequalities of wealth will be amplified as time goes on.  Even if r does fall to the growth rate on average, if the already rich can secure better than average rates of return then inequality will continue to grow.  In terms of our model, ρ appears to be a function of an individual’s capital and a not insignificant one.

This is frightening not only for its implications in terms of future inequality, but also because it suggests our democracies are increasingly being arrogated for the objectives of the wealthy.  One of the best articles on the recently launched Vox news site was on this very fact but from a political science perspective.  The study showed that the correlation between policies favored by the average citizen and their chance of being enacted was essentially zero.  Meanwhile it was a meaty .76 for economic elite and only .56 for net interest group alignment.  You would have to posit that the economic elite know what’s best for the average citizen for this to make any amount of sense.  I, however, do believe that they know what is best for themselves.  Anyways it is interesting that two different disciplines can come to similar conclusions about the power of wealth in modern society.

Finally, one more note about  λ.  If the robot future does come to pass as is increasingly likely we would expect capital to become more of a substitute for labor than it has been in the past.  This would increase the demand for capital and further staunch any decrease in the rate of return.  In fact the ultimate endgame of a robot society has been explored before.  If robots can create more robots then production is essentially solved for all tasks that can be automated and the marginal product of labor is zero.  At this point the only wealth left is ownership of natural resources.  It seems to me that without government interference this is the most unequal society imaginable, not dissimilar to the Russian oligarchs that profited massively off the natural resources of Russia while the average citizen is still quite poor.

Now Piketty doesn’t outright say that the economic elite has taken control but he does blame a conservative rise to power since the 80s that resulted in less progressive taxes and reduced regulation and nationalization.  All of these things reduced the wedge which should increase the C/I ratio.  You can read about the Doom Loop of Oligarchy, but as should be obvious as the rich get richer they get ever more influence that allows them to get even richer and so on.

So what should fill the gap of the Reagan Revolution?  Well, bringing back much higher progressive income and estate taxes is one step.  But for Piketty, the best solution is a global progressive tax on wealth.  He suggests this for data keeping purposes and to ameliorate the increasing concentration of wealth.  As an economist, I am almost convinced the former benefit excites him far more than the latter.  As he points out, Earth runs a trade deficit with Mars.  That is, there is an amount of capital seemingly unaccounted for after adding up all the net capital flows from every country on Earth.  However, estimates suggest a large part of that is rich people sheltering their money from taxes, wives, etc.  This is why it has to be a global tax and why the extra data would be useful apart from further analyzing trends in wealth.

Now the level of this tax would be at most a few percent per a year.  Ideally, in my mind it would be set such that it redresses the greater rate of return afforded by increasing capital.  So if your wealth class pulls 8% then it is a 3% tax and if your class pulls 10% it is a 5% tax.  This encourages people to find the best return on capital and should concentrate wealth in the hands of people that are actually better investors while the flighty heir squanders all of his money.

Now much has been made about the feasibility of such a tax since it requires global cooperation which is not a particularly successful field of endeavor.  However, I think that if the U.S. and the Eurozone implemented their own capital tax and then shared financial data we would be well on our way to implementing such a tax.  Their combined influence could certainly crack a lot of tax havens as the U.S. already did with Switzerland.  Yes an all in one step is impossible, but if the big players do it then it will already have great efficacy and others will surely follow.

Before I end my discussion I want to talk about inheritance.  If you recall in my previous post, Piketty talks about inheritance in Belle Epoque literature.  Everyone knew that it was better and easier to marry into wealth than earn it.  Immediately following WW2 this was not true at all because most wealth had been eradicated.  However, with C/I once again reaching Belle Epoque levels inheritance is poised to become very important again.  Brad DeLong estimates 30% of national income could eventually be inheritance under current conditions.  Piketty has estimates in the double digit percentages for the number of people that will inherit an amount of money greater than the amount of money that an average person will earn in their entire lives.  Realize though that the average person is unlikely to be the beneficiary of such an inheritance.  It will probably be bequeathed to someone with good earnings potential from a college degree or any of the other perks associated with being raised in a family with wealth saved larger than the average person earns their entire life.

On top of the absurdly wealthy pulling away from everyone else, we see a just as pertinent inequality in the patrimonial middle class pulling away from the bottom half of society.  Remember the very sad fact that half the population owns basically nothing and be grateful if your bank account (which many poor people do not have) contains an amount distinguishable from zero.  Not only will you recognize the plight of so many, but being grateful about things is a great way to improve your happiness.  You can thank me later.

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