Monday, July 21, 2014

Piketty (19) Unrighteous Wealth

My greatest concern a about Piketty’s approach is that the does not distinguish between righteous wealth. He considers the possibility, but decides that it is too hard, because the wealth usually have mixed motives (445).

Assessing the morality of wealth is beyond the capability of Piketty or of any democratic government. When governments portray wealthy as unrighteous, it is usually and excuse for one group of people to steal wealth from another.

God has a different perspective. Jesus introduced the concept of unrighteous wealth in the parable of the shrewd manager (Luke 16). He described some wealth as righteous, but he expanded on the dangers of unrighteous wealth in the parable of the Rich man and Lazarus. He explained that the soul of the person who owns unrighteous wealth is in serious danger. It is almost impossible to get into the kingdom.

Jesus did not give governments responsibility for confiscating unrighteous wealth. Confiscated wealth remains unrighteous wealth.

Unrighteous wealth that Government transfers to another person remains unrighteous wealth. The only way to escape the clutches of unrighteous wealth is to give it away. Zacchaeus understood Jesus teaching so he gave most of his wealth away.

When a person becomes a Christian, one of the first things that we should expect is that the Holy Spirit will convict them about the unrighteous wealth that they own. They should be encouraged to give it away.

When unrighteous wealth is given away, it is transformed into righteous wealth. In the book of Acts, people sol their property and laid the proceeds at the apostle’s feet. They were most likely getting rid of unrighteous wealth. That fact that Ananias and Saphira had trouble giving up their wealth indicates that it was probably unrighteous wealth.

The nature of unrighteous wealth is described in God's Instructions for Economic Life given in the Torah. If we are not clear about whether our wealth is righteous or unrighteous, the Holy Spirit can show us. Discerning unrighteous wealth was too difficult for Piketty, but it is easy for the Holy Spirit.

Much of the wealth held in the western world is unrighteous wealth. If there is a gospel advance in the next few decades, we should see a massive amount of unrighteous wealth being given away. This would do more to reduce inequality than Piketty’s wealth tax.

Large holdings of unrighteous wealth, and a few people with righteous wealth. are a consequence of gospel failure.

Principles

  • Confiscated unrighteous wealth remains unrighteous wealth.
  • Unrighteous wealth must be given away to become righteous wealth.
I will post on Jesus parables and on unrighteous wealth when I am finished with Piketty.

Saturday, July 19, 2014

Nit Piketty (18) Flaw in Capitalism

Piketty thinks that he has found a flaw in capitalism: the fact that the return on capital is greater than the growth rate of the economy. He attributes the increasing inequality to a flaw in capitalism. The key is r>g. He writes,

The overall conclusion of this study is that a market economy based on private property, if left to itself contains... powerful forces of divergence, which are potentially threatening to democratic societies and to the values of social justice on which they are based.

The principal destabilising force has to do with the fact that the private rate of return on capital, r, can be significantly higher for long periods of time than the rate of growth of income and output, g.

The inequality r>g implies that wealth accumulated in the past grows more rapidly than output and wages. This inequality expresses a fundamental local contradiction. The entrepreneur inevitably tends to become a rentier, more and more dominant over those who own nothing but their labour. Once constituted, capital reproduces itself faster than output increases. The past devours the future.

The consequences for the long-term dynamics of the wealth distribution are potentially terrifying, especially when one adds that the return on capital varies directly with the size of the initial stake and that the divergence in the wealth distribution is occurring on a global scale.
r>g is not a flaw of capitalism. It reflects the nature of the world. Capital makes people more productive. This makes everyone better offer off, including labour.

Therefore increasing the capital income ratio is good. The question is who benefits. It seems reasonable that those who do the saving should benefit most. They should benefit more than those who did not save.

Piketty grudgingly seems to accept this reality, but then moves quickly on to attacking inheritances.

Friday, July 18, 2014

Piketty (17) Capital v Wealth

Piketty uses the terms capital and wealth interchangeably. I think that his is a serious problem with his thinking. For an economist, capital is productive stuff like factories, machinery, and computers. The purpose of capital is production.

Wealth is a broader concept. It includes all assets that give a rate of return. Many of these are financial assets, which represent the ownership of real capital (eg shares). Others are loans that are only loosely linked to assets. The focus of wealth is income, which is Piketty’s concern. He is not interested in production. He focuses on understanding how wealth gives people control of income. This is a legitimate concern, but his interest is in wealth, not in capital. Therefore, his use of the word capital to describe wealth is not helpful.

For example, Piketty says that the Industrial Revolution allowed European nations to claim a huge share of world income (59). He ignores the fact that the accumulation of capital enabled them to expand production extensively, which created enormous wealth.

Viewed in this way, wealth becomes a bad thing. This means that by association capital is a bad thing too. For example, Piketty sees 1914-1945 as a good period, because inequality decreased. It was actually a really bad period, because massive capital destruction occurred all over the world. Immense resources went in the production of armaments, where then blown up. That loss of capital made everyone worse off.

Piketty is wrong. Capital is really important. That reason that so many people in the world have escaped from subsistence is the last few centuries has been the accumulation of capital equipment. Capital makes people more productive. Most of the world needs more capital.

Wealth is a different issue. It may be distributed unfairly and obtained illegally. However, we must be careful that we do not destroy capital in an attempt to eliminate unequal distributions of wealth. That would make everyone worse off.

Thursday, July 17, 2014

Piketty (16) Uncertainty

Piketty shows that r is usually greater than g. This might be true on average, but averages cover a multitude of sins.

People involved in business know how easy it is to get a negative rate of return, and even lose capital. Piketty makes it seem like a 4 percent rate of return is automatic. This is misleading. Getting a good rate of return on assets is extremely difficult. It takes a lot of energy, diligence and wisdom.

Wednesday, July 16, 2014

Piketty (15) Middle Class

Piketty says that the big change in the twentieth century was the emergence of the middle class. In 1910, this group held very little wealth. Their share increased significantly during the century. This was achieved mainly through the ownership of residential housing and superannuation.

The overall importance of capital today, as noted, is not very different from what it was in the eightieth century. Only its form has changed: capital was once mainly land but is now industrial, financial, and real estate. We know that the concentration of wealth remains high, although it is noticeably less extreme than it was a century ago. The poorest half of the population still owns nothing, but there is now a patrimonial middle class that owns between a quarter and a third of total wealth, and the wealthiest 10 percent now own only two-thirds of what there is to own rather than nine tenths (377).

Tuesday, July 15, 2014

Piketty (14) Solution

Piketty admits that his proposed solution, a universal tax on capital is unlikely to be adopted. This means that he does not have a workable to his perceived problem.

He assumes that all solutions must be provided by the state. Unless there is an international organisation with the power to overcome national states, any solution that depends on state power is unworkable, because the wealth can motive their wealth from one state to another to avoid taxes.

Piketty sees inequality as an affront to democracy.

Our democratic societies rest on a meritocratic worldview, or at any rate a meritocratic hope, by which I mean a belief in society in which inequality is based on merit an effort than on kinship and rents. This belief and this hope play a very crucial role in modern society, for a simple reason: in a democracy, the professed equality of rights of all citizens contrast sharply with the very real inequality of living conditions, and in order to overcome this contradiction it is vital to make sure that social inequalities from rational and universal principles rather than arbitrary contingencies (422).

Today the rents produced by an asset are nothing other than the income on capital, whether in the form of rent, interest, dividends, profits, royalties, or any other legal category of revenue, provided that such income is simply remuneration for ownership of the asset , independent of any labour.(422)
There is something astonishing about the notion that capital yields rent, or income that the owner of capital obtains without working. There is something in this nation that is an affront commons sense that has in fact perturbed any number of civilisation, which have responded various ways, not always benign (423).
In my view, democracy is not the solution. It can make it possible for the majority to appropriate the wealth of a minority. But in the process it will destroy capital, and in the long run that will destroy wealth.

Monday, July 14, 2014

Piketty (13) Forecast for the Future

Piketty shows that the distribution of wealth is changing. Wealth grew during the 19th century. It collapsed between 1910 and 1945 and was flat until 1974. Wealth is now growing again.

Piketty assumes that inequality will increase. He says that the 20th century was abnormal, because capital/income ratios declined, as two wars and the great depression destroyed capital. Following 1945, shortages of skilled labour shifted the balance towards labour. At the same time, unions and labour laws increased the share going to labour. That trend ended in about 1973, and since then the capital/income ratio has been increasing, and inequality along with it.

Piketty says we are coming back the 19th century situation. The twentieth century was abnormal. The 19th century was more normal, so we are reverting the norm.

This does not make sense. Most the wealth in 1800 was land. The aristocracy were allocated their land holdings by William the Conqueror and the winners of various civil wars. Renting land was mostly money for nothing, but the land has to be developed to get better returns.

The industrial revolution favoured capital. A huge army of labourers moving from the country to the cities kept wages down until the middle of the century. At the same time, the landed aristocracy declined.

By 1900, wealth was dominated by industrial capital. Land was a tiny share of wealth. Some of the industrial wealth like the railways was gained through political privilege. Most was gained through innovation and saving to produce what people wanted.

Piketty says that the situation that prevailed in the 19th century is a more normal situation, and that we are going back to that. This does not make sense to me. The 19th century was a very different. During this century, the wealth of the landed gentry declined, and the industrial revolution produced rapid economic growth. There is no reason why our future should be like that.

The nineteenth century was a period of relative peace. Between the defeat of Napoleon and the First World War, a hundred years later, many wars occurred, but they were relatively minor. The gold standard meant that inflation was almost non-existent for the entire century. Recessions occurred, but they mostly resolved quickly.

There is no reason to expect these conditions will prevail in the twenty-first century. We are more likely to see serious wars and economic disaster.

Saturday, July 12, 2014

Picking on Piketty (12) Robert Rowthorn

One of the best critiques of Piketty’s theoretical explanation has been presented by Robert Rowthorn from the University of Cambridge (UK) in his Note on Thomas Piketty. He explains that Piketty uses the standard neoclassical theory of factor shares.

This theory establishes a link between the capital intensity of production and the share of profits in total output. The nature of this link depends on the elasticity of substitution between capital and labour. When this elasticity is greater than unity, an increase in the capital-output ratio leads to an increase in the share of profits. This, in essence, is Piketty's explanation for the increased share of wealth-owners in national income. Thus, the shift in income distribution is due to the over-accumulation of capital: there has been too much real investment.

The above explanation has two related flaws. Piketty's assumption regarding the elasticity of substitution is not correct. There is considerable evidence that this elasticity is less than unity. Moreover, Piketty's method for measuring changes in the capital-output ratio is misleading. He fails to allow for the disproportionate increase in the market value of certain real assets, especially housing, in recent decades. This leads him to conclude, mistakenly, that the capital-output ratio has risen by a considerable amount. In fact, conventional measures of this ratio indicate that it has been either stationary or has fallen in most advanced economies during the period in question. This would suggest that the basic problem is not the over-accumulation of capital, but just the opposite. There has been too little real investment.
The increase in the capital/income ratio measured by Piketty is the result of price effects.
Piketty documents how α and β have both risen by a considerable amount in recent decades. He argues that this is not mere correlation, but reflects a causal link. It is the rise in β which is responsible for the rise in α. To reach this conclusion, he first assumes that β is equal to the capital-output ratio K/Y, as conventionally understood. From his empirical finding that β has risen, he concludes that K/Y has also risen by a similar amount. According to the neoclassical theory of factor shares, an increase in K/Y will only lead to an increase in α when the elasticity of substitution between capital and labour σ is greater than unity. Piketty asserts that this is the case. Indeed, based on movements α and β, he estimates that σ is between 1.3 and 1.6 (page 221).

Thus, Piketty's argument rests on two crucial assumptions: β = K/Y and σ > 1. Once these assumptions are granted, the neoclassical theory of factor shares ensures that an increase in β will lead to an increase in α. In fact, neither of these assumptions is supported by the empirical evidence which is surveyed briefly in the appendix. This evidence implies that the large observed rise in β in recent decades is not the result of a big rise in K/Y but is primarily a valuation effect.
Rowthorn shows that K/Y has been falling in the United States since 1981 and has been roughly constant in most of Europe. This implies that the income share of wealth owners is rising because of a low rate of real investment and a falling capital–output ratio.
Piketty argues that the higher income share of wealth-owners is due to an increase in the capital-output ratio resulting from a high rate of capital accumulation. The evidence suggests just the contrary. The capital-output ratio, as conventionally measured has either fallen or been constant in recent decades. The apparent increase in the capital-output ratio identified by Piketty is a valuation effect reflecting a disproportionate increase in the market value of certain real assets. A more plausible explanation for the increased income share of wealth-owners is an unduly low rate of investment in real capital.

Broken Windows

Did you hear about the man whose neighbor’s children threw stones through his windows, breaking the glass? They had been throwing stones on the roof of his house for some time, so this was the last straw. The man grabbed the rifle that his Uncle Pat had given him and went next door and shot the parents of the stone-throwing children. The children escaped to the home of another neighbor before he could shoot them.

The man was so angry that he pumped the neighbor’s house full of lead, killing the parents, their three children, and the children they were sheltering. Even a stray dog scavenging in the rubbish bin was wounded.

The news media described the situation as spiraling violence.

The police said they were investigating.

The judge said that the man was entitled to defend his home from attackers.

When Uncle Pat heard abut the shooting, he was delighted.

Friday, July 11, 2014

Piketty (11) Elasticity of Substitution

The biggest debate about Piketty's book has been about the elasticity of substitution between capital and labour. Economists have traditionally believed that as the supply of capital increases, the rate of return will decline, ie there will be diminishing marginal returns to capital. Therefore, even if the capital/income ratio increases, then the rate of return on capital will decline. This will cause share of income going to capital to decline.

Piketty’s formulation implies that over the long term, the elasticity of substitution between capital and labour seems to have been greater than one. This means that an increase in the capital/income ratio seems to have led to a slight increase in α, the capital share of national income (221).

If this elasticity is greater than one, as more capital is added to the productive process, the owners of capital push aside wage demands and claim a increasing share of output as their reward for investing.

Several economists have challenged this result. Matthew Rognlie argues that Piketty has confused gross and net elasticities.

Economists generally talk about gross elasticity in the context of a gross production function. Piketty uses net concepts, so he means elasticity of substitution in a net production function. This a different concept. Net elasticity is always less than gross elascitiy, and almost always less than one.
Lawrence Summers claims in the Inequality Puzzle that,
As the capital stock grows, the increment of output produced declines slowly, but there can be no question that depreciation increases proportionally. And it is the return net of depreciation that is relevant for capital accumulation. I know of no study suggesting that measuring output in net terms, the elasticity of substitution is greater than 1, and I know of quite a few suggesting the contrary.
There will be continuing debate on this issue.

Thursday, July 10, 2014

Picking Piketty Apart (11) Push-back

Piketty's analysis has been challenged by various economists.

1. Rate of Return
Some economists have questioned his suggestion that the rate of return on capital is consistently above 4 percent.

Lawrence Summers argues that the largest single component of capital in the United States is owner-occupied housing. The return comes in shelter services which are consumed.

Robert P Murphy says that Piketty confuses the rate of return with the rental price of capital. He bases his critique on Eugen Böhm von Bawerk who wrote Capital and Interest (1881).

2 Savings
There have been debates about whether savings rates are as high as Piketty claims.

Debraj Ray argues that r>g has nothing to do with whether equality goes up or down. The key force driving rising inequality is “the savings propensities of the rich.

The owners of capital income also happen to be richer than average, and richer people can afford to (and do) save more than poorer people. But that has to do with the savings propensities of the rich, and not the form in which they save their income. A poor subsistence farmer with a small plot of land (surely capital too) would consume all the income from that capital asset. It may well be that the return on that land asset exceeds the overall rate of growth, but that farmer’s capital income would not be growing at all.
This is probably correct, and all that is needed to explain the inequality of wealth.

I expect there will be continuing debate about the economic explanation provided by Thomas Piketty.

I do not think we can be too certain about what will happen in the future. As g declines, the rate of return on capital (r) could decline. If the fall n growth is serious, savings rates could decline too. If either of these happened, Piketty’s prediction would fail.

In some ways, the debate about r>g is irrelevant. A variety of economic, social and legal factors affect the share of national income going to the owners of wealth. Attempting to explain this with two equations is overly ambition.

However, there is no doubt that wealth is currently very unequally distributed. Understanding why this has happened will require a great deal more economic, social and legal analysis.

Arguing about r>g will be a distraction from the real work that needs to be done.

Wednesday, July 09, 2014

Picking Piketty Apart (10) Statistical Check

Piketty examines each of his variables and estimates where they change in the future.

First g,
He suggests that economic growth will be slower in the future due to declining population growth. New technology and innovation will not be able to compensate.

Then r,
Piketty says that the over the long run, the rate of return is about 4-5 percent a year.

The principal conclusion that emerges from my estimates is the follow. In both France and Britain, from the eighteenth century to the twenty-first century, the pure return on capital has oscillated around a central value of 4-5 percent a year, or more generally in an interval from 3-6 percent a year. There has been no pronounced long-term trend either upward or downward… it often exceeded 4-5 percent in the eighteenth and nineteenth centuries, whereas in the early twenty-first century it seems to be approaching 3-4 percent as the capital/income ration returns to the high level observed in the past (206).
Then r>g,
Through most of history, r-g has been positive.
Throughout most of human history, the inescapable fact is that the rate of return on capital was always 10 to 20 times greater than the rate of growth (353)
He assumes that r will continue to be greater than g in the future.
Finally s
Piketty investigates the rate of return in many countries. Rates vary between countries and over time, but they have averaged between 7 and 10 percent in western countries between 1970 and 2010 (175).

If these estimates are correct, then the capital income ratio will continue to grow and the share of income that goes to capital will increase too.

Tuesday, July 08, 2014

Piketty (9) r>g

The implication of Piketty's two laws is that if growth (g) is slower than the rate of return (r) ie r>g, and saving rates will remain high, then the capital/income will increase. This leads to increased inequality.

For example, if g=1% and r=5%, saving one-fifth of the income from capital (while consuming the other four fifths) is enough to ensure that capital inherited from the previous generation grows at the same rate as the economy (351).
The basic point of these two laws is that if r>g it is easy for those with existing wealth to grow their wealth faster than the economy is growing. As wealth is unequally distributed, this increases inequality.

When growth is faster, it becomes easier for holders of wealth to save a much greater share of their return on capital and grow their wealth faster than the economy is growing.

β=s/g implies that the capital/income ratio will increase significantly in the twenty-first century, as we return to the equilibrium for a low growth economy with a savings rate of about 12 percent. r>g suggest that most of this new capital will go to the holders of existing wealth.

If the increase in wealth goes to those who already hold wealth, the mass of the population, who own no wealth is left to share out the remainder amongst themselves.

The reason the accumulation of wealth is a problem is that the existing distribution of wealth is so unequal. I will say more on this in future posts, but the fact that wealth begats wealth is not the problem. The problem is that wealth is so unevenly distributed that only a few benefit from the accumulation of capital.

There are two important questions that Piketty does not answer.
  1. Why do so few families own any capital, beyond their residential dwelling, which is not really capital at all?
  2. Existing wealth is distributed unequally. Is this legitimate or not?

Monday, July 07, 2014

Picking on Picketty (8) Explanatory Theories

The weakness of Piketty’s analysis is the lack of explanatory theory. The problem with r>g is that it has more descriptive power than explanatory value. He is very effective at describing how things are. However, he is much less effective in explaining why they are as they are. He makes suggestions, but is unable to give the causal links that show why thing are as they are.

His first law of economics is an accounting that does not explain much.

α = r × β
Where
α= share of national income that comes from capital income.
r= rate of return on capital
β=capital/income ratio
If either or both of the rate of return on capital or the capital/income ratio increase, the share of national income going to capital will increase.

The second law of economics is different. Piketty says it only applies in the long-run, under certain assumptions. There will be debate about where and when it applies.
β=s/g
Where
s=savings rate
g=growth rate of the economy

In the long run, the capital/income ratio adjusts to the structural growth of the economy and the savings rate, ie how much is saved out of the increased income.

According to neoclassical economics, an increase in savings does not necessarily lead to an increase production. Growth in production is constrained by population growth and technical innovation. Piketty suggests that this is limited to about 2 percent a year. If savings increases faster, the capital/labour ratio adjusts accordingly.

This formulation allows Piketty to estimate the long run equilibrium capital/income ratio for a given savings rate. This insight is hidden away in the middle of the book, so it has been missed by many who skimmed the book, but it is his most important theoretical contribution.
The law β=s/g apples in all cases, regardless of the exact reasons for a country’s saving rate. This is due to the fact that β=s/g is the only stable capital/income ratio in a country that saves a fraction s of its income, which grows at a rate g.

The argument is elementary. Let me illustrate it with an example. In concrete terms: if a country is saving 12 percent of its income every year., and if its initial capital stock is equal to six years of income, then the capital stock will grow at 2 percent a year, thus at exactly the same rate as national income, so that the capital/income ratio will remain stable.

By contrast, if the capital stock is less than six years of income, then a saving rate of 12 percent will cause the capital stock to grow at a rate greater than 2 percent a year and therefore faster than income, so that the capital/income ratio will increase until it attains its equilibrium level.

Conversely, if the capital stock is greater than six years of annual income, then a saving rate of 12 percent implies that capital is growing at less than 2 percent a year, so that the capital/income ratio cannot be maintained at that level and will therefore decease until it reaches equilibrium.

In each case the capital/income ratio tends over the long run towards its equilibrium level β=s/g... it allows us to understand the potential equilibrium level toward which the capital/income ratio tends in the long run, when the effects of shocks and crises have dissipated (170).
There is a long run equilibrium ratio between wealth and income which remains stable once established. This equilibrium is the basis for Piketty’s claim that the capital/income ratio will increase to about 600 percent in most Western country’s as the growth rate declines to 2 percent or less (assuming the savings rate continues to be about 12 percent.

The equation β=s/g is indeterminate. There are almost limitless values that can satisfy the equation. Piketty constrains them by assuming that the saving rate is determined independently, and remains about 12 percent of national income.

However, changes into the savings rate can make a significant in a slow growth economy (2 percent). If the savings rate rose to 16 percent, the capital/income ratio would be 8. If the saving rate dropped to 8 percent, the capital income ratio would be 4, less than what it is in many Western countries now. This suggest that the savings rate is quite an important variable.

On the other hand, if the saving rate increases dramatically, and the extract capital is channelled into productive activities, the growth rate can increase without a change in the capital/income ratio, ie g=6, s=24 and β=4. This is more like the Chinese situation.

Saturday, July 05, 2014

Picking Piketty Apart (7) Mobility

When analysing inequality, Thomas Piketty focuses on the share of income and wealth going to three groups, the top decile, the middle forty percent and the bottom fifty percent. He also looks at the share of the top one percent.

A limitation with this approach is that it does not tell us what is happening to individuals, families and groups over time. The people making up Piketty’s groups can change by economic events. People in the bottom half can move up. Others born into the top 10 percent can drop down.

There is always (by definition) a top ten percent in every society, but the membership of that group can change over time. To understand inequality we also need to understand income mobility.

In the beginning the 19th century, most of the top 10 percent were landed aristocracy. By the end of the century, most of the top ten percent were industrialist. A few would have made the transaction from renter to industrialist, but most did not.


By the end of the twentieth century, the landed gentry cannot afford to maintain their stately homes. Industrialists have been hammered by competition from China. The top 10 percent are now bankers and super manager. A place into the top 10 percent is never permanent.

Friday, July 04, 2014

Picking Piketty Apart (6) Statistics

Thomas Piketty deals with four broad themes in his book called Capital.

  1. Statistics
  2. Explanatory theory
  3. Forecast for the future.
  4. Policy recommendations.
Statistics
Piketty puts considerable effort into proving that wealth is unequally distributed. His statistics show that inequality is increasing. Everyone assumes that this is the case, but it is good to have statistical proof.

Piketty presents a lot of statistics. As someone who has dabbled in statistics a bit, I like the way that he does not just do a data dump, but uses his graphs and tables to tell an economic and social story. Piketty and his colleagues have collected a massive database of statistical information. He presents the information in a way that is east to understand. Statisticians often dull their readers with numbers. Piketty uses statistics to illuminate his story.

I have also done enough with statistics to know that measuring income is hard, and measuring wealth is even more difficult, so I expect there will continue to be arguments about his statistics, but I doubt that these will change the underlying story.

That said, Piketty tends to gets a bit exuberant in some of his interpretations. He consistently see a U pattern, a series declines between 1914 and 1950, but is now returning to the level that prevailed in the 19th century. I see quite a few reverse Js. Many of the measures he describes as a U are a long way from returning to the level of the 19th century.

Thursday, July 03, 2014

Picking Piketty Apart (5) Solution

Part 4 of Capital by Thomas Piketty is called Regulating Capital. That title sums it up. Piketty sees government regulation as the solution to all the problems he has identified.

Piketty has no confidence in progressive income tax to solve inequality. When income taxes are raised too high, wealthy people set about evading them. He notes that top tax rates have declined in the last few decades, because a lower rate captures more tax.

The solution proposed by Piketty is an annual progressive annual tax on global wealth. He suggests that this tax would be 0 percent on wealth less than a million. The tax might rise to 5 to 10 percent per year on fortunes greater than a billion euro.

Piketty acknowledges that a global wealth tax might not produce a lot of revenue, but that is not it purpose. The objective is to eliminate large holdings of wealth. This claims that this would reduce inequality.

Wednesday, July 02, 2014

Picking Piketty Apart (4) Inequality

Part 3 of Capital is called Structures of Inequality. In this part, Piketty analyses the nature of inequality. He says that,

By definition, in all societies, income inequality is the result of adding up these two components: inequality of income from labour and inequality of income from capital. The more unequally distributed each of these two components is, the great the total inequality.

The third decisive fact is the relation between these two dimensions of inequality: to what extent do individuals with high income from labour also enjoy high income from capital.

The distribution of capital ownership (and income from capital) is always more concentrated than the distribution of income from labour.
To analyse inequality, he divides the population of society into three groups.
  • Lowest fifty percent
  • Middle forty percent
  • Top ten percent (top decile)
To understand what is happening in the top ten percent, he sometimes investigates the top one percent (percentile).

Piketty prefers this approach to analysing equality over other measures like Gini coefficients. His approach makes sense, because it describes inequality very graphically.

In the United States, the top decile owns 70 percent of the wealth. The bottom fifty percent owns only 5 percent, and there are five times as many of them. The middle forth percent owns only 25 percent of the wealth, and there are many of them too.

The big change in the twentieth century was the emergence of the middle class. In 1910, this group held very little wealth. Their share increased significantly during the century. This was achieved mainly through the ownership of residential housing and superannuation.

The other big change in last few decades is the emergence of the super salaries in the top decile.
The final and perhaps most important point is the increase in very high incomes and very high salaries of “supermanagers,” that is , top executives of large firms who have managed to obtain extremely high, historically unprecedented compensation packages for their labour.
This has made the top ten percent more dependent on labour income.

The last chapter of this part looks at inheritances.
We find a spectacular decrease in the flow of inheritances between 1910 and 1950 followed by a steady rebound thereafter, with an acceleration in the 1980s.

Tuesday, July 01, 2014

Picking Piketty Apart (3) Caital/Income Ratio

Part 2 of Capital by Thomas Piketty is called The Dynamics of the Capital/Income Ratio.

Piketty measures capital (a stock) in terms of national income (a flow).
In the early 19th century, capital was dominated by land. By 1910, land was unimportant and the capital of firms incredibly important. Public wealth is insignificant, because most assets balanced by debt.

In Europe, the Capital/Income Ratio was 700% from 1700 to 1910. It dropped to 3000% between 1915 and 1950. It has been rising slowly since then to reach 400%.

The United States was more stable. The Capital/Income Ratio was about 450% from 1870 to 1925. It dropped to 350% from 1930 to 1970 It has risen slowly since then to above 400%.

Piketty argues that Capital/Income Ratios will return to the level that prevailed in the 19th Century.

He then goes on to look at the split in income between labour and capital.
Capital’s share of income was on the order of 35-40% in both Britain and France in the late eighteenth century and through the nineteenth, before falling to 20-25 in the middle of the twentieth century and then rising again to 25-30% in the mid-twentieth and early twenty-first centuries.

Piketty is very thorough. He lists numerous factors that may modify the results he is predicting. He provides a clear explanation of most of these issues.
  • Land Value
  • Durable goods
  • Valuables
  • Foreign Assets
  • Tobins Q
  • Cobb Douglass production function
  • Foundations
  • Public wealth
  • Slaves
  • National accounts
  • Retained earnings
  • Mixed income
  • Sovereign Wealth Funds
  • Marginal Production

Monday, June 30, 2014

Picking Piketty Apart (2) Income and Capital

Capital in the Twenty-first Century has four parts. Part 1 is called income and Capital. It introduced the concepts of national income and the capital income ratio.

National income is defined as the sum of all income available to the residents of a given country in a given years, regardless of the legal classification of that income. Nation income is close related to the idea of GDP… GDP measures the total of goods and serviced produced in a given year within the borders of a given county. In order calculate nation income, one must first subtract from GDP the depreciation of the capital that made this production possible. When depreciate is subtracted from GDP, once obtains net domestic product. Then one must add net income received from abroad (43).
The capital income ratio is an important analytical for assessing the importance of capital.
Income is a flow. It corresponds to the quantity of goods produced and distributed in a given period, (which we generally take to be a year).

Capital is a stock. It corresponds to the total wealth owned at a given point in time. This stock comes from the wealth appropriated or accumulated in all prior years combined.

The natural and useful way to measure the capital stock in a particular country is to divide that stock by the annual flow of income. This gives the capital /income ratio (46).
The capital/income ratio in most developed countries today is about 6. This indicates that the capital stock is about six times the size of national income.

After defining, his terms, the remainder of part one describes how growth in production and output that have evolved since the industrial revolution.
The global distribution of income is more unequal than the distribution of output, because the countries with the highest per capita output are also more likely to own part of the caporal of other countries and therefore receiving a positive flow of income from them… Rich countries are doubly wealthy. They produce more at home, and invest more abroad, so their natural income per head is greater than their output per head. The opposite is true for poor countries (68).
He also notes the increase in per capita incomes.
Much of this spectacular growth occurred in the twentieth century. Globally, the average growth in per capita output of 0.8 percent per year over the period 1700-2012 breaks down as follows: growth of barely to 0.1% in the 18th century, 0.9% in the 19th century and 1.6 % in the 20th century., This equals the multiplication of output by a factor of roughly ten over three centuries (86).
Economic growth led to a transformation of consumption from mostly foodstuffs to manufactured goods and services.

The big transition was from poverty to relative wealth. For all of history, most people have lived at subsistence levels, with no hope of escape. During the 19th century, a new standard of living was achieved for almost everyone. See the hockey stick.