Thursday, January 16, 2014

Thomas Piketty & The Marxist Meme

The Marxist meme, for those of you new to this blog, claims that we're poor because the rich people stole all the money. It is an idea that slides easily into the mind, quickly learned but very hard to unlearn, despite making no economic sense. Economically uneducated people (such as my Trotskyist friends) are enchanted by it.

But even brilliant geniuses can fall victim to the meme, a case in point being the young, French economist, Thomas Piketty. His new book, Capitalism in the 21st Century, (h/t Tyler Cowen) will be released in English in March. Needless to say, I haven't read it yet. I may never read it--it's 900 pages long, albeit apparently very well written. I have read Milanovic's excellent review, here (pdf).

Piketty's model starts out with accounting identities. These are facts that are true by definition, such as in a balance sheet liabilities must always equal assets. It doesn't matter if the firm is a stock market star or nearing bankruptcy, if the balance sheet isn't balanced it's time to fire the accountant. There are macroeconomic identities as well. For example (oversimplifying), global expenditures must equal global incomes, since whatever I spend is necessarily somebody else's income.

So accounting identities can be manipulated mathematically while still remaining necessarily true, and this is what Mr. Piketty does. His first law is simply rewriting some known identities.

First among these is that income is allocated between capital and labor. Income from capital is known as return on capital, while income from labor is called wages. The total income is the sum of the return on capital and wages. So it could be, for example, that 30% of total income is awarded to capital, while 70% is awarded to wages. The fraction of total income that's awarded to capital is called alpha.

The second identity is a relationship between the average global return on capital (let's designate that by r), and the rate of growth of the global economy (let's call that g). Piketty shows that if r > g, then alpha must get bigger over time. That is, a larger and larger fraction of the global wealth will accrue to capital, with an ever smaller fraction going to wages.

Conversely, if r < g, then the reverse is true--wages will grow relative to capital.

In the former case, r > g, reasonably assuming that rich people own most of the capital, then more and more wealth will accrue to the 1%. The rich will get richer, and the poor, while perhaps not getting poorer, will certainly be getting richer a lot slower. In the latter case, r < g, the premium goes to wages, and so wealth is more evenly distributed across society.

So which is it? The relative values of r and g depend on empirical fact rather than accounting identities. And here Mr. Piketty apparently excels--he has collected extensive data from most of the capitalist world from before the French Revolution to the present. He has found that for most of the last 200-300 years that r > g. The exception has been the period from 1913 to 1970--during that time r < g. His conclusion is that r > g is the normal state of capitalism, while r < g was an aberration that will likely never be repeated.

Today global growth is in the 2-3% range, while the average return on capital is roughly 4-5%. Thus r > g, and accordingly an ever increasing fraction of wealth is accruing to the top 1%. This is certainly true in the US, evidenced by high unemployment, declining labor force participation, and stagnant wages. Piketty argues that global growth can't get much higher. It depends predominantly on two things: population growth (stagnant), and improvements in technology (yielding approximately 1.5%). Growth is as high as it is because of China, but as it becomes fully integrated into the capitalist system its growth rate will slow, taking global growth down with it.

The return on capital has averaged 4-5% over the past two centuries, and barring exceptional circumstances is unlikely to change significantly. So Mr. Piketty forecasts r > g for as far as the eye can see.

The exceptional period from 1913 to 1970 was due to the World Wars (echoing my Trotskyist friends). By destroying so much capital, the return on capital was greatly reduced (perhaps even negative in some years). Further, rebuilding Europe and Asia enabled very strong growth. So, with r < g, this was the heyday of labor, when workers could claim an ever larger share of the pie. Unfortunately, economists coming of age during that time thought that was normal, and that capitalism would inevitably lead to a richer and more equitable society. Mr. Piketty says that's wrong.

Piketty's view is very pessimistic, essentially condemning a large fraction of the population to relative poverty. He suggests that 50% of the population will generally benefit from the trend toward capital, but that the bottom 50% will be losers. This, at least, is better than the robber baron age when it really was only the top 1% who were able to capture the largest share of income.

Among Piketty's solutions is to reduce the rate of return on capital through higher taxes. He supports (in some cases) a return to the 90% tax bracket--not to raise revenue (it won't) but rather to lower r. Instead of a war, let's just destroy capital through taxes. This is where the Marxist meme comes through most obviously.

So I am reminded of three things. First, many years ago I saw a TV interview with some futurologist. In a thought experiment he imagined a world where robots did all the work, and people simply lived off interest on the capital. Everybody would be a member of the leisure class, and labor would collect no wage whatsoever. We'd all own our bit of a robot.

Second, I frequently buy my morning coffee at a convenience store that is part of a state-wide chain. They pay minimum wage and are always trying to recruit employees. One of the perks they offer is stock in the company. In light of Mr. Piketty's argument, the company's stock may, in fact, turn out to be much more valuable than the wage. It's always been important to save for retirement, but if Mr. Piketty is correct, then accumulating capital at an early age becomes even more crucial.

Finally, Mr. Piketty criticizes Gary Becker's theory of human capital, i.e., that the investment made in education, etc., is a form of capital. In Piketty's opinion this just muddies waters that don't need to be muddied, namely the distinction between labor and capital. (Or as my Trotskyist friends would put it, don't cross the class line.) Mr. Piketty likely disagrees with the thesis I've put forward elsewhere that we're all petty bourgeois now. But whether or not human capital is really capital, there is no doubt that people who conserve human capital will also be able to accumulate real capital.

Human nature being what it is, some government redistribution of wealth will always be necessary. But perhaps we should redistribute capital rather than income.

Note (April 25th, 2014): I have written a follow-up post on Piketty's book here.

Further Reading:

1 comment:

  1. About the fifty percent, Gabriel Palma looks at another fifty percent