Back in January I posted about Thomas Piketty's new book Capitalism in the 21st Century here. I confessed to not having read the book, understandable since it hadn't appeared in English yet. But I still haven't read it, and now I don't plan on doing so. I have read many reviews, most of which have been negative. As an amateur economist I can read whatever I want to read, and I don't feel like reading Piketty's book.
Much of today's post is based on Kevin Hassett's very nice talk and accompanying slides, here.
My previous description of Piketty's work seems to be reasonably accurate, if simple-minded. Let me just briefly summarize. Piketty defines two quantities. r is the rate of return on capital, roughly equivalent to the interest rate or to the inverse of the price-earnings ratio. g is the global economic growth rate, usually expressed as a percentage of GDP. Piketty's claim is that if r is bigger than g (r > g), then an ever larger percentage of global income will accrue to capital. Contrary, if r < g, then the income will instead accrue disproportionately to labor.
Piketty, who has done an extensive study of historical economic data since the French revolution (for which he is universally credited), contends that r < g for much of the 20th Century, up until 1970 or so. Accordingly, this was the heyday of labor, with the rise of unions, the growth of the middle class, and indeed, the increase of all the good things we associate with capitalism. But in the 19th Century, and then again since 1970, r > g, which favors capital. As capital is mostly owned by rich people, the rich get richer and the poor get (relatively) poorer, leading to wider inequality. That, indeed, is what we have seen in selected wealthy countries.
Piketty goes on to claim that r will be greater than g for the indefinite future, and hence the outlook for capitalism is bleak.
The reviews I have read criticize this in three ways. First, they doubt that r will always be greater than g. If global growth declines (which seems likely), then the return on capital must per force decline with it, at least in the longer term. And even in the shorter term r can't remain high. As capital accumulates, then more capital is chasing ever fewer opportunities, leading to declining returns, i.e., smaller r. Indeed, we find evidence for this trend in current data--low interest rates and the record cash hordes accumulated by corporations indicate that there is a glut of capital. Unlike Piketty's claim that r is generally around 5%, today it's closer to 1%.
Apparently there is a loophole in this logic that Mr. Piketty could squeeze through. r can remain permanently greater than g if the elasticity of capital substitution is larger than one. Now I'm not professional enough to really tell you what that means, but roughly it says if capital can completely replace a worker, then capital will grow at the expense of wages. For example, a hamburger-flipping robot might completely replace a hamburger-flipping person. The elasticity of substitution is very high, though perhaps not greater than one. While the flipping person is redundant, the hamburger-flipping-robot-repairman is still on call. So even in this case the elasticity is likely less than one.
Mr. Hassett reports that 40% of capital is invested in buildings and real estate. This investment replaces no labor at all--the elasticity is zero. (We think Mr. Hassett is joking when he argues that buildings replace people holding umbrellas.) He suggests that the economy-wide elasticity is on the order of 0.4 or 0.5--far less than what Piketty's theory requires.
Then Piketty is dinged on factual grounds. While his study of inequality seems beyond reproach, he may not be looking at it the right way in doing comparisons. Within the US, for example, it is certainly true that income has gone disproportionately to the rich since 1970. We say that the Gini coefficient (a measure of inequality) has increased. But two other ways of looking at it give you a different result. First, mostly because of the dramatic rise in living standards in China, the global Gini coefficient has decreased, i.e., there has been a global trend toward greater equality. This contradicts Mr. Piketty's thesis.
Second, the appropriate measure of poverty is not necessarily gross income, but rather gross consumption. The poor are only poorer if they can't buy what they used to buy. But the Gini coefficient for consumption has remained remarkably constant in the US since 1970. Mr. Hassett explains that, though the rich received large investment returns, government transfer funds have increased in tandem. Measured by consumption, the poor are not poorer.
Finally, Mr. Piketty completely ignores human capital, i.e., any investment in education and skills. Many, such as the economist Gary Becker, believe that the majority of capital is, in fact, the human sort. Mr. Piketty apparently ignores it because it can't be bought or sold like a factory. You can't sell your education. Capital is only invested in stuff you can sell.
The counter argument is that lots of things are illiquid, and yet they're regarded as capital. In the 1990s the post office invested heavily in mail sorting machines, expecting a continued increase in first class mail. That, of course, didn't happen, and presumably those machines lost most of their value. Why should they be counted as capital, but education not? The only reason, so it seems to me, is to avoid a measurement problem, for no doubt the value of human capital is much harder to quantify. But it's still capital.
If you account for human capital, then a good deal of money accounted as wages is instead a return on capital. In that case a much larger fraction of the population will benefit from capital substitution--the phrase don't work harder, but work smarter will hold in spades. Piketty apparently admits as much, suggesting that about 50% of the population will benefit from the trend toward capital.
I find these counter arguments compelling. That, of course, is no reason not to read Mr. Piketty's book. But I find I'm just no longer interested.
Note: Blogging has been very light recently. Partly I am busy with my day job--it's nearing the end of the semester. And then I'm working on my new Jobs book. You can read a draft excerpt here.