Weekend Reading: Nate Silver Interview
Talk: Preliminary Notes on Fiscal Policy in a Depressed Interest-Rate Environment: The Honest Broker for the Week of March 15, 2014

Weekend Reading: Piketty’s Triumph

Piketty’s Triumph: Three expert takes on Capital in the Twenty-First Century, French economist Thomas Piketty's data-driven magnum opus on inequality....

Jacob S. Hacker and Paul Pierson: "A Tocqueville for Today: "When Alexis de Tocqueville visited America in the early 1830s, the aspect of the new republic that most stimulated him was its remarkable social equality.

“America, then, exhibits in her social state an extraordinary phenomenon,” Tocqueville marveled. “Men are there seen on a greater equality in point of fortune and intellect … than in any other country of the world, or in any age of which history has preserved the remembrance.”

To Tocqueville, who largely ignored the grim exception of the South, America’s progress toward greater equality was inevitable, the expansion of its democratic spirit unstoppable. Europe, he believed, would soon follow America’s lead. He was right—sort of. Democracy was on the rise, but so too was inequality. Only with the 20th century’s Great Depression, two terrible wars, and the creation of the modern welfare state did concentrations of economic advantage in rich democracies start to dissipate and the fruits of rapid growth begin to accrue generously to ordinary workers.

Now another Frenchman with a panoramic vista—and far more precise evidence—wants us to think anew about the progress of equality and democracy. Though an heir to Tocqueville’s tradition of analytic history, Thomas Piketty has a message that could not be more different: Unless we act, inequality will grow much worse, eventually making a mockery of our democratic institutions. With wealth more and more concentrated, countries racing to cut taxes on capital, and inheritance coming to rival entrepreneurship as a source of riches, a new patrimonial elite may prove as inevitable as Tocqueville once believed democratic equality was.

This forecast is based not on speculation but on facts assembled through prodigious research. Piketty’s startling numbers show that the share of national income coming from capital—once comfortingly believed to be stable—is on the rise. Private wealth has reached new highs relative to national income and is approaching levels of concentration not seen since before 1929.

Piketty’s powerful intellectual move is to place the subject of American income inequality in a broader historical and cross-national context. The forces most responsible for our egalitarian past, Piketty reminds us, were rapid growth—both of the population and of the economy overall. France never had the former, which is why it had a true “rentier” class of propertied aristocrats in the early 20th century when the United States was still a land of small-scale owners and the newly rich. Yet economic growth remains the biggest factor: When the economy expands modestly from year to year, returns on capital generally exceed the advance of labor income, and fortunes of the already rich grow while the rest of society falls behind.

Since the resurgence of income inequality, concerned observers have comforted themselves with the notion that holdings of wealth—while far more unequally distributed than income—are not amassing at the top as quickly as incomes are. If we look forward, however, that reassuring notion appears suspect. Some of the great fortunes made in the new gilded age will fund philanthropy or frivolity. Most, however, will be funneled back into capital investment or passed on to heirs. Piketty notes that the returns of such investments are invariably largest for those with the greatest wealth—the Matthew effect is another force for increasing concentration. Meanwhile, inheritances are returning as a major source of advantage for the already advantaged. As rising income inequality passes down through a narrowing demographic pyramid, we can expect wealth bequests to become an increasingly important source of inherited privilege.

Inequality is becoming a “wicked” problem like climate change—one in which a solution must not only overcome powerful entrenched interests in individual countries but must be global in scope to be effective. Piketty is rightly pessimistic about an immediate response. The influence of the wealthy on democratic politics and on how we think about merit and reward presents formidable obstacles. Fierce international competition for the rich and their dollars leads Piketty to believe that without a serious countermovement, capital taxation will trend toward zero. Inequality is becoming a “wicked” problem like climate change—one in which a solution must not only overcome powerful entrenched interests in individual countries but must be global in scope to be effective.

Nonetheless, it is capital taxation, and ultimately global capital taxation, that Piketty sees as the eventual solution. Taxing only consumption and labor income violates the notion that citizens should finance the commonwealth on the basis of their ability to pay. A global capital tax—modest, progressive, based on transparency—could reinforce the fraying link between economic standing and individual contributions toward vital collective activities. Moreover, halting progress in this direction has already taken place, as rich countries seek—without great success so far—to crack down on the tax havens and corporate financial engineering that increasingly make taxes voluntary for the superrich. Because wealth is still so concentrated in advanced industrial nations, agreements that covered citizens of and transactions within Europe and North America would go a long way toward bringing these activities into the open. A modest tax on the largest fortunes might also encourage more productive uses of capital, gradually taxing away big estates with small returns.

Piketty suggests that the pressures for change will eventually prove overwhelming. Either ever-richer capitalists will tear one another apart in the race for diminishing returns, or the rest of society will rise up and impose a fairer framework. For a book that insists on the primacy of politics, however, Piketty has relatively little to say about how—with organized labor weakened, moneyed interests strengthened, and anti-government forces emboldened—the kind of political movement necessary for a fairer future will emerge. (It was war, after all, not universal suffrage, that ultimately tamed inequality in the 20th century.) Yet perhaps with this magisterial book, the troubling realities Piketty unearths will become more visible and the rationalizations of the privileged that sustain them less dominant. Like Tocqueville, Piketty has given us a new image of ourselves. This time, it’s one we should resist, not welcome.

Heather Boushey: "Against U.S. Economic Clichés: "Capital in the Twenty-First Century is written in the tradition of great economic texts.

Where John Maynard Keynes wrote The General Theory of Employment, Interest and Money in reaction to the “classical economists” and Karl Marx wrote Das Kapital in reaction to the “bourgeois economists,” Thomas Piketty writes in reaction to the “U.S. economists.” Like his predecessors, he does not mince words. After taking a professorship at MIT at 22, he moved back to Paris at 25, in 1995, because “I did not find the work of U.S. economists very convincing.” Piketty’s method is an explicit critique of academics “too often preoccupied with petty mathematical problems of interest only to themselves.” While mathematical tools are critical to the modern economics profession, Piketty is right to call on all social scientists, including economists, to “start with fundamental questions and try to answer them.”

Piketty asks two fundamental questions in his new book: “What do we really know about how wealth and income have evolved since the eighteenth century, what lessons can we derive from that knowledge for the century now under way?” Piketty and his colleagues have spent recent years putting together a World Top Incomes Database, their detailed investigation into income in countries around the globe, spanning several decades. In some cases—France and the United Kingdom—he also relies on facts about the accumulation of wealth going back centuries. As he puts it, “It is by patiently establishing facts and patterns and then comparing different countries that we can hope to identify the mechanisms at work and gain a clearer idea of the future.”

Informed by this historical, cross-country data, Piketty evaluates—and rejects—a number of generally accepted conclusions in economic thought, while being careful to note the limitations of inevitably “imperfect and incomplete” sources. The main finding of his investigation is that capital still matters. The data show a recent resurgence in developed countries of the importance of capital income relative to national income, back to levels last seen before World War I. In Piketty’s analysis, without rapid economic growth—which he argues is highly unlikely now that population growth is slowing—returns from investment will continue to grow faster than output. Inheritances and income inequality will keep rising, possibly to levels higher than ever seen.

Among other conclusions, the data lead Piketty to describe the popular argument that we live in an era where our talents and capabilities matter most as “mindless optimism.” The data also lead him to reject the idea that wage inequality has grown as technological change increased the demand for higher-skilled, college-educated workers.

Piketty agrees that in the long run, investments in education are an important component of any plan to reduce labor-market inequalities and improve productivity.

Instead, Piketty’s evidence suggests it is the rise of what he calls the “supermanager” among the top 1 percent since 1980 that is driving the rise in earnings inequality. It is here that Piketty takes his sharpest swipe at economists. In his discussion of the thriving top decile, he points out that “among the members of these upper income groups are U.S. academic economists, many of whom believe that the economy of the United States is working fairly well and, in particular, that it rewards talent and merit accurately and precisely. This is a very comprehensible human reaction.” Piketty agrees that in the long run, investments in education are an important component of any plan to reduce labor-market inequalities and improve productivity. But on their own they’re not sufficient.

This book is significant for its findings, as well as for how Piketty arrives at them. It’s easy—and fun—to argue about ideas. It is much more difficult to argue about facts. Facts are what Piketty gives us, while pressing the reader to engage in the journey of sorting through their implications.

Branko Milanovic: "Must We Return to “Pre-tamed” Capitalism?: "Thomas Piketty’s Capital in the Twenty-First Century is a monumental book that will influence economic analysis (and perhaps policymaking) in the years to come.

In the way it is written and the importance of the questions it asks, it is a book the classic authors of economics could have written if they lived today and had access to the vast empirical material Piketty and his colleagues collected.

Piketty’s key message is both simple and, once understood, almost self-evident. Under capitalism, if the rate of return on private wealth (defined to include physical and financial capital, land, and housing) exceeds the rate of growth of the economy, the share of capital income in the net product will increase. If most of that increase in capital income is reinvested, the capital-to-income ratio will rise. This will further increase the share of capital income in the net output. The percentage of people who do not need to work in order to earn their living (the rentiers) will go up. The distribution of personal income will become even more unequal.

The story elegantly combines theories of growth, functional distribution of income (between capital and labor), and income inequality between individuals. It aims to provide nothing less than the description of a capitalist economy.

Through the action of wars and social movements, capitalism appeared to most social scientists to have been “tamed.” Piketty argues that this view turns out to have been wrong.

Two questions can be asked: Why didn’t this model hold during the period of “the golden age” of capitalism (between approximately 1945 and 1975), when functional income distribution was stable and income inequality declined? Why does it matter for the 21st century? The answer to the first question is that the “short 20th century” was special. The physical destruction associated with two world wars led to a significant destruction of the advanced world’s capital stock. In addition, the advent of the welfare state, motivated by the Great Depression and strong socialist movements, imposed a need to heavily tax capital. The 20th century was thus different from the 19th. Through the action of wars and social movements, capitalism appeared to most social scientists to have been “tamed.” Piketty argues that this view turns out to have been wrong. The fundamental nature of capitalism was not altered—the external circumstances were different.

Why does Piketty’s model herald the return of “patrimonial capitalism” (the term he introduces to mean that an important part of the upper class receives income from property) in the 21st century? The reasons are the reverse of the ones that drove developments during the short 20th century. The period of prosperity after the end of World War II saw the rebuilding of large fortunes (owned, of course, by different people today); the capital-to-output ratio in advanced countries gradually rose back to the higher levels of prewar years. The Reagan-Thatcher revolutions of the 1980s reduced the taxation of capital, and of high incomes in general, and further increased the share of capital in net output. If this process continues, the return to features of 19th--century capitalism is inevitable.

The return is all the more likely since the rate of growth—at the technological frontier where most rich countries operate today, that rate is equal to the sum of “pure” technological progress and population growth—is decreasing. Once the convergence of Europe and Asia to U.S.-like levels of income is achieved, the rate of growth cannot exceed more than, say, 2.5 percent per annum (a combination of about 1.5 percent in technological progress and 1 percent in population growth). Piketty writes: “Decreased growth—especially demographic growth—is thus responsible for capital’s comeback.” If the rate of return on private wealth is higher than 2.5 percent, then the 19th-century-like effects of “pre-tamed” capitalism will reappear.

Or will they? There are significant differences between the 19th century and ours that Piketty does not fully acknowledge, although he mentions them. First, it is not obvious that the rate of return on private wealth will remain high enough to sustain Piketty’s prediction. Even if we look at the admittedly transitory situation of today, the rate of return is stuck barely above zero percent, less than the rate of growth of the rich world’s economies. The tendency toward a decreasing rate of return, possibly lower than the rate of growth, cannot be ruled out.

Second, the role of labor incomes has changed since the 19th century. As Piketty acknowledges (he writes about it in both this and earlier works), extraordinarily high labor incomes play a larger role in society today than in the past, even if they concern mostly the richest 1 percent through 5 percent of income recipients—not the top 0.1 percent, where “capital is still king.” A dose of “meritocracy” has been introduced into the distribution. The overlap between being rich and owning capital so evident in the 19th century will be less prominent in the 21st.

Third—the convergence of China, and even more that of India, and even more that of Africa—may take a century or longer to complete. As long as the convergence is still ongoing, global growth will be higher than the steady-state rate of 2.5 percent due to the faster growth rate of “infra technological frontier” countries such as China, India, Nigeria, and Indonesia. This is an aspect of the problem that Piketty neglects. The former Third World might end up playing the same role in the 21st century that Europe, Japan, South Korea, and others played in the past 50 years—maintaining upward global growth as they were catching up with the United States.

So these are possible problems with Piketty’s analysis. But if we take it at its face value, what are the remedies he suggests? A global tax on capital—needed to curb the tendency of advanced capitalism to generate a skewed distribution of income in favor of property holders. The high taxation of capital, and of inheritance in particular, is not something new, as Piketty amply demonstrates. It is technically feasible since information on the ownership of most assets, from housing to stock shares, is available. (Piketty, by the way, provides lots of specific information on how the tax could be implemented.  He also gives some notional rates: no tax on capital below almost 1.4 million dollars, 1 percent on capital between 1.4 million and 6.8 million dollars, and 2 percent on capital above 6.8 million dollars.) For such a global tax to be effective, however, a huge amount of coordination would be required among the leading countries—a task to whose challenges Piketty is not oblivious. Implementation by one or two countries, even the most important economies, could lead to capital flight. The main offshore tax havens would also have to cooperate, although they would lose hugely lucrative business. But an agreement across the Organisation for Economic Co-operation and Development on the uniform taxation of wealth, however farfetched it might seem today, should be put on the table. This is, in Piketty’s view, the only way to “regulate capitalism” and make both capitalism and democracy sustainable in the long run.

In a short review, it is impossible to do even partial justice to the wealth of information, data, analysis, and discussion contained in this book of almost 700 pages. Piketty has returned economics to the classical roots where it seeks to understand  the “laws of motion” of capitalism. He has re-emphasized the distinction between “unearned” and “earned” income that had been tucked away for so long under misleading terminologies of “human capital,” “economic agents,” and “factors of production.” Labor and capital—those who have to work for a living and those who live from property—people in flesh—are squarely back in economics via this great book.