Without better knowledge of the trends in secular income structure and of the factors that determine them, our understanding of the whole process of economic growth is limited; and any insight we may derive from observing changes in countrywide aggregates over time will be defective if these changes are not translated into movements of shares of the various income groups. – Simon Kuznets (“Economic Growth and Income Inequality,” The American Economic Review, Vol. 45, No. 1, March, 1955, p. 27).
The distribution of wealth and incomes had been ignored by mainstream economists, not regarded a material factor in the functioning of market economies, for decades before and after Kuznets published this statement. Now we are learning how prophetic it was. When Kuznets was working on distribution issues in the 1950s, at a time when income inequality was declining in the United States (and Europe), he complained vociferously about the lack of relevant data. Now the needed data is available, thanks in no small measure to the work of French economists Thomas Piketty and Emmanuel Saez, who compiled a comprehensive database of the incomes of many countries taken directly from income tax returns.
The database was first published in 2003, but public awareness of its significance did not materialize until after the Crash of 2008. Now, at last, Piketty has published a nearly 700-page book, Capital in the Twenty-First Century (Belknap, Harvard, 2014). The book instantly became a best-seller, and now the reactions are coming in. Having studied the inequality problem in the United States closely for nearly four years, and having now read the Piketty book effectively twice, I am prepared to offer a critical “digest” of it, from the perspective of those like myself primarily interested in the future of the U.S. economy.
It is important to get a sense of what Piketty intended to accomplish with this book, and of the degree of his success. In his introduction, he reveals the broad conceptual framework of his presentation: Data sources like income tax returns and estate tax returns provide information on the degree of inequality among income earners and among wealth holders. This information concerns “flows” of money. Other data sources reveal “the total stock of national wealth (including land, other real estate, and industrial and financial capital) over a very long period of time” (pp18-19); “We can measure this wealth for each country in terms of the number of years of national income required to amass it.” (p. 19) This “capital/income approach,” a ratio of a “stock” (net worth, wealth, or “capital”) to a “flow” (national income) Piketty argues, “can give us an overview of the importance of capital to the society as a whole.”
Initially, he “takes the inequality of income from labor and capital as given,” in order to focus (in Parts One and Two) on the “global division of national income between capital and labor” (p. 40). Thus, he isolates and defers for later discussion the topics of income and wealth concentration and distribution that have dominated the discussion in the United States. These include the rapid rise of U.S. income inequality since 1980, and the much greater degree to which wealth (and the income derived from wealth) is unequal than is the income from labor.
In a second post, I will present a detailed review of the growth model Piketty employs in connection with the global division of national income between capital and labor, i.e., the capital-labor split. This is a much more difficult topic, and most readers will find this new to the inequality debate; but it is based on decades-old growth models, one of which Piketty now offers as “The Second Fundamental Law of Capitalism.” The reliability of this model is crucial to the impression he conveys of the future stability of the U.S. economy.
In a third post, I will review Piketty’s impressions about the future of U.S. inequality, and suggest how inadequacies of his neoclassical framework support the need for the new “distributional macroeconomics.” I will argue in that regard that the mechanics of distribution and growth are dominated by: (1) The prevalence in U.S. society of unearned income (economic rent); (2) the principle Piketty refers to as “The law of Cumulated Growth” (p. 76); and (3) Keynes’ principle of effective demand, which I have referred to as “The Law of Effective Demand.” These are three complementary, and cumulative, aspects of what Piketty calls “divergence,” that is, progressive decline. As I have argued for several years, the problem is far worse, and far less “long-run,” than Piketty envisages, and now Piketty’s own analysis helps me clarify why.
This post is devoted to some general reflections on the impact Piketty’s work is having. What has been his effective contribution thus far?
Just getting attention focused on the inequality issues is a big deal, especially for Americans. A lot of people here haven’t been thinking about it, and because of Piketty’s book, hopefully, many more people will become aware that U.S. inequality is far worse than Europe’s. In these comparisons, he’s mostly talking about the income inequality that has developed since the 1970s, which is what we’ve been talking and thinking about in America for several years. It has been no secret that the U.S. has the highest income inequality among wealthy nations – the Piketty/Saez reports in 2011 showed this. But the comparative data in Piketty’s book shows how much worse the U.S. experience is than that of France, Great Britain, or Germany, and other more egalitarian wealthy nations:
In my view, there is absolutely no doubt that the increase in inequality in the United States contributed to the Nation’s financial instability. [I]t is important to note the considerable transfer of US national income – on the order of 15 points – from the poorest 90 percent to the richest 10 percent since 1980. * * *
[I]n the thirty years prior to the crisis, that is from 1977-2007, we find that the richest 10 percent appropriated three-quarters of the growth. The richest 1 percent alone absorbed nearly 60 percent of the total increase of the US national income in this period. Hence, for the bottom 90 percent, the rate of income growth was less than 0.5% per year. [fn] These figures are incontestable, and they are striking: Whatever one thinks about the fundamental legitimacy of income inequality, the numbers deserve close scrutiny. [fn] It is hard to imagine an economy and society that can continue functioning indefinitely with such extreme divergence between social groups. (p. 297)
Here, he’s clearly implying that either the United States will no longer politically tolerate this continuing deterioration, or it will continue to slide ever deeper into its depression. That the inequality growth is leading potentially to Great Depression II is an argument I have been making for several years. Piketty still couches the discussion in the context of “social” divergence with which he is most comfortable, but note his recognition of the undeniable fact, firmly established in reports from his colleague Emmanuel Saez, that the growth of income has been increasingly appropriated by wealthy people in income’s top 1% since 1980, to the point where now that group is receiving over 95% of all growth.
It is important that a mainstream, “neoclassical” economist, has at last come out and begun to discuss the truth about what these data mean. Although he overlooks factors that a Joseph Stiglitz or Robert Reich would emphasize, this is, importantly, the first time to my knowledge that a neoclassical economist has acknowledged that income inequality in the U.S. is a dire macroeconomic problem, not just a trivial matter like the difference between the pay of young adults who have college degrees and those who don’t, and not just a “political problem” as asserted by one of Piketty’s main cheerleaders, Paul Krugman. It was only two years ago that Krugman, in his latest book, characterized income inequality as a political problem, an impression he found supported by the views of Piketty and Saez:
Recently, Piketty and Saez have added a further argument: sharp cuts in taxes on high incomes, they suggest, have actually encouraged executives to push the envelope further, to engage in “rent-seeking” at the expense of the rest of the workforce. Why? Because the personal payoff to a higher pre-tax income has risen, making executives more willing to risk condemnation and/or hurt morale by pursuing personal gain. As Piketty and Saez note, there is a fairly close negative correlation between the top tax rates and the top 1 percent’s share of income, both over time and across countries.
What I take from all of this is that we should probably think of rising incomes at the top as reflecting the same political and social factors that promoted lax financial regulation.” (End this Depression Now! Norton, 2012, p. 82)
Krugman’s position was untenable: It not only implied that rising income inequality had no macroeconomic significance, but it misconceived human nature: Rising incomes at the top reflected declining federal income taxes, as he noted, and the U.S. Chamber of Commerce and other business groups had lobbied hard for the tax rate reductions that made higher after-tax incomes at the top possible. There is no reason to doubt that all or nearly all of the wealthiest Americans had zero qualms about keeping their income gains. Piketty, although he says he is striving for a softer, gentler economics more sensitive to the other social sciences, makes no contrary claim now. He clearly acknowledges that these gains were in fact at the expense of lower income groups; and that the income inequality in America, which has gradually grown since 1980, has now reached an intolerable level.
For many readers, no doubt, Piketty effectively introduces the crucial role of wealth concentration, and the division of income from wealth in the labor-capital split of income, into the inequality discussion. The role of growing wealth concentration has been mostly lacking from inequality discussions. Piketty’s main contribution, in my view, is the comparison he presents of wealth concentration among wealthy countries. He presents three tables at pp. 247-249:
Table 7.1: Inequality of Labor Income across time and space.
Table 7.2: Inequality of capital ownership across time and space.
Table 7.3 Inequality of total income (labor and capital) across time and space
In all three tables, he shows the percentage distribution among the “upper class,” the top 10% (broken down as well into the top 1% and the next 9%); the “middle class,” the next 40%; and the “lower class” (the bottom 50%):
1. For labor income, he characterizes as “low inequality” Scandinavia in the 1970s-1980s: The top 10% got 20% (the top 1% getting 5%) and the bottom 90% getting 80% of income. Medium inequality is Europe in 2010. High inequality is the U.S. in 2010, where: The top 10% got 35% (the top 1% getting 12%) and the bottom 90% getting only 65%. Very high inequality, he suggests, might be the U.S. in 2030? This is a speculative projection (his growth models do not permit projections of either growth or inequality): The top 10% gets 45% (the top 1% getting 17%), and the bottom 90% gets only 55%.
But note Piketty’s curious suggestion that it is possible for income inequality to continue to grow for another 15 years to such an extent, after he found it “hard to imagine an economy and society that can continue functioning indefinitely” at the high level of income inequality of the U.S. in 2010. I’ll return to this point in the third post in this series.
2. Low inequality in capital ownership, according to Piketty, exists only in an ideal society that has never been observed. The top 10% owns 30% of capital (with the top 1% owning 10%) and the bottom 90% owning 70% (only 25% for the bottom 50%). Medium inequality, again is perceived in Scandinavia in the 1970s and 1980s, High inequality is the U.S. in 2010, where the top 10% owns 70% of wealth (with the top 1% holding 35% of capital) and the bottom 90% owns 30% (with the bottom 50% owning only 5%). Very high inequality of wealth ownership he assigns to Europe in 1910, where the top 10% held 90% of wealth.
It is immediately apparent that wealth everywhere is far more concentrated than income. (The reason is that wealth is a stock, which accumulates from income). I’ll discuss in the third post Piketty’s prevalent perspective that “inheritable” wealth is the main problem, so that our concern evidently should be mainly with estate taxes. This overlooks the major accumulation of “new” wealth in the United States through excess earnings, a factor I had felt Piketty had overlooked altogether, until I got to p. 377:
In order to understand the cumulative logic (of wealth concentration) better, we must now take a closer look at the long-term evolution of the relative roles of inheritance and saving in capital formation. This is a crucial issue. * * * It may be that the global level of capital has remained the same but that its deep structure has changed dramatically, in the sense that capital was once largely inherited but is now accumulated over the course of a lifetime by savings from earned income.
To miss that point in connection with U.S. inequality growth, in my view, is to miss the essence of the U.S. inequality experience, and to sorely underestimate the danger the U.S. economy is in. Household wealth accumulates far more rapidly than just “in the course of a lifetime by savings from earned income”: e.g., Bill Gates (not atypically) had become a multi-billionaire while still a young man, and his wealth came from unearned income (corporate distributions), not the product of his own labor. Piketty, who has lived in France for years, appears to be out of touch with the American experience; but as will be discussed later in this series, the problem is more fundamental than that.
3. With respect to Table 7.3, “inequality of total income (labor and capital) across time and space,” Piketty’s categories are the same as for Table 7.1: Low inequality is Scandinavia (1970s-1980s), where the top 10% gets 25% (with 7% going to the top 1%) and the bottom 90% gets 70%. Medium inequality is Europe 2010, and high inequality is represented by the U.S. in 2010, as well as Europe in 1910, where the top 10% got 50% of total income (20% going to the top 1%) and the bottom 90% got 50%. Very high, is again speculatively presented as the U.S. in 2030, where the top 10% obtain 60% of total income, with 25% going to the top 1%.
This identifies the major impact in the U.S. since 1980 of the growth of income from wealth. My concern here is that Piketty has understated the intensity of income inequality growth in the U.S. in his projection for 2030, assuming we could get there at all. The top 1% share, according to the Piketty/Saez data, had already grown to over 22% before the Crash, in 2007, and has been growing again, robustly, since 2010. More on this later.
Support for Piketty’s Book
Regardless of any shortcomings in the theoretical prism used to focus on the U.S. data, and the consequent underestimation of the scope of the inequality problem here, the Piketty book provides a huge service to Americans by revealing the marked contrast between what is happening here and what is happening in most of the rest of the wealthy countries. Notably, this situation is alarming even from Piketty’s neoclassical perspective, and the main questions facing us are: How much worse can things get before the U.S. economy collapses? And how soon might that happen?
But the U.S. political situation is intransigent. Public opinion is mired in a “trickle-down” mentality, with the mainstream media persistently suggesting that the verdict is still out on whether “austerity” government, financed by still more tax breaks for the wealthy, can result in investment and income growth. The information in Piketty’s book constitutes a full refutation of the plainly erroneous trickle-down idea, which of course has been repeatedly disproved by all aggregate income data in the U.S. over the years. Senator Elizabeth Warren, who is proposing to alleviate the dangerous $1.3 trillion student debt bubble that is crippling our society with increased taxes on the wealthy, points to Piketty’s book in support, maintaining that American wealth has been relentlessly sucked to the top and has not trickled down. (See her joint appearance with Piketty in a conversation moderated by the Huffington Post’s Ryan Grimm on June 2, 2014 (here).
The noteworthy fact is that American public attention has been diverted from the incredible increase in concentration of wealth at at the top since 1980. The American public’s awareness of this entire issue is in sore need of a jolt, and it perhaps is getting that jolt from the publicity attending Piketty’s book. See, e.g., the A.P. account of April 23, 2014 (here).
The fact that inequality of income and wealth is growing in the United States at an alarmingly rapid pace has given rise to vapid denials from the political right; for example, the argument presented by Chris Giles (“Data Problems with Capital in the 21st Century,” Money Supply, May 23, 2014, here):
Two of [the book’s] central findings – that wealth has begun to rise over the past 30 years and that the U.S. obviously has a more unequal distribution of wealth than Europe – no longer seem to hold.
Without these results, it would be impossible to claim, as Piketty does in his conclusion, that “the central contradiction of capitalism” is the tendency for wealth to become more concentrated in the hands of the already rich.
Paul Krugman recently took Giles to task (here):
Giles finds a few clear errors, although they don’t seem to matter much; more important, he questions some of the assumptions and imputations Piketty uses to deal with gaps in the data and the way he switches sources. * * * Piketty will have to answer these questions in detail, and we’ll see how well he does it.
But is it possible that Piketty’s whole thesis of rising inequality is wrong? Giles argues that it is:
* * * [U]nlike what Piketty claims, wealth concentration among the richest people has been pretty stable for 50 years in both Europe and the US.
There is no obvious upward trend. The conclusions of Capital in the 21st century do not appear to be backed by the book’s own sources.
OK, that can’t be right — and the fact that Giles reaches that conclusion is a strong indicator that he himself is doing something wrong.
Krugman cites the CBO study on the distribution of income (Congressional Budget Office, Trends in the distribution of household income Between 1979 and 2007. October 26, 2011, here, p. 11) which provides Lorenz curves showing the concentration of business income over the years.
“It’ just not plausible,” he argues, “that this increase in the concentration of income from capital doesn’t reflect a more or less comparable increase in the concentration of capital itself.” Thus, Piketty’s fact-based presentation has led Krugman himself to emphasize the connection between income and wealth concentration, something to my knowledge he had not previously done.
Beyond that, there is simply an obvious, undeniable truism that wealth compounding is a natural process: If existing wealth is growing at all, it is growing for those who already possess wealth, and the more they already have, the greater their future natural accumulation will be. Wealth, therefore, is necessarily becoming more concentrated.
Attacks from the right are to be expected, as the self-interest perceived by wealthy people clearly requires opposing increases in their taxes. But this kind of reaction is a form of denialism similar to the attacks made by corporate interests on scientific evidence of climate change: Perceived self-interest easily trumps facts and logic.
Piketty has taken a rare stand, on behalf of mainstream, supply-side theory, for the conclusions that income and wealth inequality have major macroeconomic consequences, and that levels of income and wealth concentration must therefore be controlled. We have already heard Keynesian analysis from Stiglitz and Reich: The major contribution this book makes is to clarify that “mainstream” arguments denying the macroeconomic significance of inequality are unsupportable.
My perception is that there would be no winners in a major collapse into Great Depression II. Multi-billionaires may feel immune today, but their wealth and power will evaporate in a collapsing economy. Hopefully, Piketty’s book will significantly encourage the political right and all extremely wealthy people to realistically reappraise the policies of political denial, and reconsider the weakness of their perceived self-interest. That unfettered inequality growth ultimately entails deep depression, and likely the end of their success along with the end of overall human welfare and prosperity, is a prospect that presumably will concern them. The important question now is how long the current trend can last.
We cannot accept Piketty’s two “fundamental laws of capitalism” at face value. I will in the next two posts (after an approximately one-week delay) thoroughly review the underpinnings of the growth models Piketty has used, and discuss how they lead to unduly optimistic growth expectations.
JMH – 6/14/1014 (ed. 6/20)