Picking Piketty Apart — Part III: Time’s Running Out

The principles which have been set forth in the first part of this treatise, are, in certain respects, strongly distinguished from those on the consideration of which we are now about to enter. The laws and conditions of the Production of wealth partake of the character of physical truths. * * * The opinions, or the wishes, which may exist on these different matters, do not control the things themselves. * * * But howsoever we may succeed in making for ourselves more space within the limits set by the constitution of things, we know that there must be limits. We cannot alter the ultimate properties either of matter or mind, but can only employ those properties more or less successfully, to bring about the events in which we are interested. 

It is not so with the Distribution of Wealth. That is a matter of human institution solely. The things once there, mankind, individually or collectively, can do with them as they like. They can place them at the disposal of whomsoever they please, and on whatever terms. * * * Even what a person has produced by his individual toil, unaided by any one, he cannot keep, unless by the permission of society. Not only can society take it from him, but individuals could and would take it from him, if society only remained passive. * * * The distribution of wealth, therefore, depends on the laws and customs of society.  * * *

We have here to consider, not the causes, but the consequences, of the rules according to which wealth may be distributed. Those, at least, are as little arbitrary, and have as much the character of physical laws, as the laws of production. * * * Society can subject the distribution of wealth to whatever rules it thinks best: but what practical results will flow from the operation of those rules, must be discovered, like any other physical or mental truths, by observation and reasoning. – John Stuart Mill, Principles of Political Economy, Part II, first published 1848, Oxford U. Press, 1998, pp. 5-6.

This is an excerpt from Mill’s amazing introduction to his discussion of “distribution” and “poverty”, with which he divided Books I and II of his Principles of Political Economy. Book I related to his concepts of classical economics, and Book II related to the topic of primary concern to most of the classical philosopher/economists (including Adam Smith, T.R. Malthus, and Jean-Baptiste Say), namely, how a society can function in an optimal and reasonably egalitarian way. In 1848, there were only rudimentary and still largely untested theories explaining how the primarily agrarian economies of Europe and North America worked. Mill (1806-1873) is known for having provided a clear restatement of the deterministic principles of a recent predecessor in political economy, David Ricardo (1772-1823); The conceptual framework that Mill advanced consisted of “laws” and “physical truths” seen to control production. Political economics would soon have to face great change in economies, as industry developed and the ownership of land and the means of production consolidated in the hands of fewer and fewer owners. 

The Ricardian perspective, as it continued to develop through Alfred Marshall and into the 20th Century, was popular with “conservative” economists because it suggested that market economies are stable and will always return to full employment equilibrium after a crisis. Mill was the favorite of one such economist, J. Laurence Laughlin (1850-1933), who became the department-head of the new economics department of the University of Chicago from 1892-1916. In 1885, Laughlin published an abridged version of Mill’s “Principles of Political Economy” (see e-book at Project Gutenberg, here) which included notes, and a rare “history of political economy.” Mill’s polished-up Ricardian perspectives still dominate neoclassical thinking today, and their popularity at the University of Chicago paved the way for the “no holds barred” philosophy of Milton Friedman and the “Chicago School” of economics.

The quoted passage contains a rare insight which ranks, in my opinion, among the most important insights in economic history: Mill perceived the existence of “physical truths” controlling the process of the production of wealth that cannot be altered by anyone’s perception or understanding of them. The distribution of wealth, on the other hand, is determined by the laws and customs of society. And, most poignantly, once society has established its rules of distribution, the resulting consequencesare as little arbitrary, and have as much the character of physical laws, as the laws of production. This perspective seems remarkable for 1848, a time when economic science was just getting started, even for a philosopher of Mill’s caliber. It is an insight that has been largely missing from economic reckoning ever since. It boils down to this:

Our policy choices determine how wealth is distributed and, once established, these choices have inexorable consequences.  

This is the first of three important insights which have formed the basis of my own perspectives on economics, and the framework from which I perceive and interpret the nature of economic reality. The second is Simon Kuznets’ remarkable perception in 1955 (as quoted in the first post of this series) that:

[O]ur 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.    

In other words, we cannot hope to understand economic change on the basis of changes in “countrywide aggregates.” We must study the effects of changing distribution.

The third is a fundamental insight underlying John Maynard Keynes’ General Theory of Employment, Interest and Money (1935), namely, his understanding that classical and neoclassical theory was not dynamic at all, but founded on a description of an economy in “full employment equilibrium” to which deterministic properties were improperly assigned:

For there would obviously be a natural tendency towards the optimum employment of resources in a Society which was functioning after the manner of the classical postulates. It may well be that the classical theory represents the way in which we should like our Economy to behave. But to assume that it actually does so is to assume our difficulties away. (Ch. 3)

There are reasons why economies nearly always function sub-optimally, and Keynes identified some of the most important, primarily the “principle of aggregate demand.” To the extent we feel compelled to regard political economics as a search for what Mill envisioned as “physical laws,” I would start with “The Law of Aggregate Demand.”

I believe that the overall perspective, or model, these insights provide meets the test of “model-dependent realism” developed by Stephen Hawking and Leonard Mladinow, as discussed in my previous post in this series; It provides a “lens” through which our observations of economic facts and experience can provide a correct understanding of our shared reality. In broad strokes, the reality I have perceived is that capitalist market economies are unstable and tend naturally to decline (Keynes), that such decline is greatly and increasingly exacerbated by the growing wealth and income inequality that society’s choices have allowed in the U.S. economy (Mill), and that we have no hope of understanding these consequences and their mechanisms except through the study of the trends in distributional data (Kuznets).

It does not matter that none of these three great theorists never ultimately found a “unified field theory” of economics, or even that their own theories about how economies work were, at best, only partially correct. After all, they did not have the data Kuznets understood that we needed. What does matter is that consistently applying a distributional perspective to the analysis of facts and theories opens the door to a much deeper, and considerably different, understanding of reality than had previously been possible.   

The Slow Pace of Learning

Convinced that distributional data was extremely important, the French economists Thomas Piketty and Emanuel Saez devoted years to accumulating the long history of income tax returns of the major developed countries of the world, and in doing so, they changed the course of economic history. It is, however, a very slowly developing change. They first published their database in 2003, and when their findings came out in 2011, a perplexed economics profession did not know what to make of them. Their data demonstrated that income inequality grows in lockstep with a decline in the progressiveness of taxation; indeed, they identified the progressiveness of taxation as the degree to which it inhibits inequality growth. And others have documented the extreme effect of the growth of income inequality on aggregate income growth. But no one, including themselves, grasped the full import of their data.

The economics profession gradually began to address the questions presented by the increasingly unequal distribution of income and wealth, but progress was slow, for these were issues that mainstream economics had ignored ever since John Stuart Mill addressed them philosophically and his contemporary, Karl Marx, began to address them theoretically.

It took a decade for either Piketty or Saez to weigh in substantively with anything more than a very good study of the income elasticity of top income tax rates. Piketty’s publication in 2014 of Capital in the 21st Century, though, has mostly contributed to the existing high level of confusion about inequality issues. The attention his book is getting in the United States is almost entirely limited to his subjective evaluation of the obviously advanced deterioration of the U.S. economy, which among wealthy nations is by far the most inequality-afflicted economy in the world.

The plight of the U.S. economy virtually guaranteed a high level of attention in the United States to any book Piketty published. It is remarkable, then, that Piketty published a book in which substantive discussion of inequality was preceded by a nearly 300-page anecdotal and theoretical presentation supporting a production function-based growth model which, as demonstrated by the comprehensive technical review of his two “fundamental laws” presented in my previous post, is seriously flawed. As quoted in the last post, Piketty conceded that the record of the accumulation of a country’s productive capital is fundamentally unrelated to the distribution of its wealth and income among its citizens; this is a corollary of the point Mill made nearly 170 years ago. Why, then, did Piketty publish this book? That even Thomas Piketty himself has been unable to arrive at a better understanding of inequality speaks volumes about the threadbare inadequacy of the neoclassical framework in which he was trained.

History Repeats Itself

John Stuart Mill, despite the attraction of his deterministic model to “conservative” economists, was an avid socialist, as was Adam Smith before him. (See my extensive review of Smith’s views in “The Cult of the Invisible Hand,” December 22, 2013, here.) The flavor of Mill’s deep concern for the general welfare was revealed in his Chapters on Socialism, first published posthumously in 1879:

Since the human race has no means of enjoyable existence, or of existence at all, but what it derives from its own labour and abstinence, there would be no ground for complaint against society if everyone who was willing to undergo a fair share of this labour and abstinence could attain a fair share of the fruits. But is this the fact? Is it not the reverse of the fact? The reward, instead of being proportioned to the labour and abstinence of the individual, is almost in an inverse ratio to it: those who receive the least, labour and abstain the most. * * * The very idea of distributive justice, or of any proportionality between success and merit, or between success and exertion, is in the present state of society so manifestly chimerical as to be relegated to the regions of romance.  (Oxford University Press, 1998, p. 382.)

Piketty, for obvious reasons, is less forthright about his views on economic justice. In his concluding remarks, he encourages us to loosen up on political perspectives on wages and wealth:

The clash of communism and capitalism sterilized rather than stimulated research on capital and inequality by historians, economists, and even philosophers. It is long since time to move beyond these old controversies and the historical research they engendered, which to my mind still bears their stamp. (Capital in the Twenty-First Century, p. 5 76)

Amen. As a Frenchman, Piketty does not shy away from discussing Karl Marx, whose theories on capital accumulation, he says, paved the way for his own. Amongst the knowledgeable, Marx is routinely acknowledged as one of the best and most prescient theorists in economic history. Marx believed, as Piketty observes, that a top-heavy capitalist system would ultimately collapse of its own over-concentrated weight. That possibility, unfortunately, still exists.

In the last paragraph of his book, however, Piketty merely hints at the lopsided balance of intellectual power attending inequality:

[I]t seems to me that all social scientists, all journalists and commentators, all activists in the unions and in politics of whatever stripe, and especially all citizens should take a serious interest in money, its measurement, the facts surrounding it, and its history. Those who have a lot of it never fail to defend their interests. Refusing to deal with numbers rarely serves the interests of the least well off. (Id. at 577 )

Yes, indeed: But a Wall Street Journal article has successfully downplayed Piketty’s contribution in this respect. (“Thomas Piketty, a Not-So-Radical French Thinker,” by Pascal-Emmanuel Gobry, May 22, 2014, here.) The headnote says Piketty “may be causing a stir in the U.S., but his views are ho-hum in his own country.” According to Gobry, Piketty argues that “capitalism creates a vicious cycle of inequality,” whenever “the rate of return on assets is higher, over the long run, than the rate of overall economic growth,” and asserts the need (quoting Paul Krugman) “to restrain the growing power of inherited wealth.” Gobry’s ultimate point, of course, is that inequality is no big deal.

My counterpoint is that inequality is a very big deal, but the evidence for that is in the second part of Piketty’s book, not the first. Despite his strong stance regarding inequality in the United States, Piketty has led with his chin. In that regard, my overall concern is that Piketty himself has not properly framed the inequality issue. By wrongly lumping together the issues of “capital and inequality,” Piketty has perpetuated a much brighter image of our future than we should be expecting. NYU economist Debraj Ray supports this conclusion: 

It is unclear that the story of rising inequality in the US is one of physical (or financial) capital coming to dominate. Rather, inequality in the United States appears to be propelled by incredibly high returns to human capital at the top of the wage spectrum. This points to a very different set of drivers, and also shows that the physical capital story is not pervasive. (“Nit-Piketty: A comment on Thomas Piketty’s Capital in the Twenty First Century,” by Debraj  Ray, May 23, 2014, here

Others have reportedly begun to raise concerns about Piketty’s theory similar to mine, regarding the concepts of “capital” and “wealth” (See, Ed Conard, Unintended Consequences, May 30, 2014, here). The most important point, in my mind, is the relatively innocuous nature of the trend in capital accumulation, compared with the concentration of wealth itself. Conard provided this chart of 200 years of changes in top 1% wealth and top 10% wealth in the United States. Piketty’s numbers appear fairly similar to Edward Wolff’s for the last decade or so, and this chart reflects the increasing concentration of top 1% wealth since 2000 that Wolff has reported.

US-WEALTH-INEQUALITY-piketty 1810-2010

The significance of this long run series to Piketty was that it was supposed to represent a long-run equilibrium condition of the stock of productive capital. That flawed idea, apparently, is beginning to collapse in the public debate. 

As I have explained, my “heterodox” (non-mainstream) perspective on wealth concentration in the U.S. arises from direct analysis of distributed wealth, and its relationship with distributed income: A smattering of attention has been paid to the concentration of wealth in the United States over the last few years, but not nearly as much as has been paid to income inequality. As soon as I began working on American inequality I began to investigate wealth inequality, presenting my initial findings in two posts: “Growth in Inequality of Wealth: 1979-2007,” 4/11/2011, here), and “Growth of Inequality of Wealth: After 2007,” 4/13/2011, here).

Initially, I found that the top 1% of U.S. wealth holders had improved their reported net worth by about $8.8 trillion between 1979 and 2007. That figure, however, was first reported in nominal dollars and, as I began reporting in 2013, the top 1%’s reported net worth had improved by nearly twice that much, in current (2010) dollars, and with the addition of post-2007 wealth accumulated by the top 1% and estimates of its unreported wealth accumulating in “offshore” (overseas) accounts, the total top 1% increase in net worth through 2012 (1979-2012) can reasonably be estimated at $22-25 trillion. (See, e.g., “Finding a New Macroeconomics: (10) Reinhart, Rogoff, and Redistribution,” 6/30/2013, here, and “Inequality and the National Debt,” 4/9/2014, here.) Here is the graph I prepared a year ago comparing the growth of top 1% wealth in the United States, using Edward Wolff’s wealth concentration data, with the U.S. national debt and the GDP, all in 2010 dollars:

my graph 1952-1982 cThis shows clearly the extent of the inequality problem in the United States. Top 1% wealth has been concentrating rapidly since 1980, as a result of society’s choices which allowed wealthy people to make more money (market deregulation) and which allowed them to keep increasingly greater shares of their improved incomes (via tax reductions), as demonstrated by the Piketty/Saez income distribution data. The result — accumulating wealth at the top funded by federal borrowing needed to replace the revenues lost by the tax cuts — has been breathtaking.

Wealth concentration at the top has exceeded the growing national debt by an amount I have estimated in the $5-8 trillion range. That is money sucked up from the bottom 99%. And as lower 99% incomes decline, their tax contributions to the federal government also decline substantially and the deficit increases accelerate, requiring greater interest payments to the wealthy people who hold federal debt. Currently, interest on the debt is the fastest rising category of federal debt, projected by the CBO to exceed the entire defense budget by the end of this decade.

Lessons Learned

Conservatives will seek to have the invalidaton of Piketty’s growth model serve to persuade us to dismiss outright his concerns about growing wealth concentration. But that would be an incredibly bad mistake. We must learn from his conceptual mistakes. We must remember his acknowledgement that the neoclassical approach to understanding growth does not explain changes in income and wealth distribution:

[A]part from the question of short-term volatility, such balanced growth does not guarantee a harmonious distribution of wealth and in no way implies the disappearance or even reduction of inequality in the ownership of capital. (p. 232)

He has also identified two fundamental realities that we will need to incorporate into a distributional macroeconomics: “The law of cumulative growth” and the related “law of cumulative returns” (Capital in the 21st Century, pp. 74-75). These laws go a long way toward establishing the reasons for astronomically growing wealth inequality in the United States. Interest bearing obligations, such as federal bonds, increase wealth exponentially if held for extended periods. Properly depreciated factories and machines, however, do not. In other words, inequality growth is in large measure a financial problem; and it is a problem related to the ownership, but not the concentration, of capital stock.

We need to acknowledge right now that the inequality problem is much worse than envisioned by Piketty. In the long run, he envisions a U.S. economy with a reasonably stable aggregate production function through 2030. However, the long-run prospects for U.S. economic recovery are extremely bleak, even if the capital-to-labor ratio in the production function falls (perhaps especially if it does.) Top 1% wealth is increasing by about $300-400 billion per year. Saez and Piketty have both confirmed that at least 95% of all income growth now accrues to the top 1%. The question now is whether the U.S. economy can even make it to 2020 without a complete collapse into Great Depression II.

We know from direct observation what is happening in the United States: Every day we are confronted with news reports of falling prosperity, increasing poverty, record numbers of unemployed and of homeless children, declining wages and stagnant employment, declining food quality and health care, a rapidly growing student debt problem, and the bankruptcy of cities like Detroit, which is exercising widespread foreclosures and shutting down residential water service to a great many homes for nonpayment of bills. It is obviously a problem of insufficient money in the economy of the bottom 99%; a problem of money being steadily sucked up to the top 0.1% and 0.01%. And even the most rudimentary statistical tests, as recently found (to their apparent surprise) by IMF economists, show that growing inequality is the most important factor determining growth. (See my essay, “Two Sides of the Same Coin,” March 28, 2014, here.)

And we know what has to be done: Increase the minimum wage, increase the progressiveness of taxation across the board. Tax wealth, but without waiting for the inheritance cycle to gradually reduce estates. And re-regulate businesses to cut back on the vice-like grip monopolistic market power has established across most consumer and producer markets.

As it happens, Paul Krugman’s Op-ed in today’s New York Times, “Charlatans, Cranks, and Kansas” (June 30, 2014, here ) highlights the crux of our problem.  Krugman reports that two years ago Kansas enacted the largest percentage tax cut in one year that any state has ever enacted:”Look out, Texas,” proclaimed Governor Brownback, predicting that  the cuts would jump-start an economic boom. Instead, Kansas has plunged deep into debt, and its debt has been downgraded. Krugman asks:

Why, after all, should anyone believe at this late date in supply-side economics, which claims that tax cuts boost the economy so much that they largely if not entirely pay for themselves?

The Kansas tax cut, Krugman observes, closely follows the blueprint of the American Legislative Exchange Counsel (ALEC), a right-wing group that supports the interests of the wealthy:

And I do mean for the wealthy. While ALEC supports big income-tax cuts, it calls for increases in the sales tax — which fall most heavily on lower-income households — and reductions in tax-based support for working households. So its agenda involves cutting taxes at the top while actually increasing taxes at the bottom, as well as cutting social services.

But how can you justify enriching the already wealthy while making life harder for those struggling to get by? The answer is, you need an economic theory claiming that such a policy is the key to prosperity for all. So supply-side economics fills a need backed by lots of money, and the fact that it keeps failing doesn’t matter.

The time has come to recognize that all of neoclassical theory, the theory that still dominates academic economics today, is essentially a supply-side construction. It is, moreover, a retrograde version of the original classical economics. Smith and Ricardo, for example, agonized over the definitions of economic rent — money collected without providing anything of value in return — an important concept ignored by mainstream economics today. We need a renewed focus on the long-suppressed doctrines of Henry George (Progress and Poverty, 1879) and on taxing economic rent.

Now that we understand the irrelevance of the production function to aggregate growth, we’ll need to banish production functions from macroeconomics, just as Keynes attempted to banish Say’s Law (the notion that supply creates its own demand) in the 1930s. 

“For my own part, I believe that there is social and psychological justification for significant inequalities of incomes and wealth, but not for such large disparities as exist today,” wrote Keynes in the last chapter of his General Theory:

But it is not necessary . . . that the game should be played for such high stakes as at present. Much lower stakes will serve the purpose equally well, as soon as the players are accustomed to them.

I wonder if that was ever true and, if so, whether it is still true today in the United States: The top billionaires here, and everywhere else, seem to have no endgame in mind. 

We find ourselves in essentially the state of economic theory development that faced John Stuart Mill in 1848. If we are ever going to improve our understanding, we had better get started now, and move a whole lot more quickly.

Time is running out.

JMH – 6/30/2014 (ed. 7/1/2014)




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