Some Critical Views of Piketty’s Capital in the 21st Century

The reviews of Thomas Piketty’s Capital in the 21st Century are now coming out. For my followers who don’t follow such conversations concerning economics, the book’s most controversial claim is that when the rate of the return on capital(r) is greater than the rate of national growth(g), capital owners will receive income at a higher rate than a middle class worker. In the words of MIT professor Robert M. Solow, “modern capitalism is an unequal society, and the rich-get-richer dynamic strongly suggest that it will get more so”.

I first heard about the book from Don Boudreaux at Cafe Hayek when he commented on Piketty’s language. In short, Don writes,

Piketty’s writes, first, that Europeans and Americans of 200-odd years ago ‘claimed’ a share of global output.  Claimed?  The impression conveyed, if only subtly, is that global output is somehow out there and then Europeans and Americans managed by some means to lay their hands on a disproportionately large share of that existing output, leaving people in other parts of the world with a disproportionately smaller share of this output.

Why not write instead – as I am certain is more accurate – “… the lead that Europe and America achieved during the Industrial Revolution allowed these two regions to produce a share of global output that was two to three times greater than the the population-adjusted amount of output produced by people in the rest of the world” ?

Europeans and Americans back then didn’t become wealthier than people elsewhere by seizing some disproportionately large chunk of a pot’o’prosperity that existed independently of these Europeans’ and Americans’ own productive and innovative efforts.  Europeans and Americans created and produced the additional ‘disproportionate’ wealth that they then enjoyed.

This is an important point to make, considering that economics developed from the view that man is naturally social. In fact, the French economist Frederic Bastiat wrote in the preface to his Economic Harmonies that “I have proposed to put you on the road to this truth: All men’s impulses, when motivated by legitimate self-interest, fall into a harmonious social pattern. This is the central idea of this work, and its importance cannot be overemphasized”.

The second “review” I want to point out is from Greg Mankiw. He also shares skepticism of the book, but for different reasons:

The book has three main elements: 

  1. A history of inequality and wealth.
  2. A forecast of how things will evolve over the next century
  3. Policy recommendations, such as a global tax on wealth.

Point 1 is a significant contribution. I like this part of the book a lot. 
Point 2 is highly conjectural. Economists are really bad at such things. In particular, the leap from r>g to the conclusion of a growing role of inheritance in society seems too large to me. Many capital owners consume much of the return on their capital, so wealth does not grow at rate r. This consumption ranges from fancy cars and luxurious vacations to generous charitable giving. In addition, unless mating is perfectly assortative, or we return to an era of primogeniture, wealth per family shrinks as it is split among children.  So, from my perspective, Pikettty tries to draw way too much from r>g. . . .

In other words, Piketty assumes too much about capital owners’ future decisions. While Hunter Lewis’ review does a good job at pointing out the problem of data, Peter Klein points out a much larger error in Piketty’s work (scroll down):

Piketty understands “capital” as a homogeneous, liquid pool of funds, not a heterogeneous stock of capital assets. This is not merely a terminological issue, as those familiar with the debates on capital theory from the 1930s and 1940s are well aware. Piketty’s approach focuses on the quantity of capital and, more importantly, the rate of return on capital. But these concepts make little sense from the perspective of Austrian capital theory, which emphasizes the complexity, variety, and quality of the economy’s capital structure. There is no way to measure the quantity of capital, nor would such a number be meaningful. The value of heterogeneous capital goods depends on their place in an entrepreneur’s subjective production plan. Production is fraught with uncertainty. Entrepreneurs acquire, deploy, combine, and recombine capital goods in anticipation of profit, but there is no such thing as a “rate of return on invested capital.”

Profits are amounts, not rates. The old notion of capital as a pool of funds that generates a rate of return automatically, just by existing, is incomprehensible from the perspective of modern production theory. Robert Solow, in a glowing review of Piketty’s book, states: “The key thing about wealth in a capitalist economy is that it reproduces itself and usually earns a positive net return.” But this is nonsense from the point of view of microeconomics, entrepreneurship, uncertainty, innovation, strategy, etc.

Much of the excitement around Piketty’s work deals with his estimate of the long-term rate of return on capital, and how this compares to the long-term rate of economic growth. I hear from third parties that Piketty’s calculations (the early work was done with Emmanuel Saez) are thorough and careful, and I have no reason to doubt the empirical part of the book. But it seems like a pointless exercise to me — I don’t know what the underlying constructs even mean.

Of course, there are many other issues related to the interpretation of these data and what they mean for social mobility, fairness, etc. For example, there may be much more vertical movement than Piketty’s admirers admit — few people remain in one part of the income distribution all their lives. And most Americans are capitalists, with some of their financial wealth invested in equities through their retirement portfolios. So the link between (say) stock-market performance, rents on land and natural resources, and interest returns and the distribution of financial wealth among individuals is complicated.

Indeed. I might have $1,000 of capital for my semester’s classes, but $1,000 of pens cannot replace my Biology 100 textbook.



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