Don Boudreaux on Thomas Piketty and Theory-Making in Economics

Over at EconLog:

Mysteriously, Piketty never asks the obvious question: Why do shareholders continue to invest in corporations that so wastefully spend their funds? Here’s an even deeper mystery: If current patterns of executive compensation serve no purpose other than to enrich unproductive corporate oligarchs, what explains the high and rising market value of the capital that Piketty believes to be the main driver of increasing wealth inequality? How can it be that the value of capital invested in corporations continues to grow if boards of directors are consistently inattentive to the productivity of their management teams? Piketty does not ask these questions because, for him, wealth perpetuates itself. Wealth grows automatically, for the most part independently of human creativity, risk-taking, effort, and entrepreneurial gumption. [ . . . ]

There’s no doubt that contrary data can be cited on the relationship between compensation and productivity. Yet this fact makes it all the more important that a scholar bring sound economic reasoning to the table. A skilled and careful scholar, when confronted with the claim that executive compensation is untethered from executive productivity, would ask questions that, again, Piketty ignores. This skilled scholar would ask, “Why do shareholders continue to invest in corporations?” He would also ask, for example: “Why do no profit-hungry, entrepreneurial capitalists try to exploit this market failure by setting up corporations that pay their executives more sensibly and in ways that induce increased productivity?” “Why do the values of corporate shares continue to grow?” “Why is the real value of the Dow Jones Industrial Average today about 650 percent higher than it was, say, in 1981—the year before the top marginal personal income-tax rate in the United States was cut from 69 percent to 50 percent?”

Piketty’s failure to ask such questions is part of the larger, overarching flaw in his book: it contains far too little microeconomic analysis. And that flaw is fatal.

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