By Per Krusell, Savings Banks Foundations and Swedbank Chair in Macroeconomics, IIES, Stockholm University, and a CEPR Research Fellow, and Tony Smith, Professor of Economics, Yale University. Originally published at VoxEU.
Over the last several weeks, we have thought quite a bit about the main message in Thomas Piketty’s now world-famous book, Capital in the Twenty-First Century (Piketty 2014). We have also discussed it at great length with colleagues. In sum, at least in our departments, there has been a massive collective effort at interpreting both the material presented in the book and the background material on which the book builds. In this column we would like to present one perspective on the book that does not seem to have attracted sufficient attention in the public discussions. We develop these arguments in detail in a separate document (Krusell and Smith 2014).
Piketty takes us on a historical and geographical tour of inequalities in income and wealth. The tour in part feels like a rollercoaster ride. At the very least, it ought to make us all think very hard about the determinants of the levels and trends in inequality, along with possible policy interventions.
- His efforts to collect new historical data and his efforts at measuring wealth – especially among the wealthiest – are laudable.
- The central aspect of the book, however, is actually his prediction for the 21st century – he forecasts a dramatic increase in inequality.
His conclusion is provocative, as is his proposal of a global tax on capital to stem this increase. The problem we have is that we simply do not at all agree with the macroeconomic reasoning that undergirds his forecast.
What is The Cause of Our Skepticism?
Piketty’s forecast does not rest primarily on an extrapolation of recent trends that he has uncovered in the data. This is what one might have expected, given that so much of the book is devoted to digging up and displaying reliable time series on income and wealth distributions. (Actually, we were surprised to see that there is very little clear evidence of rising wealth inequality in recent years, and even this evidence has recently come under criticism by Chris Giles at the Financial Times.) Rather than being based on data, Piketty’s forecast rests primarily on economic theory. We take issue with Piketty’s argument.
The theory in the book is presented in the form of two ‘fundamental laws’, as Piketty dubs them.
- One law is merely a definition – capital’s share of income equals rk/y, where r is the return on capital, k, and y is (national) income.
- The other law is much more than a definition – it asserts that k/y will, in the long run, equal s/g, where s is the savings rate in the economy and g is the sum of the growth rates in population and technology.
Capital’s share of income can therefore be written as rs/g.
Based on this expression, Piketty then argues as follows. First, the return to capital is insensitive to how much capital is accumulated. As a result, capital’s share of income will be determined largely by s/g. This, he asserts, will rise rapidly in the future, since most experts expect population growth to fall toward zero and technology growth to decline substantially, too.
Putting this together, regardless of what s is, we are poised for a very sharp rise in s/g (so long as s is positive).
- Piketty considers as plausible that g will be cut at least in half, so his theory implies that capital’s share will at least double.
- This doubling would bring us back to levels of inequality similar to those in the 19th century – since capital is today so unevenly distributed.
Critique of Piketty’s Second Law
Piketty’s second law is not mathematically incorrect, but it relies on assumptions – as do all economic theories. The central assumption concerns how the economy saves. Piketty assumes that the ‘net’ saving rate is constant and positive, i.e. the economy increases its capital stock from year to year by an amount that is a constant fraction of (net) national income.
This assumption may sound standard but actually it is not – precisely because it is expressed in net terms. In particular:
- With zero growth in population or technology, the assumption that the capital stock is always growing (because net saving is positive) implies that more and more output must be diverted away from consumption towards investment.
Eventually, because capital needs to keep rising, it is necessary to devote 100% of GDP to capital formation!
- Even a fall in growth from 2% to 1% would require that a sharply increasing fraction of GDP be reallocated from consumption to building capital.
We do not think any such reallocations have been observed historically in cases in which growth rates have been persistently low.
Piketty’s theory is closely related to the standard model of economic growth, based on Solow’s pioneering contribution (Solow 1956) – a model that is taught in virtually every intermediate-level undergraduate textbook. This model assumes instead that the gross savings rate, i.e. gross investment (including depreciation) as a fraction of (gross) national income, is constant. Under this assumption, as the growth rate falls to zero, the net savings rate also falls to zero – a sharp contrast with Piketty’s theory. Postwar US data, moreover, is consistent with this theory in that decades with low growth have typically been associated with low (or even negative) net savings rates.
One might argue, of course, that the assumption of a constant gross savings rate is an extreme one that is not grounded in economy theory. There is, of course, an entire field in economics devoted to studying individual consumption behaviour, as well as its aggregate consequences. This literature formulates theories and tests them against data.
The benchmark theory – deriving from contributions by, among others, Friedman (1957), Cass (1965), and Koopmans (1965) – maintains that, at zero growth, capital is maintained at a constant level, i.e. the net saving rate is zero, again in sharp contrast with Piketty’s assumption.
- More generally, the prediction arising out of this literature is that savings rates tend to fall, not rise, as growth falls.
- Neither the textbook Solow model nor a ‘microfounded’ model of growth predicts anything like the drama implied by Piketty’s theory.
In both cases, theory suggests that the wealth–income ratio would increase only modestly as growth falls. Thus, declining overall growth is simply not a powerful force for generating high inequality, and we would not want to make predictions based on it.
We are not sure why Piketty has chosen such an extreme assumption on saving. We have looked in the source materials underlying the book for a test of his assumption, and a comparison with the obvious alternative, and standard, theories, but did not find a clear test or comparison. What is clear, however, is that what lies behind his extreme predictions is his extreme – and, we think, unrealistic – assumption about saving.
Our view, instead, is that wealth dispersion in the Western world – which is very large and most definitely a compelling target of theoretical and empirical study – has primary determinants much different than those emphasised in Capital in the Twenty-First Century. These include, to mention but a few, educational institutions, skill-biased technical change, globalisation, and changes in the structure of capital markets. It is to these forces that those who care about inequality should be devoting their attention, and to which policy reforms ought to be targeted.
Cass, D (1965), “Optimum Growth in an Aggregative Model of Capital Accumulation”, Review of Economic Studies, 32: 233–240.
Friedman, M (1957), A Theory of the Consumption Function, Princeton, NJ: Princeton University Press.
Koopmans, T C (1965), “On the concept of optimal economic growth”, in Study Week on the Econometric Approach to Development Planning, Amsterdam: North-Holland: 225–287.
Krusell, Per and Tony Smith (2014), “Is Piketty’s ‘Second Law of Capitalism’ Fundamental?”, mimeo, 28 May.
Piketty, Thomas (2014), Capital in the Twenty-First Century, Harvard University Press.
Solow, Robert (1956), “A Contribution to the Theory of Economic Growth”, Quarterly Journal of Economics, 70(1): 65–94.
This seems like a naked re-assertion of the conventional views of mainstream, neoclassical economics. The closing paragraph is exactly that, a recitation of the names of the usual suspects. Other than that, the authors don’t have much to say.
Yes, this was a disappointing refutation of Piketty. If this all the mainstream has to say, they’re clearly whistling through the graveyard while their false religion crumbles day-by-day.
No, I and other have objected vociferously with Piketty’s r>g, which he presents as a “fundamental law” that capital (which he defines very broadly) earns higher returns than the economy as a whole. That’s just bollocks. Anything that grows PERSISTENTLY at a higher rate than GDP will eventually become the entire GDP, and then be incapable of out-earning it. It’s ludicrous on its face. This article points out the same “trees don’t grow to the sky” fallacy from another angle. It’s also disproven empirically by periodic financial crisis (which produce negative returns on capital, as in bigger losses than the fall in GDP) and by periodic huge investments in assets that lose money (the railroad boom of the later 19th century in the US).
You can agree that inequality is rising and that capitalists have in the last 30 years succeeded in getting more of the economic pie for themselves without buying r>g. Piketty goes off the rails by greatly overstating what his data shows.
I’m not sure how that is wrong other than you asset it is
Pull out a calculator. It’s not an assertion. It’s trivial to prove it yourself.
For those who think Piketty has made an obvious math mistake, let’s use that calculator. Consider a society with “capital” of k = $10 billion on Jan 1, 2004, and Total Income y during all of 2004 of $2 billion, some of which is from returns on that capital, some of which is not. Assume that in both 2004 and 2005, the “rate of return” to capital r is 5%. the savings rate “s” is 8%, and that the growth rate g of Total Income (GDP) is 1.6%–so g is much lower than the rate of return r. Note that the savings rate s determines how much of GDP is not consumed, and hence becomes (new) capital.
Piketty’s ratio of rk/y for 2004, measuring the share of total Income represented by returns from capital, is (.05)(10 billion)/ 2 billion = 0.25 = 1/4. That is, 1/4 of the total income of the society in 2004 was from returns on capital. The question is whether this ratio will increase to a fraction greater than 1/4 for 2005, given the rates above. Some say that it must necessarily be larger in 2005 than 2004, since r > g, and that therefore Piketty is wrong to assert that the ratio can ever stabilize (except when return from capital = ALL income, a nonsensical situation.)
But the math shows otherwise: the ratio rk/yin 2005 will be exactly the same as in 2004. Watch:
In 2004, 8% of Total Income was saved, which is 0.08(2 billion) = 0.16 billion. That gets added to the previous capital of 10 billion from , so on Jan 1, 2005, the new value of k is 10.16 billion. The new income y for 2005 will be 1.6% higher than in 2004, so it will be 1.016(2 billion) = 2.032 billion
The value of the ratio rk/y for 2005 is thus (.05)(10.16 billion) / 2.032 billion, which equals 0.25, or 1/4. Note that this says that in 2005, as in 2004, 1/4 of the Total Income comes from returns on capital. The ratio has not increased, nor will it do so as long as the savings rate s and the growth rate g and the rate of return r remain the same.
It is thus not true that Piketty has made an elementary math mistake. His theory may of course still not be correct, as his, like any, mathematical model may happen to not correspond to reality. But the internal math of his theory is quite consistent, and, as he asserts, given stable rates where r >g, implies a stable (not ever-increasing) share of total income from returns to capital.
You are again misunderstanding Piketty’s model. The “r” of Piketty’s model is the rate of return to capital (or “wealth”, in his sense), but it is NOT the “rate of growth” of capital, because the owners of capital do not retain all of their “return” as capital. Instead, they spend a lot of it on things that are immediately consumed, and hence cannot (by definition) be (additional) capital, even in Piketty’s broad sense.
Also, some of the “other” GDP gets saved, or otherwise turns into wealth (or capital, in Piketty’s broad sense), as well, providing a (different) source of “growth” to capital. But in no sense is “r” by itself an accurate indicator of how much total capital increases each year–that depends, crucially, in addition to “r”, on how much of the return to capital is consumed rather than retained, and on the savings rate (more precisely, the “non-consumption” rate) of the general economy’s GDP as a whole.
You are assuming that if r equals, say, 3%, then total capital in year 2 is 1.03 times total capital in year 1. If you were correct, your attribution of a “trivial” error in exponential compounding to Piketty would be correct. But that is, again, NOT what a “rate of return to capital” of r = 3% implies in PIketty’s model.
Dan Kervick went through all this (with a couple side comments by me) a couple weeks ago re another Piketty post, and there is no doubt that Piketty’s model is mathematically valid–it does not contain the “trivial” error that you attribute to it. In fact, what is trivial (for a math professor like myself) is to construct a realistic example in which r > g in Year 1, but in which the ratio of wealth (capital) to income in Year 2 is exactly the same as in Year 1. This “stable” wealth to income ratio (unchanging from Year 1 to Year 2, and hence from any Year N to Year N + 1) is what Piketty predicts will be approached in the long run under (some, relatively plausible) circumstances that he models–and the math is impeccable, I can assure you. As I pointed out back in the previous post, it’s just wholly implausible that an economist of his stature would have made this sort of trivial mathematical error–and he didn’t! :)
None of the above, of course, means that Piketty’s model is “correct”–but that’s because many impeccable (internally consistent) math models simply don’t fit the real world’s contingent circumstances. Perhaps his does, or perhaps it doesn’t–the jury will be out on that for quite a while. But, if his predictions are not empirically correct, and hence his model is not “realistic”, it won’t be because he couldn’t figure out that his basic math model had a “trivial” compounding flaw that a 10th grader could see–it just doesn’t have any such flaw.
I have to also observe that I am a bit amused to be defending Piketty’s model (though only in the mathematical aspect, not whether it actually conforms to real circumstances), since, as a socialist, I find the whole thrust of his argument to be irrelevant. We socialists find the CURRENT distribution of wealth, as well as that in the ‘golden age’ of the 50’s to 70’s, to be wholly unjust and obscene–worrying about whether it will get worse (which implies that it’s just peachy as it is right now) is…quite the waste of time. I’m glad that Piketty has drawn attention to the fact that the emperor is naked, but I see little point in speculating whether some naked people are more nude than others… :)
No, the wealthy do not consume at anything like ordinary people. So the overwhelming majority of their profit goes into more wealth. Piketty’s definition is extremely broad, and clearly includes real estate, private jets (which have resale value) and collectables (which the rich do treat as trading as well as consumption items). He can’t have his cake (his very broad definition of wealth) and then try to pretend that income on wealth does not largely go into wealth in the next time period.
You are certainly correct that the very wealthy direct a much higher portion of their returns on capital (as well as their labor income, of which they often have quite a bit as well) into more “wealth” than the non-wealthy do–especially as Piketty broadly defines wealth. But that is irrelevant to his mathematical model, which relies only on the overall savings rate “s” of society as a whole. [I also note that a fair amount of capital is owned by the 50th to 99th percentile of households, whose savings rates are not nearly as exorbitant as the scene you (correctly) paint in your comment–that scene is really only accurate for the top 1% or even 0.1%; but this point is also irrelevant to Piketty’s math!]
If you look at my math example above, the savings rate I used there for society overall is 8%–which is higher than it has been in reality for quite some time now. Crucially, note that this overall rate already includes whatever (high) savings rate the wealthy have–it is greatly reduced, however, by the very low rates the rest of society have. New capital is formed by the overall savings rate (or “diversion into wealth” rate, given Piketty’s take on wealth) for society as a whole, which for quite a while has been in the single digit percentage range, and for which the 8% figure I used in my example is certainly a reasonable ball park example.
So, again, just work through the example I gave above, and you’ll see that Piketty’s model is valid mathematically. Historically plausible rates for r, s, and g simply don’t lead to absurdities–they lead, precisely as he suggests, to stabilizing ratios of income from capital to total income. The math just has no room for any other conclusion. Again, this doesn’t mean Piketty is correct overall–just that there is no trivially obvious math mistake in his model.
Piketty does not present r>g as a fundamental law – and indeed he spends a great deal of time discussing the unusual period in the middle of the 20th century when this did not hold true. He just says that our current situation, and seemingly the normal situation for most of human history, does seem to involve r being greater than g.
I recently bought Piketty’s book (in French) and while I’m probably not going to understand all the economic issues, I certainly am able to hone in on the political angles. And so it is, on the second page, Piketty makes clear what his mission actually is. After first explaining that capitalism created unsustainable inequalities during the 19th century and “most likely” will do so again in the 21st (while not mentioning these two periods coincide with the two great bouts of globalization) he says:
In other words, Piketty is clearly out to defend globalization and his entire work is oriented towards finding solution to the problems created by globalization while at the same time maintaining globalization. Good luck with that.
This is why he is so popular in the Anglo-Saxon world. The first era of globalization (1880-1913) was led by Great Britain while the second (1975 – present) is led by the United States. The key is to limit the debate to ways to correct the ever more obvious mal-distributions of income and wealth in the first world all while excluding any critiques of free trade and mass immigration from third world countries. And so within the globalization constraints Piketty has choosen to limit himself to, he is only able to come up with his rather weak (and easily defeated by the Anglo-Saxons) proposal for a global tax on capital. And so this is a safe book upon which to base the discussion.
Piketty’s book needs to be seen within the context of the current debates in France. The protectionist ideas of Maurice Allais, the French winner of the Sveriges Riksbank Prize in economics, have been adapted by Marine Le Pen, leader of the Front National. She has been busy taking on board various Keynesian ideas as well, and these two moves have allowed her to make huge inroads with working class French voters. Allias generally agreed that free trade among economically similar countries was beneficial but pointed out the obvious fact that “free trade” between rich and poor countries would be a disaster for the workers of the rich countries. And there is no contradicion between Allias and Keynes, although Keynes did start out as a strong supporter of globalization, over time his views changed radically:
In France, there are people farsighted enough not to have to wait until the second globalization disaster strikes and so increasingly the debate is between nationalism and globalization; with the nationalist arguments on the rise. The Left /Right debates are becoming obsolete. The French term “UMPS” combines the right and left mainstream, pro-globalization parties, in a similar way the term Depublicrats would in the US. Piketty is trying to intervene in this debate by basically providing a little Hopium and Changium for the pro-global Left and giving the pro-Global right a nice target to attack all the while sidelining the nationalists and keeping them out of the debate..
In the Anglo-Saxon world then the Piketty book serves a useful purpose of providing a safe arena for debating the current problems all while never questioning globalization. Just the fact that leading Democrats are talking about the book helps fill their partisan supporter[s lungs with a much needed whiff of some new Hopium and Changium and helps tamp down any heretical outbursts of anti-globalization rebel rousers from the extremes. Look for the Democrats 2016 candidates to run on a Piketty-inspired platform.
But in the end, try as some farsighted people might, the second globalization will only end with a disaster along the scale of the two world wars that resulted from the first episode of globalization. And if current events tell us anything, this disaster will occur sooner and not later. Perhaps much sooner.
And interesting artilce from Steve Keen about diversity in national economies.
In essence, comparative advantage needs to be considered on the firm level rather than national level. This allows a nation to weather any temporary downturns in a single sector.
Globalization on the other hand seems to be comparative advantage taken to its logical extreme.
Thank you for this cogent, well-reasoned analysis. It rings so true since it frames an obvious issue in the way it must be framed for American “consumption” today–two positions, roughly recognizable as “red” and “blue,” and 1000 miles away from the REAL problem.
Tailor-made for the American “electorate,” such as it is.
Multinationals have the twin tools of playing wage arbitration and tax arbitration – so any notion of a nation “for the people” can’t beat that. By mentioning a global tax on capital, at least Piketty lets on he knows something of the problem. How that gets implemented is of course problematic, and requires co-operation among all countries, including how it gets divvied up. With import duties you have more control – and we have the infrastructure already – it’s just that we only collect less than 2%. But that is branded “protectionism” – a horrible monster under our beds that will eat us in our sleep. (according to almost all economists) Then nowadays we’d also have to find a way to levy duties on the flow of “soft” goods as well – like offshored computer code flowing across the internet half way around the world at a transport cost of 2 cents a minute, etc…
The US does have a world personal income tax. But they don’t seem to try all that hard to enforce it with the big guys. Guess the NSA doesn’t think those data transfers are all that interesting.
At what point will there be a discussion about import duties at the state level? Income generated at the multinational box store does not stay local.
The first reason for import duties would be to protect domestic industry from slave labor countries. Less reason to try and employ everyone at a big box store, and then have banks lend them money and the USG give them food stamps so they have some “disposable income” to spend.
There is still such a thing as “beneficial trade” – when trading partners offer something that the other doesn’t have and the trade is more or less balanced. Slaves for treasury bonds doesn’t meet that definition, IMO.
Thank you Nero. I certainly loved your summary. If we, Keynesians and all, have known about the contradictions to old fashioned capitalism presented by its own recurring attempts at globalization (i.e expansion) – it clearly is a feudal relationship – then we should fix it. Picketty will be intentionally misinterpreted when he calls for a global tax on capital, because altho it addresses just this problem, it avoids discussing it because Picketty is pro-globalization. Gotta wonder why. So what’s a globalist to do? Maybe back off and wait until all countries have a shared living wage. Curious. Because this is the opposite of capitalism whereby the wages are raised by the productivity, so the wages come after the productivity. Too bad Picketty didn’t see the problem this creates! And about those quislings pushing globalization at any price – they will jump on this superficial Picketty suggestion as a cure all when it will merely perpetuates the problem for decades. But let’s not confuse the movement here in the US with quislings of this ilk. In Ralph Nader’s new book he describes a coalition of right and left who understand the destruction of corporatism and multinational corporatism and see the value of making policy that will actually work. Here’s hoping Ralph is reading the tea leaves correctly.
I think this analysis is right on and that the problems of globalization (especially unfettered free flow of capital) and mass immigration are linked.
This would probably be a good one line summation of Michael Hudson’s book ‘Trade, Development and Foreign Debt’ 2009.
”Citigroup says yields aren’t high enough to attract the capital needed to finance current-account deficits in some of those nations….”
Basically countries need to employ labor to supply domestic consumption as the first order of business. Interest rate swaps and foreign exchange swaps aren’t the right tools to build an economy.
Shock Doctrine documented several countries such as South Africa and Poland who won political independence but didn’t follow through with financial independence.
By Fadhel Kaboub
The Job Guarantee program can be adopted through the democratic process as an overarching plan to restore financial sovereignty, promote full employment, sustainability, higher quality of life, and long-term prosperity. All of this is desirable, feasible, and affordable. Those who think otherwise and yet still aspire for a democratic society in Egypt will by sorely disappointed to know that there can not be true democracy without full financial sovereignty to deliver social and economic justice for its people.
By Dan Kervick
So the reason we can afford to develop and improve our countries has little at bottom to do with the monetary system. We can continue to develop and improve our countries because we haven’t run out of material resources and human resources; because we haven’t run out of the capacity to invest our nation’s resources intelligently in building a better future; because real progress is better than stagnation and decline; and because our systems of governance are still effective enough to accomplish the job so long as they are prodded and animated by an energetic, organized and mobilized public that knows what it wants.
I like the analysis. We need to remember 1880-1913 (era of coal) and 1975-present (era of oil/gas). An economy doesn’t operate off of capital, despite current belief, it operates off of energy. I will be branded a futurist for saying this but I’ll say it anyway. Any survivable future economy has to be measured in terms of energy. Funny thing is we have been doing that for 10s of thousands of years though without our knowing it. It has only been in the last 200 years that we have turned the concept of economy into the abstraction of capital flows, and we have done it, I believe, to maintain power and privileged.
Actually energy is measured by the amount of capital investment to produce it. So we do tie things together that way.
If that were true we wouldn’t be fracking, extracting tar sands, or coal for that matter. These industries thrive because of the financialization of capitalism not because they are inherently efficient. Fracking is capital and resource intensive with low long term returns, tar sands extraction and production is absolute madness fed by the global addiction to oil (which makes it “cost effective”), and the coal industry’s externalities are beyond all cost benefit analysis. The fact that we produce products 10,000 miles away from consumers because of “lower cost” also furthers the argument. Capital is part of politics and society first and foremost not a true measure of energy produced versus energy consumed. This is my concern. Any connection to actual energy usage is a loose one at best. The most obvious example of this is oil. A barrel of oil, currently, can be extracted from the earth for as low as $1 a barrel. While the estimated amount of human labor contained in that one barrel amounts to 20,000 hours. How can $1 possibly amount to 20,000 hours of human labor (20000 labor hours per dollar)? Even if we went off of the market value of about $100 per barrel we would be looking at 200 labor hours per dollar). That is the equivalent of five 40 hour weeks labor for $1. That is madness! If we actually measured economic activity in terms of energy oil would be one of the most precious commodities on earth, but as is the case with Capitalism politics and society determine value, not energy produced and consumed. The system is not scientific, and despite our best efforts it cannot be scientific since it relies on irrational foundational premises (Capital as a measure of value, the rationality of the market, etc.).
Your pointing out that we don’t really know how much energy we can economically extract. So your “currency” is still an unknown. Should we call it potential, probable, and proven currency reserves?
No, Working Class Nero, globalization ultimately is besides the point, a distraction. The problems caused by globalization are not really caused by globalization – but by global ignorance of things that are so familiar and easy that hardly anybody correctly understands them intellectually. (I need to work harder to see what is in front of my nose, to get them myself :-) ) By the 99% of each nation individually and collectively deciding to let an internationally united 1% bamboozle and rob them.
Allias generally agreed that free trade among economically similar countries was beneficial but pointed out the obvious fact that “free trade” between rich and poor countries would be a disaster for the workers of the rich countries. This is not a fact. It is like saying trade among rich people benefits them. But if rich and poor trade then the rich people are hurt! Yes, “would be” a disaster in the current situation of widespread economic ignorance and magical thinking. Then free trade can and does harm the workers, the 99% in rich countries. It is tough to say what to do if a country has already decided to commit national suicide as France has, by adopting the Euro. Allais or Le Pen’s protectionism could have merit then.
But workers in a normal (non-Eurozone) country, like the USA or Canada cannot be harmed if they do the essential thing – decide on full employment at a good wage. Essentially, workers in a country with a JG, workers in a country practicing Functional Finance, one that decides on full employment cannot be hurt by, can only be helped by, foreign trade. All workers have to do to prevent multinational wage arbitrage is to directly prevent it by putting a solid floor on wages. This kind of me-first economic nationalism is also the best and truest kind of internationalism – and benefits foreign countries and workers elsewhere. This is the very easy “solution to the problems created by globalization while at the same time maintaining globalization.”
Every country can go it alone. There is no case for concerted action. Opposing globalization the wrong way can be and usually is falling for the divide and conquer Capitalist International plot to set workers of different countries at each others throats. All that needs to be done is for each country to stop attacking itself, stop allowing its “elites” to economically strangle its own society. Any country can adopt MMT. It has nothing to do with issuing a reserve currency. It has nothing to do with whether the country trades internationally. All it has to do with is genuine national independence (= your own military and your own currency) – and doing the accounting correctly.
You quote from David Singh Grewali’s What Keynes warned about globalization. Some of what he says is good. Some is nonsense – what he says about the unsustainability of US debt issuance, or its lack of safety. I frequently quote from and link to Keynes’s National Self-Sufficiency – but it needs to be understood correctly. To my mind, the best summary of international aspects of MMT is still what’s in Abba Lerner’s 1951 Economics of Employment. Basically, that there is nothing that needs to change. That simply deciding to have full employment is a perfect defense against “the problems of globalization.” He would have categorized Piketty’s silly and unworkable idea of a global wealth tax as “sentimental internationalism”, popular then and now. And he shows how a policy of functional finance is almost always (e.g. for an “advanced” country) an even better national defense to foreign trade ( “dumping”, undercutting, or protectionism) than simple minded protectionism. And Keynes, while disagreeing with Lerner at first for going to far, eventually decided, shortly before his death, that he was irrefutable.
Great comment! Puts the whole thing in perspective. I always distrust fashionable books. I think globalization could have been a good thing, btw–it did not have to end up being what it has become.
Thanks. Very few MMTers – except for the academics themselves (Neil Wilson is another exception) – understand that – and think that MMT needs something extra for open economies. I agree with your distrust. Unfashionable, even ridiculed, books and ideas are often the best ones.
I don’t understand economics. I’d be baffled before I reached the end of page one of any intermediate-level undergraduate textbook. I’ve been a regular follower of NC for many years now because here I have found articles and commentary about economic issues I have been able to comprehend to a greater or lesser degree (the recent articles on PE excepted, as that seems to be an extremely arcane world in an incomprehensible reality of its own.
Hence I have only a feeble and likely incorrect understanding of what Picketty is saying, and criticism/commentary on it invariably becomes technical and esoteric. What I know experientially is that I was able to retire from ‘work’ twenty years ago in search of a Henry Thoreau ‘Walden’ life-style with a lump-sum of savings I hoped would be able to support me for the twenty-five years I would have to exist before my entitlement to State support in my old age kicked in. And that hope has been realised. Despite numerous ‘crashes’ and a Global Financial Crisis, and despite the fact that my only income over that period has been dividends and interest, I am for tax purposes ‘wealthier’ than I was twenty years ago due to the capital growth of my portfolio (which I don’t trade) and what I was able to save – and re-invest – of the income.
I have been frugal, yet gone without nothing I felt I needed. Most significant, in all probability, is the fact that I chose not to bring children into the world as even twenty years ago I saw only a future of uncertainty and probable social and environmental catastrophe for them.
At the most simplistic level this seems to confirm Piketty’s thesis. Even in the ‘bad’ times, as long as my income was sufficient for me not to have to dip into it, my capital grew. Most years I was able to add to it a little. Over the same period I have seen friends and former collegues whose income was invariably far greater over this period fail to, refuse to or even be unable to save as their outgoings expanded to fit the income available – and occasionally exceeded it. Offspring, of course, are horrendously expensive, but while I have been in the same home for twenty mortgage-free years they have moved to a bigger, ‘better’ property every five years or so with expenses and loans to match. I’ve had the same car for twenty years and it still has less than 100,000K on the clock.
“Under this assumption, as the growth rate falls to zero, the net savings rate also falls to zero – a sharp contrast with Piketty’s theory”, says the above in presumably an attempt to refute Picketty. I don’t know if that’s a fact or not, but it seems to me that if it is it’s to some degree a matter of choice. I know there are many who barely survive and certainly cannot affort to save, but I offer that in many more cases and assuming an reasonably affluent society to start with, even a sustained growth rate of zero could still support some degree of saving by many like myself who choose not to ‘consume’ unnecessarily – and as those savings have to go somewhere capital values will inevitably increase.
You have lead a very fortunate life. Not all of us are so lucky.
How can you have growth in “technology”? Technology is a descriptive category not a quantity. it’s like having growth in “clothing” or “weather”.
How can you accumulate “capital”? Eventually the pile of capital would be so big it would reach the moon. Then Jupiter! If everybody in the world accumulated capital the radius of the earth would grow and earth would become a huge sphere of capital like a giant planet. Alien astronomers would marvel at the phenomenon. Although maybe they’ve seen it before. Who knows?
When the sphere of capital reaches Jupiter, that must mean income is monstrous. Since the return on capital is income but it’s not all of income. Where would all that income be spent? it’s hard to say. Maybe on Jupiter.
Gravity may become a problem. Saving would become difficult because you’d be too heavy to move your capital around and spend it. This could constrain economic activity. However, growth in technology may produce a solution. Or, there would be innovation in bedding so folks could rest and refresh themselves from the exhaustion. How big could capital grow before gravity would cause an economic collapse that neither technology or bedding could prevent? It’s hard to find the perfect equation. But if you’re an economist, you won’t let that stop you.
That probably won’t happen because technology already provides a solution. Remember that capital is defined as plant & equipment, real estate, Bugatti, ocean going yachts, Swiss ski chalets and also “paper” wealth – which really isn’t paper at all, but an electronic form of it that exists on a computer hard disk in byte representation.
For instance, I need an electron microscope to see my capital!
Then $18,446,744,073,709,551,615 only takes 8 bytes – so you can see we won’t grow all the way to Jupiter – unless we get inflation, but that’s not very likely.
What is this craazy thread?
Given that Piketty reportedly questions/rejects (I haven’t read the book) abstracted economic calculus in his introduction, I don’t know why he even bothered trying.
Unless he thinks that “no publicity is bad publicity.” Controversy drives the cultural conversation drives book sales.
Now that’s math you can believe in.
Just look at what has happened to Japan’s savings rate over the past 35 years to see what happens in an aging, low growth economy. Piketty is simply twisting the theory to satisfy his socialist needs.
Piketty actually provides an interesting perspective on Japan in his discussion of economic growth where he points out that per capita gdp growth in developed countries is pretty stable around 1 or 1.5% a year, with growth higher than this in developed countries generally just being a result of population growth. Japan has been doing just as well as anyone else per capita, their total GDP is just not doing well because of their demographic situation. So no policy that they take is likely to really improve GDP growth, but on the other hand that’s not a big deal since per capita growth is all that really matters for living standards anyway. Japan has a 3.6% unemployment rate.
Exactly. Everyone always bemoans Japan’s stagnation. I wish we had such a stagnation.
‘k/y will, in the long run, equal s/g, where s is the savings rate in the economy and g is the sum of the growth rates in population and technology.’
Does anyone else see a little maff problem here? One is that presumably k/y is a typo for rk/y; otherwise, we’d be dividing a stock by a flow.
More importantly, Krusell hints at — but doesn’t actually come out and say — that this equation blows up to infinity as the denominator g goes to zero.
Cut groaf from 2% to 1%, and capital’s share doubles. Cut groaf to 1/2%, and it doubles again. To 1/4%, and it doubles again. This is unworkable.
1. Fraud [stealing] is at the heart of economic disparity.
If you choose to ignore the obvious, then please feel free to dust off your formulas and dazzle the herd with mysterious spells, complex incantations, and other wizardry, but, if you wish to see the system as it truly is, then you will see that all systems are simply legalistic mechanisms that allow the few to steal from the many.
2. Time is discrete moments, not a continuum.
Those who attempt to extrapolate [anything] are doomed by the suggestion that the intellectual process is not as they believe. Although inter-related, the movie that is playing in our brains [the continuum] is simply how we make sense out of reality and not reality in and of itself. Therefore, it becomes impossible to predict the future [as there is none as we might conceptualize].
Therefore, you have on the one hand, economists spewing-out out absurd non-sense to justify the theft, and, on the other, those who attempt to rationalize the mess by suggesting the solution is at the bottom of a Cracker Jack box.
You can not steal labor-value from the majority of the people on the planet and have things turn out well. This is so basic that most people completely miss it. And when it happens on the level it is happening today, how can this world be anything but…what it is.
I’d give +100, too, but I don’t know what #2 means. So all you get from me today is +50.
When it is acknowledged that there need to be “changes in the structure of capital markets” a confusion is created because markets are the end point of capitalism. They are at the end of the food chain. The change that needs to take place would naturally occur long before any market entered the picture.
I’m still reading the book (in English), and it causes passers-by to regard me approvingly everywhere from the subway to NJPAC to Queens Boulevard as if I were an intellectual. However.
The authors say above: “Actually, we were surprised to see that there is very little clear evidence of rising wealth inequality in recent years, and even this evidence has recently come under criticism by Chris Giles at the Financial Times.” This is a hard statement to swallow, and causes one (me) to want to cry out “Circumspice! Circumspice!” and to squint painfully at the rest of the article. (And I haven’t even looked at Yves’ today post from David Cay Johnston.)
Piketty wrote a lengthy response to Chris Giles:
In that response Piketty attempts to define the purpose of his book. “The main message coming from my book is not that there should always be a deterministic trend toward ever rising inequality (I do not believe in this); the main message is that we need more democratic transparency about wealth dynamics, so that we are able to adjust our institutions and policies to whatever we observe.”
“The main message coming from my book is not that there should always be a deterministic trend toward ever rising inequality (I do not believe in this); the main message is that we need more democratic transparency about wealth dynamics, so that we are able to adjust our institutions and policies to whatever we observe.”
This would be like suggesting that the antidote to war is better field hospitals.
Perhaps dispensing with that which keeps one warm and comfortable might allow a look beyond those edifices which obscure all critical thinking. If each person received that labor-value s/he actually earned, how would it be possible to have any significant degree of disparity?
Pardon: I do not agree with your analogy, impermanence (“antidote to war” etc.). I think that a closer analogy would be that the preventive to war would be to understand the causes and motives for war, and adjust our policies. We have not gone to war with Russia or Syria or Iran or North Korea–at least, not yet–despite the enthusiasm for war in some circles. Some of the things we have done instead–mostly applying sanctions–seem to have had or are having a useful effect.
Of course human affairs are complicated, and I think most will agree that an application of force in the Rhineland in 1936 might well have meant the end of Hitler in that year, and spared humanity much suffering. But that was then.
As for understanding and adjusting economic policy, NY banking regulator Benjamin Lawsky (whom Yves first called to our attention) is pressing to have the COO of BNP (and some other executives) fired as part of the settlement (for doing business with Iran, et cetera). To attach the banking crime to a human being would be a major adjustment. Even our timid government’s proposed settlement–a fine of $10 billion–represents an adjustment, because it’s large enough to wipe out BNP earnings for more than a year. These penalties, while only a bare beginning, might–“might,” not “will”–might cause banks to adjust their policies of (unlawful) business as usual.
Yves recently urged us to write to Benjamin Lawsky (wonderful name!) to thank him and urge him on.
Mr. Benjamin Lawsky, Superintendent
New York State Department of Financial Services
One State Street
New York, NY 10004-1511
Confusion to our enemies.
As the Piketty wave continues to break on shore I recommend we move to higher ground and read/reread Marx’s Capital. His critique of Capitalist ideology is still the best around even after 150 years. He recognized that markets were political (or class oriented) in nature and not forces beyond human intervention. It seems strange that we continue to invest so much in overcoming the restrictions that natural law has placed upon us (space travel, energy generation, communication technology) yet we cannot overcome something that is completely contrived by the human mind. The timelessness of Marx’s critique should indicate just how dated our economic system really is.
“The benchmark theory – deriving from contributions by, among others, Friedman (1957), Cass (1965), and Koopmans (1965) – maintains that, at zero growth, capital is maintained at a constant level, i.e. the net saving rate is zero, again in sharp contrast with Piketty’s assumption.”
Historically (e.g., ancient Rome), at zero growth, debtors became slaves, thus increasing “capital.”
Empirically, at zero growth, capital grows because money is loaned at interest, i.e., the rate of return on capital (the non-zero interest rate) is greater than the rate of growth of the economy (zero).
If you think about it, the Fed’s present ZIRP (zero interest rate policy) reflects the Fed’s understanding that we have been in a zero growth state for the last five years. In those same five years, we have seen an acceleration of wealth inequality. Correlation does not prove causation, but a deliberate policy to lend money to the banks at zero interest so they can charge 20 percent interest on credit cards may.
Yes, if someone would only clue in Fed economists on the difference between “wholesale” and “retail”.
Coming out of Sweden, this remark is …. uh, remarkable. Remarkably wrong, that its.
The Piketty claim, in Chapter 10, is very simple. Income-becomes-wealth. What in heaven’s name should happen to it. Like the French we buy gold-coins and hide them under the bed?
Moreover, nobody is talking about or referring to the work done by GW Domhoff at the UofC in Santa Cruz, the results of which can be found at his web-site: Who Rules America?.
Piketty and Domhoff are making a statement about Welath that is not altogether too far-fetched. Which I interpret to mean that if nations do not apply the confiscatory powers of taxation, the situation will only worsen over the next hundred-years.
Is that too unbelievable given the present data? Methinks not, particularly in the US where taxation rates are some of the lowest of any developed nation. See comparative rates here.
EU – 35.7
US – 26.9
‘Nuff said? Or is this debate entering the polemical phase because no cogent reasons against Piketty’s charge can be found … ?
*Giles’ article in the FT has been largely refuted by economists. He reached a bit too far to undermine completely Piketty’s charge about Income Becoming Wealth and therefore causing Wealth Disparity – just as we have created Income Disparity. What is mind-boggling is that we should be even discussing the matter, the consequence of Income Becoming Wealth is so damn obvious. When we should be discussing what should be done about it – and I don’t think Piketty’s suggestion (of an international tax on income) is even a starter ….
Otoh, YS has a point. It is not at all obvious that r will ever be either equal to or greater than g for any significant period of time (like constantly). Unless you miscount the beans, of course.
It is conceivable, as Piketty demonstrates for Income and Domhoff for Wealth (both Net Worth and Basic Wealth including Debt), that Wealth Disparity is due to Income Disparity. Ipso facto.
And even more so when high-taxation is devastated in order to permit a Trickle-up Economy as we have in the US.
Piketty is trying to show his Socialist colours. So be it … nice try.
He should content himself with having demonstrating reasonably well that Income Disparity is fundamentally a no-no in any country that holds fervently to the notion of Social Justice. Domhoff has demonstrated amply well that Wealth is inequitable in the US, and he has been doing so for 20 years. To deaf ears …
Are not both of those well-justified Economic Truisms enough to raise the alarm-cry? Probably not in a nation of the evidently deaf-and-dumb.
Moving right along …
Many seem to use the rate of return on capital to calculate the next year’s wealth. I made the same mistake until I came to page 351 in Piketty. From Piketty and Zucman’s paper, it is calculated as follows.
Wealth next year W_(t+1) is calculated from wealth this year W_t by the formula W_(t+1)=W_t (1+s/β) assuming that there is no capital gain or loss, where s is the savings rate and β the capital to income ratio. So wealth does not grow exponentially as some have been saying. Suppose β=7 (sometimes Piketty writes this as 700%), current income 200 units so that , W_t is 1400, s is 10%, and growth rate g=2%. We have the current income which is 200 which goes to 204, the next year. Savings 20 is added so that W_(t+1) is 1420=1400(1+10/100times1/7)=1400(1+1/70)=1420 as it should be. So the next year β goes down. On the other hand, if β=3 with others s,g the same, then income still goes from 200 to 204, W_t goes from 600 to 620, so now β is slightly bigger than 3. In both cases, income grows at the rate of 1/50, but in the first case wealth grows at the rate 1/70 where as in the second case, it grows at the rate of 1/30. If s, g remain the same, in the long run β converges to 5, assuming various conditions are satisfied through out. In any case, it is only a rule of thumb to see the direction of β under various restrictions.
I welcome corrections.
Yes, and my question is “so what?”
I don’t mean to belittle your comment – your explanation is very well put. I am just wondering this: Who is going to be around long enough for Piketty’s supposed claim to be proven or disproved?
What are we to do about the fact that Income Disparity today is keeping (in the US) 15% of the American population, 15.5% of Germany’s population and 14.1% of the UK population below the Poverty Threshold*?
In France, by comparison, it is 6.2% and in Switzerland 6.9%!
Where there’s a will, there’s a way. Tomorrow can wait. People are suffering today, right now, in some of the richest nations on this planet …
*All poverty percentages from WikiPedia here.
Actually, I am an Australian. We are somewhat better off here. We have Medicare, pension and various allowances though there are danger signs.
Great! Only 13% of Aussies live below the poverty-line.
Really great … !
I do not know how this works here. I seem to be close to this since the government supplements my superannuation. I find that I can contribute over five thousand an year to charities. May be Medicare is a big help.
No need for corrections, you have it precisely correct!
The mistake you refer to (that of confusing the rate of return to capital with the rate of growth of capital), from which you no happily longer suffer, is (obviously) easy to make, since some very bright people have made it. To avoid it, one need only remember that owners of capital spend much of their return from that capital on consumption–they don’t save all of it as new capital. Moreover, those with no capital in January may save some of their labor income during the year, and thus own some (new) capital when December rolls around.
Thus, capital increases each year due to various people (owners of capital and owners of labor power alike) saving some (not all) of their income–but “r”, which refers only to the rate of return on previous capital, doesn’t indicate by itself how capital is growing. To know the latter fact, one also needs to know how much new income was created by labor and how much of all income was saved (became new capital.) These two additional factors, represented by g and s, together with r, determine the trend (towards some stable ratio of income from capital to total income) that Piketty analyzes mathematically, and which you have correctly captured in your comment.
Again, this doesn’t mean Piketty’s overall take is valid, or even relevant–it just means that there is no reason to believe that he made an elementary math mistake in his model, or that the fact that r could be greater than g for a long time leads to absurdities or infinities. Neither belief is warranted in the slightest. If one wants to critique Piketty, one has to do it on grounds other than that r > g leads trivially to mathematical fallacies.
Interesting read. I’ve never understood the r>g framework. Never mind the specific math; it just makes no sense.
Capital and labor are the same thing; the former is past labor, while the latter is current labor. The whole point of the concept of money is to value human labor in a common unit of measure and transport that value across space-time. The universe charges no monetary fee to use its various resources. At a micro level of course there are ‘wages’ and ‘raw materials’ and so forth, but at a macro level, the system is closed. The only resource priced in currency units is labor, whether we are talking monuments or highways or yachts or schools or prisons or child sex slaves.
The only way that past labor can produce a greater return than current labor is if public policy chooses to make it that way.
Actually, I am an Australian. We are somewhat better off here. We have Medicare, pension and various allowances though there are danger signs.
I am an old, retired man, so I have the time and the interest to read all sorts of blogs about our economic problems. This blog is one of the better ones. There are many, many people who offer their explanations about the causes of our current economic predicament, and they usually offer their ideas about what should be done to change our economic lives for the better. This blog is full of examples.
There are four fundamental questions that need to be answered: “Where do we stand? How did we get here? Where do we want to go? How do we get there from here?”
Many blogs, especially this one, provide daily answers to the first question and most, if not all, are correct. We know where we stand. The same is true for answering the second question. Everybody knows how we got here.
There are differing ideas about where we want to go, but most of them, if implemented, would improve things. The timing of the implementations and their beneficial effects are rarely spelled out in detail. But we have a fairly clear idea of where we want to go.
But there are no answers to the question of how we get there from here. And this vacuum says a lot about how we got here. Our present situation is no accident. It was deliberately created by those who wanted it. Our situation is not the result of mindless forces, but rather it is the result of people who have set goals, sometimes vague ones, and who have answered the question, “How do we get there from here?” on their own terms. The techniques they used to put us into this painful mess, facing a dangerous future, are still in operation.
The problems we face today have been with us for a long time, for generations, and we were able to continue to get by. This was in large part due to our national bounty. There was always land to be settled, railroads to be built, wars to be fought, etc. Government funding of projects that stimulated our economy has always been a major part of moving us forward. But all that has changed. There are some stimulative projects that we know about, but there is no will to implement them. Eventually, after much suffering of innocents, we may start to work on some of them, but, and this is a really big “but,” we are truly running out of time. It will not be long before we will be inundated with problems that will take the future out of our hands. Then we will be lost. But that is to be expected. People who act like losers usually lose. And we are acting like losers. We bitch, bitch, bitch, and do nothing to make the changes we need. There is an old song that says: “Do nothing until you hear from me.” Well, now you have heard from me. It is time to stop doing nothing and start doing something. It is time to answer the fourth question, “How do we get there from here.”
Now, before you start typing an angry response to what I have just said, read the rest of this. I have done my part–and I am still doing it. I have answered the four eternal questions, and my answer to the fourth one stands more or less alone. I actually have a plan for how to get there from here. It begins with an explanation of how our transformative power was deliberately taken from us generations ago, and how we have swallowed hook-line-and-sinker the false story told to us by those who usurped, and still hold, our power. Regaining control of our transformative power is the essential ingredient to making meaningful and timely change. My plan explains step-by-step the tasks that must be performed in order to get there from here. Unfortunately, it will probably take two election cycles to get back our transformative power so that we can get down to brass tacks. It can be done sooner, but we will have to come together.
The basic idea that will bring on success is that we the people have the power to make the changes we need to regain control of our lives. The way to look at our problem is that we ordinary Americans are living in a rich, but exploited, democracy which is occupied by external forces which demand tribute from us on the pain of forced labor for starvation wages. But we greatly outnumber our oppressors. They will never grant us our freedom, no matter how often we follow their approved process for change. We must turn their process against them, by pushing their administrators out of their posts and replacing them with our own people. The weakness in their oppressive system is that we can seize control of it. But we will have to work together. Fortunately, we can work in plain view, because our oppressors believe that we do not have the nerve to rebel.
The first step in my plan is to make a list of all the changes we would make when we get power. Then we have to determine what the four major age cohorts, less than 26, 26-50, 51-75, 76 and up, must do in order to implement our revolution. Out of this will come an intergenerational pact which binds each cohort to contribute what it can in order to receive the rewards at the end of the revolution.
There is more, the whole thing is about 400 pages long. But it is time for me to stop. What usually happens when I write posts like this one is that some people ask me to tell more, while others lambaste me. What rarely happens is seeing others offer their own answers to the fourth question, “How do we get there from here?”
But I am still working on my plan. Now that it is written, I am working to get people to help me implement it. People under age 26 seem to be the most interested. But I won’t live to see it implemented. I am too old. But I can see it get started. But as in the one true democracy of ancient Athens, nothing will get done unless the people do it. We have to get off our lazy asses and do what it takes. Otherwise, all is lost.