's
book, but here's a review that does some valuable assessments of his
notion of capital and his parsing of historical and contemporary
inequality, amongst other things, all of which have some relevance
to the so-called re-basing in Nigeria. As the debate in the pages
of this list suggest, however, while changes to our understanding of
economic thinking per se are important, and, as Galbraith
concludes his own assessment and review of Piketty's work ,
acknowledgement that Nigeria's political
(or ruling) classes) appear to be able to muster. It's a political
economy after all.
Kapital for
the Twenty-First Century?
By James K. Galbraith
Capital in the Twenty-First
Century
by Thomas Piketty (trans. Arthur
Goldhammer)
Belknap Press, 2014, 671 pp.
1.
What is "capital"? To Karl Marx, it was a social, political,
and
legal category-the means of control of the means of production
by
the dominant class. Capital could be money, it could be
machines; it
could be fixed and it could be variable. But the essence of
capital
was neither physical nor financial. It was the power that
capital gave
to capitalists, namely the authority to make decisions and to
extract
surplus from the worker.
Early in the last century, neoclassical economics dumped this
social
and political analysis for a mechanical one. Capital was
reframed as a
physical item, which paired with labor to produce output. This
notion
of capital permitted mathematical expression of the
"production
function," so that wages and profits could be linked to the
respective "marginal products" of each factor. The new vision
thus
raised the uses of machinery over the social role of its
owners and
legitimated profit as the just return to an indispensable
contribution.
Symbolic mathematics begets quantification. For instance, if
one is
going to claim that one economy uses more capital (in
relation
to labor) than another, there must be some common unit for
each
factor. For labor it could be an hour of work time. But for
capital?
Once one leaves behind the "corn model" in which capital
(seed)
and output (flour) are the same thing, one must somehow make
commensurate all the diverse bits of equipment and inventory
that make
up the actual "capital stock." But how?
Although Thomas Piketty, a professor at the Paris School of
Economics,
has written a massive book entitled Capital in the
Twenty-First
Century, he explicitly (and rather caustically) rejects
the
Marxist view. He is in some respects a skeptic of modern
mainstream
economics, but he sees capital (in principle) as an
agglomeration of
physical objects, in line with the neoclassical theory. And so
he must
face the question of how to count up
capital-as-a-quantity.
His approach is in two parts. First, he conflates physical
capital
equipment with all forms of money-valued wealth,
including land
and housing, whether that wealth is in productive use or not.
He
excludes only what neoclassical economists call "human
capital,"
presumably because it can't be bought and sold. Then he
estimates
the market value of that wealth. His measure of capital is not
physical but financial.
This, I fear, is a source of terrible confusion. Much of
Piketty's
analysis turns on the ratio of capital-as he defines it-to
national income: the capital/income ratio. It should be
obvious that
this ratio depends heavily on the flux of market value. And
Piketty
says as much. For example, when he describes the
capital/income ratio
plummeting in France, Britain, and Germany after 1910, he is
referring
only in part to physical destruction of capital equipment.
There was
almost no physical destruction in Britain during the First
World War,
and that in France was vastly overstated at the time, as
Keynes showed
in 1919. There was also very little in Germany, which was
intact until
the war's end.
So what happened? The movement of
Piketty's ratio was largely due to much higher incomes,
produced by
wartime mobilization, in relation to the existing market cap,
whose
gains were restricted or fell during and after the war. Later,
when
asset values collapsed during the Great Depression, it mainly
wasn't
physical capital that disintegrated, only its market value.
During the
Second World War, destruction played a larger role. The
problem is
that while physical and price changes are obviously different,
Piketty
treats them as if there were aspects of the same thing.
Piketty goes on to show that in
relation to
current income, the market value of capital assets has risen
sharply
since the 1970s. In the Anglo-American world, he calculates,
this
ratio rose from 250-300 percent of income at that time to
500-600
percent today. In some sense, "capital" has become more
important,
more dominant, a bigger factor in economic life.
Piketty attributes this rise to slower
economic growth in relation to the return on capital,
according to a
formula he dubs a "fundamental law." Algebraically, it is
expressed as r>g, where r is the return on capital and g is
the
growth of income. Here again, he seems to be talking
about
physical volumes of capital, augmented year after year by
profit and
saving.
But he isn't measuring physical volumes, and his formula does
not
explain the patterns in different countries very well. For
instance,
his capital-income ratio peaks for Japan in 1990-almost a
quarter
century ago, at the start of the long Japanese growth
slump-and for
the United States in 2008. Whereas in Canada, which did not
have a
financial crash, it's apparently still rising. A simple mind
might
say that it's market value rather than physical quantity that
is
changing, and that market value is driven by financialization
and
exaggerated by bubbles, rising where they are permitted and
falling
when they pop.
Piketty wants to provide a theory relevant to growth, which
requires
physical capital as its input. And yet he deploys an empirical
measure
that is unrelated to productive physical capital and whose
dollar
value depends, in part, on the return on capital. Where does
the rate
of return come from? Piketty never says. He merely asserts
that the
return on capital has usually averaged a certain value, say 5
percent
on land in the nineteenth century, and higher in the
twentieth.
The basic neoclassical theory holds that the rate of return on
capital
depends on its (marginal) productivity. In that case, we must
be
thinking of physical capital-and this (again) appears to be
Piketty's view. But the effort to build a theory of physical
capital
with a technological rate-of-return collapsed long ago, under
a
withering challenge from critics based in Cambridge, England
in the
1950s and 1960s, notably Joan Robinson, Piero Sraffa, and
Luigi
Pasinetti.
Piketty devotes just three pages to the "Cambridge-Cambridge"
controversies, but they are important because they are wildly
misleading. He writes:
Controversy continued . . .
between
economists based primarily in Cambridge, Massachusetts
(including
[Robert] Solow and [Paul] Samuelson) . . . and economists
working in
Cambridge, England . . . who (not without a certain confusion
at
times) saw in Solow's model a claim that growth is always
perfectly
balanced, thus negating the importance Keynes had attributed
to
short-term fluctuations. It was not until the 1970s that
Solow's
so-called neoclassical growth model definitively carried the
day.
But the argument of the critics was not
about Keynes, or fluctuations. It was about the concept of
physical
capital and whether profit can be derived from a production
function.
In desperate summary, the case was three-fold. First: one
cannot add up the values of capital objects to get a
common
quantity without a prior rate of interest, which (since it is
prior)
must come from the financial and not the physical world.
Second, if
the actual interest rate is a financial variable, varying for
financial reasons, the physical interpretation of a
dollar-valued capital stock is meaningless. Third, a more
subtle
point: as the rate of interest falls, there is no systematic
tendency
to adopt a more "capital-intensive" technology, as the
neoclassical model supposed.
In short, the Cambridge critique made meaningless the claim
that
richer countries got that way by using "more" capital. In
fact,
richer countries often use less apparent capital; they
have a
larger share of services in their output and of labor in their
exports-the "Leontief paradox." Instead, these countries
became
rich-as Pasinetti later argued-by learning, by improving
technique, by installing infrastructure, with education,
and-as I
have argued-by implementing thoroughgoing regulation and
social
insurance. None of this has any necessary relation to
Solow's
physical concept of capital, and still less to a measure of
the
capitalization of wealth in financial markets.
There is no reason to think that
financial
capitalization bears any close relationship to economic
development.
Most of the Asian countries, including Korea, Japan, and
China, did
very well for decades without financialization; so did
continental
Europe in the postwar years, and for that matter so did the
United
States before 1970.
And Solow's model did not carry
the day. In 1966 Samuelson conceded the Cambridge
argument!
2.
The empirical core of Piketty's book is about the distribution
of
income as revealed by tax records in a handful of rich
countries-mainly France and Britain but also the United
States,
Canada, Germany, Japan, Sweden, and some others. Its virtues
lie in
permitting a long view and in giving detailed attention to the
income
of elite groups, which other approaches to distribution often
miss.
Piketty shows that in the mid-twentieth century the income
share accruing to the top-most groups in his countries fell,
thanks
mainly to the effects and after-effects of the Second World
War. These
included unionization and rising wages, progressive income tax
rates,
and postwar nationalizations and expropriations in Britain and
France.
The top shares remained low for three decades. They then rose
from the
1980s onward, sharply in the United States and Britain and
less so in
Europe and Japan.
Wealth concentrations seem to have peaked around 1910, fallen
until
1970, and then increased once again. If Piketty's estimates
are
correct, top wealth shares in France and the United States
remain
today below their Belle Époque values, while U.S. top income
shares
have returned to their values in the Gilded Age. Piketty also
believes
the United States is an extreme case-that income inequality
here
today exceeds that in some major developing countries,
including
India, China, and Indonesia.
How original and how reliable are these measures? Early on,
Piketty
makes a claim to be the sole living heir of Simon Kuznets, the
great
midcentury scholar of inequalities. He writes:
Oddly, no one has ever
systematically pursued Kuznets's work, no doubt in part
because the
historical and statistical study of tax records falls into a
sort of
academic no-man's land, too historical for economists and too
economistic for historians. That is a pity, because the
dynamics of
income inequality can only be studied in a long-run
perspective, which
is possible only if one makes use of tax records.
The statement is incorrect. Tax records
are not the only available source of good inequality
data. In
research over twenty years, this reviewer has used payroll
records to measure the long-run evolution of inequalities; in
a paper
published back in 1999, Thomas Ferguson and I tracked such
measures
for the United States to 1920-and we found roughly the same
pattern
as Piketty finds now.*
It is good to see our results confirmed, for this underscores
a point
of great importance. The evolution of inequality is not a
natural
process. The massive equalization in the United States between
1941
and 1945 was due to mobilization conducted under strict price
controls
alongside confiscatory top tax rates. The purpose was to
double output
without creating wartime millionaires. Conversely, the purpose
of
supply-side economics after 1980 was (mainly) to enrich the
rich. In
both cases, policy largely achieved the effect intended.
Under President Reagan, changes to U.S. tax law encouraged
higher pay
to corporate executives, the use of stock options, and
(indirectly)
the splitting of new technology firms into separately
capitalized
enterprises, which would eventually include Intel, Apple,
Oracle,
Microsoft, and the rest. Now, top incomes are no longer fixed
salaries
but instead closely track the stock market. This is the simple
result
of concentrated ownership, the flux in asset prices, and the
use of
capital funds for executive pay. During the tech boom, the
correspondence between changing income inequality and the
NASDAQ was
exact, as Travis Hale and I show in a paper just published in
the
World Economic Review.
The lay reader will not be surprised. Academics, though, have
to
contend with the conventionally dominant work of (among
others)
Claudia Goldin and Lawrence Katz, who argue that the pattern
of
changing income inequalities in America is the result of a
"race
between education and technology" when it comes to wages, with
first
one in the lead and then the other. (When education leads,
inequality
supposedly falls, and vice versa.) Piketty pays deference to
this
claim but he adds no evidence in favor, and his facts
contradict it.
The reality is that wage structures change far less than
profit-based
incomes, and most of increasing inequality comes from an
increasing
flow of profit income to the very rich.
In global comparison, there is a good
deal
of evidence, and (so far as I know) none of it supports
Piketty's
claim that U.S. income today is more unequal than in the major
developing countries. Branko Milanovi? identifies South
Africa and Brazil as having the highest inequalities. New work
from
the Luxembourg Income Study (LIS) places Indian income
inequality well
above that in the United States. My own estimates place United
States
inequality below the non-OECD average, and my estimates agree
with
those of the LIS on India.
A likely explanation for the discrepancies is that income tax
data are
only as comparable as legal definitions of taxable income
permit, and
only as accurate as tax systems are effective. Both factors
become
problematic in developing countries, so that income tax data
will not
capture the degree of inequalities that other measures reveal.
(And of
oil sheikhdoms where income goes untaxed, nothing can be
learned.)
Conversely, good tax systems reveal inequality. In the United
States,
the IRS remains feared and respected, an agency to which even
the
wealthy report, for the most part, most of their income. Tax
records
are useful but it is a mistake to treat them as holy
writ.
3.
To summarize so far, Thomas Piketty's book about capital is
neither
about capital in the sense used by Marx nor about the physical
capital
that serves as a factor of production in the neoclassical
model of
economic growth. It is a book mainly about the valuation
placed
on tangible and financial assets, the distribution of
those
assets through time, and the inheritance of wealth from
one
generation to the next.
Why is this interesting? Adam Smith
wrote
the definitive one-sentence treatment: "Wealth, as Mr. Hobbes
says,
is power." Private financial valuation measures power,
including
political power, even if the holder plays no active economic
role.
Absentee landlords and the Koch brothers have power of this
type.
Piketty calls it "patrimonial capitalism"-in other words, not
the real thing.
Thanks to the French Revolution, registry of wealth and
inheritance has been good in Piketty's homeland for a long
time.
This allows Piketty to show how the simple determinants of the
concentration of wealth are the rate of return on assets and
the rates
of economic and population growth. If the rate of return
exceeds the
growth rate, then the rich and the elderly gain in relation to
everyone else. Meanwhile, inheritances depend on the extent to
which
the elderly accumulate-which is greater the longer they
live-and
on the rate at which they die. These two forces yield a flow
of
inheritances that Piketty estimates to be about 15 percent of
annual
income presently in France-astonishingly high for a factor
that gets
no attention at all in newspapers or textbooks.
Moreover, for France, Germany, and Britain, the "inheritance
flow"
has been rising since 1980, from negligible levels to
substantial
ones, due to a higher rate of return on financial assets along
with a
slightly rising mortality rate in an older population. The
trend seems
likely to continue-though one wonders about the effect of the
financial crisis on valuations. Piketty also shows (to the
small
extent that data allow) that the share of global wealth held
by a tiny
group of billionaires has been rising much more rapidly than
average
global income.
What is the policy concern? Piketty writes:
[N]o matter how justified
inequalities of wealth may be initially, fortunes can grow and
perpetuate themselves beyond all reasonable limits and beyond
any
possible rational justification in terms of social utility.
Entrepreneurs thus tend to turn into rentiers, not only with
the
passing of generations but even within a single lifetime. . .
. [A]
person who has good ideas at the age of forty will not
necessarily
still be having them at ninety, nor are his children sure to
have any.
Yet the wealth remains.
With this passage he makes a
distinction
that he previously blurred: between wealth justified by
"social
utility" and the other kind. It is the old distinction between
"profit" and "rent." But Piketty has removed our ability to
use
the word "capital" in this normal sense, to refer to the
factor
input that yields a profit in the "productive" sector, and to
distinguish it from the source of income of the
"rentier."
As for remedy, Piketty's dramatic call
is
for a "progressive global tax on capital"-by which he means a
wealth tax. Indeed, what could be better suited to an age of
inequality (and budget deficits) than a levy on the holdings
of the
rich, wherever and in whatever form they may be found? But if
such a
tax fails to discriminate between fortunes that have ongoing
"social
utility" and those that don't-a distinction Piketty himself
has
just drawn-then it may not be the most carefully thought-out
idea.
In any case, as Piketty admits, this proposal is "utopian." To
begin with, in a world where only a few countries accurately
measure
high incomes, it would require an entirely new tax base, a
worldwide
Domesday Book recording an annual measure of everyone's
personal net
worth. That is beyond the abilities of even the NSA. And if
the
proposal is utopian, which is a synonym for futile, then why
make it?
Why spend an entire chapter on it-unless perhaps to incite the
naive?
Piketty's further policy views come in two chapters to which
the
reader is bound to arrive, after almost five hundred pages, a
bit worn
out. These reveal him to be neither radical nor neoliberal,
nor even
distinctively European. Despite having made some disparaging
remarks
early on about the savagery of the United States, it turns out
that
Thomas Piketty is a garden-variety social welfare democrat in
the
mold, largely, of the American New Deal.
How did the New Deal tackle the fortress of privilege that was
the
early twentieth-century United States? First, it built a
system of
social protections, including Social Security, the minimum
wage, fair
labor standards, conservation, public jobs, and public works,
none of
which had existed before. And the New Dealers regulated the
banks,
refinanced mortgages, and subdued corporate power. They built
wealth
shared in common by the community as a counterweight to
private
assets.
Another part of the New Deal (mainly in its later phase) was
taxation.
With war coming, Roosevelt imposed high progressive marginal
tax
rates, especially on unearned income from capital ownership.
The
effect was to discourage high corporate pay. Big business
retained
earnings, built factories and (after the war) skyscrapers, and
did not
dilute its shares by handing them out to insiders.
Piketty devotes only a few pages to the welfare state. He says
very
little about public goods. His focus remains taxes. For the
United
States, he urges a return to top national rates of 80
percent
on annual incomes over $500,000 or $1,000,000. This may be his
most
popular idea in U.S. liberal circles nostalgic for the glory
years.
And to be sure, the old system of high marginal tax rates was
effective in its time.
But would it work to go back to that system now? Alas, it
would not.
By the 1960s and '70s, those top marginal tax rates were
loophole-ridden. Corporate chiefs could compensate for low
salaries
with big perks. The rates were hated most by the small numbers
who
earned large sums with (mostly) honest work and had to pay
them:
sports stars, movie actors, performers, marquee authors, and
so forth.
The sensible point of the Tax Reform Act of 1986 was to
simplify
matters by imposing lower rates on a much broader base of
taxable
income. Raising rates again would not produce (as Piketty
correctly
states) a new generation of tax exiles. The reason is that it
would be
too easy to evade the rates, with tricks unavailable to the
unglobalized plutocrats of two generations back. Anyone
familiar with
international tax avoidance schemes like the "Double Irish
Dutch
Sandwich" will know the drill.
If the heart of the problem is a rate of return on private
assets that
is too high, the better solution is to lower that rate of
return. How?
Raise minimum wages! That lowers the return on capital that
relies on
low-wage labor. Support unions! Tax corporate profits and
personal
capital gains, including dividends! Lower the interest rate
actually
required of businesses! Do this by creating new public and
cooperative
lenders to replace today's zombie mega-banks. And if one is
concerned about the monopoly rights granted by law and trade
agreements to Big Pharma, Big Media, lawyers, doctors, and so
forth,
there is always the possibility (as Dean Baker reminds us) of
introducing more competition.
Finally, there is the estate and gift
tax-a jewel of the Progressive era. This Piketty rightly
favors, but
for the wrong reason. The main point of the estate tax is not
to raise
revenue, nor even to slow the creation of outsized fortunes
per
se; the tax does not interfere with creativity or
creative
destruction. The key point is to block the formation of
dynasties. And
the great virtue of this tax, as applied in the United States,
is the
culture of conspicuous philanthropy that it fosters, recycling
big
wealth to universities, hospitals, churches, theaters,
libraries,
museums, and small magazines.
These are the nonprofits that create about 8 percent of U.S.
jobs, and
whose services enhance the living standards of the whole
population.
Obviously the tax that fuels this philanthropy is today much
eroded;
dynasty is a huge political problem. But unlike the capital
levy, the
estate tax remains viable, in principle, because it requires
that
wealth be appraised only once, on the demise of the holder.
Much more
could be done if the law were tightened up, with a high
threshold, a
high rate, no loopholes, and less use of funds for nefarious
politics,
including efforts to destroy the estate tax.
In sum, Capital in the Twenty-First
Century is a weighty book, replete with good information
on the
flows of income, transfers of wealth, and the distribution of
financial resources in some of the world's wealthiest
countries.
Piketty rightly argues, from the beginning, that good
economics must
begin-or at least include-a meticulous examination of the
facts.
Yet he does not provide a very sound guide to policy. And
despite its
great ambitions, his book is not the accomplished work of high
theory
that its title, length, and reception (so far) suggest.
Notes
*The American Wage Structure,
1920-1947." Research in Economic History. Vol. 19, 1999,
205-257.
My 1998 book, Created Unequal, brought the pay-inequality
story up
from 1950 to the early 1990s. For a recent update, see James
K.
Galbraith and J. Travis Hale, "The Evolution of Economic
Inequality
in the United States, 1969-2012: Evidence from Data on
Inter-industrial Earnings and Inter-regional Incomes." World
Economic Review, 2014, no. 3, 1-19, at http://tinyurl.com/my9oft8.
*******
James K. Galbraith is
professor at the Lyndon B. Johnson School of Public Affairs,
the
University of Texas at Austin, and author of the forthcoming
book,
The End of Normal.