This Is the End


Markets, Risk and Human Interaction

May 7, 2014

Piketty Myopia

Thomas Piketty's book Capital in the Twenty-First Century has been lauded for its detailed analysis of data and for the end result of that analysis, a sweeping statement of an inexorable widening of the distribution of wealth between those with capital and those without. There is unabashed glee among those who have bemoaned the plight of the middle class as the one percent has pulled away, waving the book as the gotcha ya for income redistribution. As should be clear from some of my previous posts, I am one of those people bemoaning the plight, but I am a little slower than many others to take up the Piketty banner.

The book's argument looks at wealth and growth data over the past three centuries, and takes its implications forward with a similar, historical scope. In the twenty-first century” is just that; Piketty is willing to push the implications of his analysis not just over the next decade or two, but about as far as you want. To hear people discuss it, he has discovered the equivalent of a law of physics, namely that capital grows faster than GDP, and if those who own the capital are taking a larger share than GDP has to offer, those without capital must be taking less. Given the miracle of compounding, this is going to lead the capitalists not only to pull away from the proletariat, but pretty much to own everything.

It is easy to run into problems when you are assuming the future will look the past, all the more so when you are also assuming exponential growth. Capitalism is not a law of nature; it need not look the same in the future as in the past; it doesn’t even need to be at the core of society. In the sweep of history, capitalism is a recent development, one that happens to encompass roughly the three hundred years Piketty is using for his analysis. So we should temper our excitement; his work is really based on one, very long-term, sample. To see this point, rather than looking back for three hundred years, go back a few thousand. In the West we have had two other periods comparable in many respects to that of the Industrial Era of today: The Roman Era, and then roughly a thousand years later the Commercial Era. Capital has been the dominating force this time around; in the others it was the military/political complex and the Church, respectively. And in both cases, the writers of the time assumed the structure of the era would go on indefinitely. It was just the way the world worked. If we went back to the these times, the theme would be the consolidation of the political corpus or of the Church, the analysis would not have been centered on the divisions between those with capital and those without. (I won’t get into the comparable time period in China’s history, but given that Piketty cloaks his thesis with the scope of all human history, he should add a second sample to his analysis and see how his thesis fits the dynasties in China over the past couple of millennium. My bet is, not so well).

Will the future look like the past?
What might move us away from capitalism being the universal underpinning for society? Can the world look different in the future? Of course it can. How that happens and what comes next is an open question – people can't even agree on what led to the end of the Roman Era, and there we have the advantage of history to guide us. But here are some things just to give a flavor of the ways in which the capitalist system might be nudged from the current being the true and final state of mankind:

Maybe the need for capital will diminish. All of the discussion of labor and capital presupposes that labor and capital matter. Will we move into a production mode where our demands are met with low capital expenditure? Piketty recognizes the obvious point that if there is little need for capital – and technology could bring that about – then his argument is no longer valid: “If capital is of no use as a factor of production, then by definition its marginal productivity is zero. In the abstract, one can easily imagine a society in which capital is of no use in the production process. ”It might be something to think about in the abstract, but in his view it is not worth lingering, because “in all known human societies, including the most primitive, things have been arranged differently.” That is a pretty broad statement. Even if true, if extrapolating exponential growth is one red flag, a dismissal based on an its-never-happened-before argument is a second.

Maybe we will all become capitalists. Look at the low amount of capital that has been needed for many recent start-ups. Those supplying the labor are also the owners and bring with them their own capital. Perhaps those who labor also be those who own the capital with which they labor? In subsistence agriculture, each farmer owns his own capital, his plot of land. Why not subsistence capitalism? We already have outsourced many tasks to ourselves by using the cheap capital of computers and the Internet; and will be able to do more as 3-D printing and crowd sourcing comes of age.

Maybe the implications of differences in income and wealth will diminish. All of the discussion of wealth and income distribution presupposes that differences in income and wealth matter. As Piketty notes, the nineteenth century novels focused on wealth. Wealth was measured by the number of servants, and thus wealth as a multiple of average earnings x income from capital was key determinant of status. What is the focus today; what might it be twenty or thirty years from now? Looking at the middle class, which is the focus for both Piketty and many of his adherents, could we end up in a world where the differences from a day-to-day lifestyle standpoint are compressed between the super rich and the 'doing OK'? This can happen if what both the super rich and we spend our time on is inexpensive. We are heading in the direction already. We share the same smart phones and spend time in front of the same screen consuming the same content. Of course when it comes to rare wines, contemporary art, and airplane views of Central Park, a gap will remain. But for many of the super rich, we already are seeing erosion; a generation ago cars divided the rich from the middle class; now some of the wealthiest drive the same car I do.

Maybe the consumption of capital-intensive goods will diminish. Consumption drives capitalism. What happens to the consumption of the products of the Industrial Age if we move into a more virtual economy? Consumption of virtual goods almost by definition does not require a lot of the brick and mortar capitalism that has dominated the Industrial Age. Some things, like cell phones and televisions are getting cheaper and cheaper, others like education more and more expensive. If those in the lower rung weight the former more heavily than the latter – and if at the end of the day we find the day-to-day consumption of even the wealthy is also biased that way (I say “at the end of the day” to mean in the post-college years), then much of the discussion of the distribution of wealth becomes moot.

The Exception is the Rule
Piketty notes that the events from 1914 through 1945 altered the course of expanding inequality, and did so even into the 1970’s and 1980’s. “One major lesson is already clear: it was the wars of the twentieth century that, to a large extent, wiped away the past and transformed the structure of inequality.” But that is now the past, and we are back on track: “Today, in the second decade of the twenty-first century, inequalities of wealth that had supposedly disappeared are close to regaining or even surpassing their historical highs.”

The period of retrenchment from his law of growing inequality is hard to take as an aberration given that it extends nearly seventy years. That is a big chunk of time, even if you are looking at a period from the 1700’s to the present. But Piketty does pull out this period as an aberration, as an exception to the rule. But it is not. It is part of the rule. It is an example of the ebb and flow of society and nature, of the noise that destroys and supplants family fortunes, states, and civilizations. It is not unique: for example, in the fourteenth century we had the Black Death, the Hundred Years’ War, and years of devastating famine. Not to mention financial failures that dwarf those of the Great Depression – but they in turn were so dwarfed by the other calamities that they hardly merit a footnote for the period.

Piketty is unequivocal about the effects in the early twentieth century being an aberration, but not about why it was a period when his thesis did not obtain. “…we must insist on the fact that the fall in the capital/income ratio between 1914 and 1945 is explained to only a limited extent by the physical destruction of capital (buildings, factories, infrastructure, etc.) due to the two world wars…In fact, the budgetary and political shocks of two wars proved far more destructive to capital than combat itself.”

So it was not just the destruction of capital, but political shocks. But if that, here is another idea: The period between 1914 and 1980 was the only extended period from the ushering in of the Industrial Age to now where there was no industrial revolution. The first industrial revolution ran from about 1760 to 1840. The second went from the latter half of the 19th century (around the time of the introduction of Bessemer steel in the 1860s) until World Was I. And the third industrial revolution, the computer age, began to gather steam in the 1980s. So I could take Piketty's data and argue that the disparity occurs during periods of industrial revolution, and falters otherwise. No industrial revolution, no problem.

But I'm not going to move into a teleological discussion on how our society could be transformed, anymore than I would talk about the demise of the Roman or the Commercial Era, except to point out the obvious, that unexpected things come along. And to note that, as I have pointed out elsewhere for the financial markets, the more complex and tightly coupled a society or era, the more likely something that does come along can exact a fatal toll.

Conclusions are Opinions
We can move on from Piketty’s thesis to his policy conclusions, and do so independent of the arguments that make up the bulk of the book. It is enough to have the opinion, as many already do, that the disparity in income and wealth is too great, and that the immobility up and down the ladder also is too great. Or that, absent political action, these will become too great in the future. What disparity and immobility is too great is a matter of opinion, and after his analysis, that is how it remains. And if the issue is that the disparity will become too great in the future, the prudent course might be to wait and see what the future brings. The question of redistribution is a political, even a philosophical issue, not an economic one. (A side note: He differs from some others in arguing for taxes on wealth, but that is nothing new. Indeed that is how things were taxed in the China’s Song Dynasty).

Piketty’s opinion seems to be that if we project out to the point that the wealth gap becomes what it was during the Belle Epoque of the early 1900's, we have gone too far. Another person could argue that such a disparity is fine, and then we are at the “agree to disagree” point of the argument. He does ask, “Taking all these elements into account, what is the “right” split between capital and labor? Can we be sure that an economy based on the “free market” and private property always and everywhere leads to an optimal division, as if by magic?” There are not many who really believe in that magic. The question of the ideal split between labor and capital has been debated for over two centuries, which is to say it is a question that will probably never arrive at an answer. Marx stated it as the center of class warfare, couching it in terms of the working day:

The capitalist maintains his rights as a purchaser when he tries to make the working-day as long as possible…. On the other hand...the laborer maintains his right as seller when he wishes to reduce the working-day to one of definite normal duration. There is here, therefore, an antinomy, right against right, both equally bearing the seal of the law of exchanges. Between equal rights force decides. Hence is it that in the history of capitalist production, the determination of what is a working-day, presents itself as the result of a struggle, a struggle between collective capital, i.e., the class of capitalists, and collective labour, i.e., the working-class.

Marx begins with an acknowledgement of the perception of rights on the part of both the capitalist and the laborer, but then argues that the question of the length of the working day cannot be solved by an appeal to rights, but only through class struggle, wherein “force” decides between “equal rights”. (Force can mean physical force, but can also mean the force of the political process).

It is difficult to do much more than simply take sides when it comes to economic rights, because what we call economic rights are really nothing more than the bargaining in an exchange between those providing labor and those providing capital. The social and economic pie has to be split, and there is no objective way to do so. There are some areas of fairness in the civil sphere – freedom from slavery and torture – but what are the rights inherent for a particular term of exchange between the parties in a trade?

Where does this battle lead? For Marx, left unfettered capital digs it own grave, for Piketty, it grows without bound and swallows the world. For Marx, the return on capital falls to zero, for Piketty it persists above the growth rate of the economy. We can argue that Marx is wrong because up to this point we have not witnessed his outcome. I argue that Piketty is also wrong, because he makes the common error of assuming the future will look like the past, even as he recognizes that the past holds a source of failure for his thesis.

Views and opinions expressed are those of the authors and do not necessarily represent official OFR or Treasury positions or policy.