I sense that we are witnessing a special moment in economics with Paul Krugman’s article today, Notes on Piketty. He is exploring the new work by Thomas Piketty, Capital in the 21st century. He focuses on the difference between r, the rate of return on assets, and g, the overall rate of economic growth. When r is greater than g, wealth will accumulate in the hands of capitalists. When r is less than g, capital wealth falls and labor’s wealth rises through increased return to labor.
He then says that the economy (global) will converge overtime to a steady-state growth rate of n, which is the sum of labor force growth and technological progress. Piketty points to a period from 1913 to 2012, when n grew fast. And r was less than g. We saw the great rise of the middle class labor sector during that time. Now Piketty says that n is falling, that the global labor force and technological progress is slowing down. There are many reasons to think this. I might point to a series of videos from a lecture by Dr. Philip Lawn (video #1).
Krugman points to an extremely critical idea…
“a decline in n will lead to a rise in the capital-output ratio and a fall in both r and g. Which falls more? Well, it depends on what happens to the capital share in output”
Exactly… He is finally starting to talk about capital and labor share.
When n declines, the rich capitalists protect their wealth by raising their share of output. They are able to push r up relative to g as both fall. Thus their accumulated wealth will not deteriorate and may even grow more. The middle class will lose wealth in the process.
Then Mr. Krugman asks the greatest question of all. We are witnessing a special moment.
“How much of the decline in r relative to g in the 20th century reflected fast growth, and how much reflected policies that either taxed or in effect confiscated inherited wealth?”
Can you smell the flowers blossoming? Yes, the New Deal helped build a strong middle class. Yes, higher tax rates on capital and high incomes helped build the middle class. Yes, social insurance policies helped build the middle class. But what about monetary policy?
This is where Mr. Krugman may see the light. Loose monetary policy has been complementing not only the recent rise in capital share, but also the unraveling of policies that spread wealth from capital to labor. I refer specifically to policies of deregulation of the financial sector, of lower taxes on capital income and of wages falling behind a living wage standard. These policies increase the debt burden on labor by the way.
Loose monetary policy is also a policy that pushes up r relative to g. The rate of return on assets is increased when the cost of capital is lowered. Thus loose monetary policy is adding to the wealth inequality that is bringing down the US and other advanced economies. The US must protect its middle class. The solution is to raise the cost of capital through a combination of tightening monetary policy, raising taxes on capital & higher incomes and strengthening once again the transmission mechanisms of wealth to labor, namely unions, living wages and investing in locally owned businesses.
Mr. Krugman is realizing that the cost of capital must rise in order to change the tide for wealth to flow back to the middle class. The effective rate of return on “global” assets, r, must be pushed down by policy, which includes monetary policy. Look, transmission mechanisms of wealth to labor are extremely weak. So, loose monetary policy has been causing a lot of damage by establishing greater long-term wealth inequality. Piketty is warning us about this.
Mr. Krugman’s post ends unfinished. I sense that he needs time to think some things through. I can hardly wait for his follow-up.
One note: Let’s give credit where credit is due. The period from 1913 to 2012 when the middle class surged was forged in large respect by Beatrice Webb. Her work supported Keynes and the Institutional Economics later forwarded by John Commons. Students of John Commons later developed the New Deal under FDR. She even supported the role of cooperatives to strengthen local ownership of business and assets.
“In 1913, she co-founded with her husband the New Statesman, a political weekly edited by Clifford Sharp with contributions from many philosophers, economists and politicians of the time including George Bernard Shaw and John Maynard Keynes.” (Wikipedia on Beatrice Webb)
Mr. Krugman is realizing something that was understood by Beatrice Webb long ago. I reference this paper by Bruce Kaufman… Sidney and Beatrice Webb’s Institutional Theory of Labor Markets and Wage Determination