Understanding Piketty, part 2
In my last post, I gave an introduction to the massive data work underlying Capital in the Twenty-First Century, as well as two clear results from Piketty’s work. First, he showed that the optimistic Kuznets view after World War II that inequality was well on its way to being conquered was wrong, based on putting too much stock into a short-term trend. Inequality in fact has been increasing in the industrialized world since about 1980. Second, Piketty showed that a slow-growth economy is ripe for an increasing concentration of wealth in society, absent government action to counter that trend. He introduced the relationship r>g, which says the private return on capital is greater than the economic growth rate. When this holds true, as it has for most of history, inequality is likely to increase.
In this post, I address Part Two, “The Dynamics of the Capital/Income Ratio. The next two posts will address parts Three and Four, followed by a summation and critique of certain aspects of the book.
One important observation that Piketty makes is that in Europe, capital in the form of agricultural land accounted for 300-400% of gross national income (GNI), and total capital reached about 700% of GNI in the early 1700s. In Britain (Figure 3.1), France (Figure 3.2), and Germany (Figure 4.1), total capital fell below 300% of GNI in the period encompassing World War I and World War II. By 2010, total capital was back up to about 600% of GNI, but its composition had changed, with agricultural land falling to vanishingly low levels, replaced by housing and other domestic capital. In the United States (Figure 4.2), by contrast, farmland in 1770 was plentiful and cheap, making up about just 150% of GNI. Total capital also was much lower than in Europe, only about 300% of GNI. In the twentieth century, however, the U.S. did not suffer the devastation of the World Wars, so it had fewer and smaller dips in the value of total capital, which had risen to about 450% of national income in 2010; like in Europe, however, the value of U.S. agricultural land had also fallen to a tiny fraction of national income. Piketty points out if one includes the value of slaves, total U.S. capital in 1770-1810 rises by another 150% of national income (Figure 4.10), meaning that the capital/income ratio in the United States has been even more stable than it appears at first blush.
For Piketty, the resurgence of the capital/income ratio in the late 20th century is a consequence of slow growth. One important result of this is that capital’s share of national income has increased since 1975, and labor’s share has consequently fallen. According to his data for eight rich countries (the United States, the United Kingdom, Germany, Japan, France, Canada, Italy [the G-7, as they are usually called] and Australia.), “Capital income absorbs between 15 percent and 25 percent of national income in rich countries in 1970, and between 25 percent and 30 percent in 2000-2010” (Figure 6.5, p. 222). Notably, he raises the important point, central to my own academic work, that the increasing mobility of capital increases capital’s bargaining power vis-a-vis both labor and governments (p. 221). He considers it likely that this factor has been mutually reinforcing with the ability to substitute capital for labor. I would consider it not merely likely, but close to self-evident. Moreover, he omits (though I am sure he is aware) that one use capital mobility has been put to is to substitute less expensive for more expensive labor.
This increase in capital’s share of national income shatters another comforting standard economic view, that the relative share of capital and labor is fixed. This assumption is built into a workhorse of neoclassical macroeconomic analysis, the Cobb-Davis production function. Piketty shows that, as with Kuznets work, the results of Cobb and Douglas generalize from a data sample that is far too short in term (p. 219).
My next post will analyze Part Three, “The Structure of Inequality.” See you soon.
Kenneth Thomas wrote: “Notably, he raises the important point, central to my own academic work, that the increasing mobility of capital increases capital’s bargaining power vis-a-vis both labor and governments (p. 221).”
This two part factoid does not get near enough attention.
Starting with NAFTA, our government began a policy of implementing trade policies that reduced tariffs in the name of providing cheaper goods to Americans. We were told that Global Free Trade would be a “rising tide that would lift all boats”. (Capitalized because I view it as a religion.)
Corporations lobbied for free trade. They wanted the right to move production overseas without facing tariffs when their products were shipped to the US. This much was obvious.
What was not so obvious, was that by removing tariffs, the US government had left itself powerless over corporations. If they want lower taxes they just threaten to move overseas. And has anyone else noticed that the Republican mantra has been expanded to include the evils of regulation?
Global Free Trade has given us lower wages, higher unemployment, higher underemployment, lower labor participation rates, corporate bailouts, and a kind of corporation exodus for taxation purposes.
Global Free Trade has also given us a China which has used the proceeds to modernize and expand their Navy, and to become territorially expansive as concerns the East and South China seas. This is causing a military buildup in the region. And they want to drive the US out of what have been long accepted as international waters. Wait a minute, don’t China, Japan, the Philippines and the United States all have McDonald restaurants?
Corporations and China should be reminded that increases in tariffs could be one election away. Treaties can be abrogated. The sooner the better as far as I am concerned.
I think Jim, it started before NAFTA. With the de-emphysis on antitrust acknowledged in the cry of “economies of scale” we started down this road of money from money (the layman’s equation for r>g) with industry consolidation. It was in all industries. Next was the introduction in the tax code of “stock options”. Remember when the brand Sunbeam was purchased? It was all about rent collecting. While all this was going on, the people cheered Reagan as he broke the air traffic controllers.
The trial run for the big money from money was the savings and loan f*&^up. All this set the stage for NAFTA and banking.
Jim, obviously I agree that they need more attention than they usually get. But let us also remember that real wages reached their peak in 1972, so this is well before NAFTA. Moreover, real wages fell to their lowest point since then in 1992. Beginning in 1993, real wages increased again, though they have not yet gotten back to their peak. This needs explaining; probably due to a more labor-friendly NLRB during the Clinton administration and some increase in the minimum wage. But I don’t claim to know the whole answer.
Kenneth Thomas wrote: “But let us also remember that real wages reached their peak in 1972, so this is well before NAFTA.”
The period between about 1973 and 1986 (inclusive) was dominated by oil prices. So it is difficult to generalize about other economic factors.
See oil price table here:
Year—-Avg Annual Price(Inflation Adj)——-Percent Increase
Oil prices rose slowly from about $20.00 a barrel in 1972 to about $106.00 in 1980. That caused prices to go up on just about everything. Employees still had the power to negotiate higher pay or quit and get a better paying job. So inflationary cycles resulted. Remember President Ford’s Whip Inflation Now (WIN) program?
Oil prices started to go down in 1981 and inflation was tame after 1981.
Year—-Dec to Dec%
I realized that Fed Chairman Volcker had also been at work in 1981. The Fed Funds Rate peaked at 18.9 in January 1981 and 19.1 in June 1981. This appears to be a chicken and egg problem.
But the Fed had raised rates at different times during the 1970s and they could not reduce inflation. In 1976 the Fed Funds Rate was low, and inflation was low, but oil prices were not increasing much either! This looks like an interaction between oil prices and the Fed.
My guess is that OPEC finally saw that they were driving inflation and so decided to moderate their price demands after 1980.
So wages were interacting with oil more than monetary or other government policies. But this would only excuse the 1970s and up 1986. (1986 because oil prices were decreasing thus leaving more discretionary income.)
It occurs to me that the personal income increases would be helpful in understanding my comment above.
Based on data from: BEA Table 2.1 Personal Income and its Disposition.
Year—Personal Income increases
Does anyone believe that employees would have the power to get those kind of pay increases today? Again, It was the power to demand higher pay or quit and find a higher paying job. The last is sometimes forgotten. Today it would not be possible.