DR. PIKETTY’S REMEDY FOR CAPITALISM’S POTENTIALLY TERMINAL ILLNESS
February 16, 2014 § 3 Comments
The Ratio of Capital Income to Worker Income
Piketty designates the “stock of capital” as K. He defines “capital” more broadly than previous theorists. Here is his definition, according to Branko Milanovic, one of the secondary sources I have read: “The stock of capital includes all forms of explicit or implicit return-bearing assets: housing (which Piketty, unlike many authors, emphasizes as being an integral part of capital), land, machinery, financial capital in the form of cash, bonds and shares, intellectual property, and even human persons in the time of legalized slavery. ” His theory rests, in large part, on the relationship of K to the “flow of income”, which he designates as Y. He defines that relationship as β.
After postulating this relationship, he states the first “fundamental law of capitalism”: Milanovic writes: “The first fundamental law states that the share of capital incomes in total national income (α) is equal to the rate of return, in real terms, on capital (r) multiplied by β. There is nothing new here: this is simply an identity.”
I can’t tell you how many times I re-read these two sentences before I grasped their meaning. The fact that Milanovic stated them as “simply an identity” merely humiliated me. In case you have the same problem, here, I think, is what that means: First, you calculate the total amount of income. (“Y”) Then you calculate the total value of capital. (“K”) Then you calculate the rate of return on capital (“r”) by dividing the income generated by capital by the total value of capital (“K”). Then you multiply the result by β to get the share of the total income attributable to capital (“a”). (a/K)β = a
The more capital there is, the more “return on capital” will be generated. So, as the ratio of capital to total income increases, the ratio of income generated by capital to income from labor increases. To those of you with minds more agile than mine (I hope this is all of you), I apologize for this explanation. I need to write it down so it will remain available to me. I also write it down so that, in case I am wrong, some kind reader will send me a correction.
The Data On Which Piketty’s Theory Is Based
Piketty, unlike previous theorists, does not rely on household income data. He created a gigantic database consisting of tax information from France, the UK and the United States. Based on that database, he plotted a graph showing the β relationship as a U-shaped curve beginning before WWI to 2010. The ratio of capital to income was high until shortly before WWI; plunged during the two World Wars and the Depression; and has climbed back to pre-WWI levels during the past 40 years.
Piketty attributes the temporary decline of capital value and resultant income relative to non-capital income to the global destruction of capital during the two wars, the increased taxation of upper incomes to pay for them, and the Great Depression that occurred between them, when capital value fell.
Piketty contends that the two-war-depression period was a circumstance unlikely ever to be repeated. He has extended his analysis of fiscal data to include other developed countries (Germany, Italy, et. al.) and to time periods extending back for more than two centuries. He found no other instance similar to this period of time when a global Depression was bracketed by two world wars.
There are both advantages and disadvantages to his choice of data. On the one hand, it enabled him to compare results from different countries because fiscal data is available for all developed countries during very long time periods. On the other hand, fiscal data does not include information from those who file no tax returns, a group that includes those too poor to meet the minimum income required for filing. Also, tax returns do not include income consisting of government transfers of money, such as welfare, food stamps, etc.. And finally, until 1987, interest on government bonds was not taxed in the U.S. although it was plainly income.
Piketty contends that, regardless of these problems, his data is more accurate and comprehensive than data used by other theorists. I am inclined to agree with him. “Household income” is calculated on the basis of sampling techniques and assumptions that are at least subject to question as Piketty’s. For example, capital gains are excluded from household income. The “hard” data is based on 2004 incomes and then extrapolated to obtain current figures, surely an inexact process. Household data does not take account of the number of people in a “household”, a figure that varies widely in different countries and different environments. Finally, the way that household data is calculated varies among countries.
The Longterm Cumulative Effect of Piketty’s β
The revolutionary nature of Piketty’s analysis of capitalism does not become apparent until its long term effects are appreciated. He theorizes, based on the database he has compiled, that two circumstances are crucial to understanding capitalism. First, most people do not own capital, even as broadly defined by Piketty. They rely on their “human capital”: their ability to work and earn wages. Second, so long as β remains positive, meaning that income attributed to capital exceeds income attributable to wages, the wealth of capital owners exceeds wealth of those who rely on “human capital” and, when the capitalists’ income exceeds their level of consumption, they save the excess and i invest in more capital, thus creating a progressively widening gulf between them and the rest of the population.
Piketty identifies the inheritance process as a major contributor to this evolution toward more and more inequality. “Human capital” obviously dies with its owner, but capital survives for generations. The same is true, of course, of capital owned by corporations, that are designed to last indefinitely.
This depicts capitalism in ways fundamentally different from Keynes. Keynes regarded capitalism as a system that generally functioned as a just and equitable mechanism for distributing wealth that, from time to time, became unbalanced because of unwise speculation by its rentiers, the practitioners of financial speculation or various types. He taught that those problems could be corrected with carefully guided interest rates, progressive taxation and “public investment” (public works, infrastructure repair, etc.).
Piketty, to the contrary, argues that such measures will not stop the relentless disparity between the owners of capital and the rest of the population. In fact, he seems to be saying, “It’s worse than you thought and palliative remedies will not cure it.”
The Piketty Solution
According to the secondary sources I have read, and according to some of Piketty’s published articles I have scanned, he proposes a solution that is truly revolutionary. He contends that confiscatory taxes on the wealthy followed by regressive distribution of money to those at lower income levels are the only effective ways of preserving the capitalist system. And, he recognizes that such solutions, especially the taxation remedy, must be administered globally, not nationally. This is necessary to prevent the wealthy taxpayers from transferring their wealth to “safe haven” countries thereby thwarting the remedy.
To read this, while the daily press reports that the U.S.. Congress won’t even consider repealing the tax cuts on our wealthiest taxpayers, is almost surreal. Piketty is not naive. He acknowledges his awareness of the power that has devolved on wealthy capitalists as a result of their ability to buy political influence. He presents the facts, based on his research and offers solutions. He is like a man posting a large sign: DANGER! STOP! ROAD ENDS! THOUSAND FOOT CLIFF AHEAD! He has done his job. He does not feel responsible if, instead of stopping, we step on the gas.