DR. PIKETTY’S REMEDY FOR CAPITALISM’S POTENTIALLY TERMINAL ILLNESS

February 16, 2014 § 3 Comments

Summary
This essay is about a new book by Thomas Pikkety.  He relies on a giant database of fiscal information to contend that the capitalist economic system leads inevitably to a progressively widening disparity between the wealth owned by a progressively smaller number of persons and the wealth of the rest of the participants in the system.  This disparity results from the ratio of wealth attributable to capital ownership and wealth attributable to work, a ratio Piketty contends becomes progressively skewed toward capital ownership wealth.  He states that this process if not dependent on the cyclical ebbs and flows of the market, nor is correctable by the usual policy remedies of taxation and government spending by national governments.  He proposes a global remedy.
Sources
I have relied primarily on the following sources:
[This Milanovic review is the best source I have found.  It is not online, but this link will take you to the site of a Journal of the World Bank.  At the upper left corner of the screen is a clickable button that will download the review.  It is excellent.]
The limits of My Abilities
For the past few weeks I have been reading and thinking of  Thomas Piketty, a French economist and prolific writer about wealth inequality.  A few months ago he published a 950 page book entitled Capital In The Twenty-First Century”.  I have not read the book and I doubt that I ever will.  First, it is in French.  Second, I am so ignorant about math that, even in March, when the English translation becomes available in America, it will probably have so many formulae and mathematical symbols that I will not be able to understand it.  And, finally, I have learned that after reading about fifty pages of serious prose my mind begins to wander and I realize that I am not really absorbing what I’m reading, which means that Piketty’s book would take me close to a month of concentrated effort.So, although I may not tackle Piketty’s book, I will ,more likely than not, continue to rely on the reactions of others to appreciate his incites.
The Importance of Piketty’s BookThe purpose of this essay is to organize my own thoughts about Piketty’s ideas and to alert my readers  for what I believe is a major intellectual event.  Piketty’s book, according to the accounts I have read, is not a mere commentary on capitalism based on the structural systems of previous economic theories.  It appears that he is not a Keynesian, not a Marxist, not a follower of Ricardo or Malthus or Adam Smith.  He has taken advantage of digital and communication technology not available to any of those economists and has used it to accumulate and aggregate a vast store of data that would have been impractical, probably impossible, for them to match.  And, based on that data,  his book is a road grader that mows down some of the fundamental premises upon which previous economic theories were based and reaches conclusions at odds with all of them.

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.

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§ 3 Responses to DR. PIKETTY’S REMEDY FOR CAPITALISM’S POTENTIALLY TERMINAL ILLNESS

  • Thomas Laing says:

    Bob:

    I liked the Clark candy commercial. When I was 5 or so I remember my Grandfather would buy me a Clark bar about about once a week. As far as Capitalism is concerned, left unbridled its like the other systems it will eventually go from the sublime to rediculous and self destruct.

    Hope all is well in Texas.

    Tommy

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  • Christy says:

    Hi Papa, I want to thank you for your summary of Piketty’s analysis since you’re doing better than I am to make time to read multiple secondary sources about it! You have been my source, and I agree it is important. I don’t know if you will be interested in this, but my comfort when I read about the many various unsustainable human endeavors past and present has become the concepts of “spiral dynamic” theory (see Don Beck, Chris Cowan, Ken Wilber). Spiral dynamic theorists have attempted to formulate a big picture of human consciousness evolution, in which the failures of the last set of ideas drives evolution to a new set. The failures of capitalism from that perspective are seen as driving a shift to notions of equality and redistribution (the colors “orange” and “green” are used to symbolize the larger set of ideas that tend to come with each of these economic idea sets). What is most encouraging to me about locating our society somewhere at this juncture is the notion that the next level after green (to which we become driven by, for example, green’s failure to make necessary value judgments due to over-commitment to universal equality) is the first that is “integrally” aware of all the “lower” (the main–and very green–criticism of this theory being its hierarchical nature) levels, and therefore able to make use of the positive aspects of each without the single-minded dogmatic application that always leads to system collapse. This is what gives me hope for humanity, so I thought I would pass it on. I apologize for all the parentheses! 🙂

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    • Bob Hall says:

      Christy, I am pleased that you found my essay interesting. I am glad that you are thinking about ideas that offer hope that the human condition may be progressing toward more enlightenment and justice. I have not read enough to understand very much about the evolutionary analysis of human thought. I know that Marx believed that capitalism was merely a prelude to socialism and that the transition would occur as a result of what was known as dialectical materialism, a concept he imported from Hegel [thesis, antithesis, symthesis]. Hegel, I think, based on my very limited understanding of his ideas, applied that analysis to consciousness and Marx was said to have “stood Hegel on his head” and applied the analysis to material reality, i.e.the economic system. Marx thought that capitalism exploited the working class and that, when the degree of unjust exploitation became intolerable, the workers would revolt and a classless society would result. The socialist ideal was, “from each according to his abilties; to each according to his needs”. There was a revolution in Russia in 1917, and a socialist government did result, but the ideal classless society was never achieved. The idealism of Trotsky was rejected; he fled to Mexico, was granted sanctuary by Diego Rivera and Frieda Kahlo, and was assassinated with an axe to the head by an agent of Stalin.

      I assume that the rejection of the “hierarchical nature” of capitalism to which you refer would be something like the ideals to which the socialists aspired but failed to achieve. I know of only one instance where that idea actually worked: The early years of Zionist colonization of Palestine, when young Jews formed kibbutz’s. I am reading a new book by Ari Shavit, “My Promised Land” that describes some of that history. That brief episode gave way to violence and war and, finally to the nation of Israel. Israel today, however, is not a socialist utopia nor is it a classless society. There are social, religious and economic hierarchies in modern Israel.

      One more thought: Yesterday I read a long article published in The Rag Blog, by Chellis Glendinning entitled ,”A Radical Imagination: Dilemmas and Desire While Reading Pedro Susz”. This article is about the evolution of consciousness, but Susz is a philosopher who contends that the dynamic that changes thought and culture is what he describes as “insubordination”. I don’t think he advocates violent revolution. He apparently believes that we should somehow break out of and reject what he regards as the cultural imprisonment that engulfs us. Some parts of the article assumed a level of education and learning beyond mine, but I found it interesting. If you want to take a look, here is a link: http://www.theragblog.com/

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