Capitalism’s Mortality Table

January 26, 2015 § 2 Comments

Summary

This essay is my reaction to Thomas Piketty’s book, Capital in the Twenty-First Century.  Based on a massive database composed of comparative values of labor income, return on capital income and value of capital, Piketty argues that capitalist economic systems trend toward income and wealth inequality.

He warns that, unless this trend is countered by fiscal redistribution of capital values, the trend will, over time, result in intolerable degrees of inequality.  His thesis is generally based on data that shows that the rate of return on capital, which he designates “r” exceeds the growth rate of total income or output generated by the economy, which he designates “g”.  His equation is thus r>g.

Mortality and Economics

We have a unique ability.  We perceive our  own mortality.  As medical science progresses, it becomes increasingly  capable of predicting our life expectancy, based on our life styles, habits and infirmities.  This information, however, is individually specific and typically concerns relatively short time periods.

Mortality tables, instead, are broadly based on aggregate groups based on age, sex and national location.   They analyze longer time periods.

Until recently, we have not had a mortality table to measure the life span of our capitalist economic system.  Thanks to Thomas Piketty, we now have one.

He has compiled, charted and analyzed an unprecedented database of income and wealth measurements in history, gleaned from records kept by industrial capitalist countries including the United States, European nations and Japan.  His data covers the period of time from 1800 to 2012.    Based on that data, he does not furnish us a date certain when capitalism will implode, but he does offer a road map of why it will implode, if several very significant and unprecedented measures are not utilized.

This is an issue that has been the subject of pivotal scholarship since 1776, when Adam Smith’s Wealth of Nations was published.  Smith concluded that capitalism was a perpetual motion machine, guided by “an unseen hand”.  He thought it was immortal.

In 1936, John Maynard Keynes published The General Theory of Employment, Interest and Money.  His book was like Dr. Spock’s 1946 Baby and Child Care.  Keynes diagnosed chronic problems of capitalism and prescribed specific remedies that would avoid their harmful results.  If his directions were followed, the health of capitalism could be maintained, just as Dr. Spock explained how to guide parents’ management of their children’s way through childhood.

Piketty differs from Smith and Keynes in two ways:  He differs from Smith because Smith was not analyzing reality.   He was reasoning a priori, based on unrealistic assumptions about human motivation  and the aggregate effects of that motivation in an unrealistically assumed marketplace.  Piketty, with meticulous discipline, bases his analysis on actual data, acknowledging, step by step, its limits and approximations.

Piketty’s analysis differs from Keynes because his horizons are measured in decades and centuries, while Keynes’ are designed for solutions to problems that  emerge and require solutions in months, sometimes days.

Again, Keynes’ remedies  are  like Dr. Spock’s short term advice for childhood’s time period.  Piketty has constructed mortality tables for use during indeterminate time periods.  [I have not mentioned Marx, but Marx, like Adam Smith, based his prediction of worldwide revolution on assumptions about human motivation that have, so far, proved to be inaccurate.]

A Personal Note

Beginning in February, 2014, I posted four or five essays on this blog about Piketty’s book.  [See Dr. Piketty’s Remedy for Capitalism’s Potentially Terminal Illness and several subsequent posts]  When I wrote those essays I thought the daunting length (over 700 pages) of his book would prevent me from ever reading it.  I also feared my meager knowledge of math would put his analysis beyond my intellectual reach.

Since then two things have happened.  I developed a need for a diversion from worrying about my wife’s health [She has been in hospice care for the past several months.]  So, I bought a Kindle, downloaded the book and began reading.

And, as I delved into the professor’s writing, I discovered that he shared my aversion to complex mathematics, not for lack of ability but because he believes mathematical models have limited utility as tools to explain and analyze macroeconomic phenomena.  He argues that, more often than not, such models are either misleading or irrelevant because they are not firmly rooted in actual data.

He writes, “For far too long economists have sought to define themselves in terms of their supposedly scientific methods. In fact, those methods rely on an immoderate use of mathematical models, which are frequently no more than an excuse for occupying the terrain and masking the vacuity of the content.

And again:  “Economists are all too often preoccupied with petty mathematical problems of interest only to themselves. This obsession with mathematics is an easy way of acquiring the appearance of scientificity without having to answer the far more complex questions posed by the world we live in.”

The Piketty Experience

Reading his book is like taking two or three college courses from the same professor, whose syllabus might be entitled “Everything You Ever Wanted to Know About Everything.”  He cites Honore de Balzac and Jane Austin more often than economists.   He refers to the TV series Madmen.  He presents his subject in short essays, using conversational language, punctuated with occasional deadpan humor that surprises you.

He is often at the blackboard, illustrating his lecture with yet another graph.  He weaves his story back and forth from the French Revolution of 1789, to the two world wars and the Great Depression between 1910 and 1950; from the “Gilded Age” to the Great Recession of 2008.   He transitions easily from French politics, to the policies of Margaret Thatcher in Britain, to those of Ronald Reagan in the U.S..

Piketty’s book reminds me of Maurice Ravel’s Bolero.  [If you want to hear what I am referring to, here is a link:  Bolero ][A comment appended to this performance declares that the worst job in a symphony orchestra is drummer during Bolero.]  The professor discusses and analyzes each of the three parts of his argument from every angle, citing several, diverse sources of information about them, but he ties each digression tightly to the relevant elements in his argument.

His message is this:  The return on capital exceeds the growth of the “flow of income” generated by a capitalist economy.  The result is progressively increasing inequality of wealth favoring a dwindling number of very rich people and an expanding number consisting of everyone else.

This happens regardless of periodic cyclical gains and losses.  It happens despite government efforts to counter the dislocations caused by market collapses or periodic “bubbles” resulting from “irrational exuberance”.   The pace of progression may vary and may at times pause but, over time, the direction trends toward inequality.

The reason is twofold:  Those with large stocks of capital cannot consume all  the income generated by their holdings, so they save portions of their income and invest those savings in buying more capital.  And, when they die, they leave their winnings to their heirs, who, thus, begin their lives with an unearned stake which they can invest in still more capital.  So, each generation accelerates the pace and extent of inequality.

Piketty identifies the Great Depression, bracketed by two world wars, as a unique exception to this process.  Those events destroyed so much capital that the trend toward inequality was temporarily interrupted.   His data confirm, however, that the capitalists have recovered and the extent of inequality in western industrial capitalist nations is now equal to or greater than the days of the Gilden Age.

The bottom line is:  Capitalism is like casino gambling:  If  you play long enough you will lose because the house skims off a little of every dollar risked so the odds and the math will get you.  You may escape with some luck and careful decisions, but the crucial decision is to quit while you’re ahead.  In this regard, capitalism is a crueler game than the casino’s:  You can only escape from capitalism by dying.  You could join Edward Snowden in Russia, but that doesn’t look like an improvement.

If you want to review the so-called “laws of capitalism” that Piketty uses to explain his argument,  you can refer to the discussion of them in my “Dr. Piketty” post cited above.  I discussed them and cited an excellent discussion of them in a review of Piketty’s book by Branko Milanovik.

Piketty’s Paradigm Shift

Until I encountered Piketty, I identified the basic difference between liberals and conservatives, in  political terms, as follows:  Liberals believe that government should redistribute income obtained through progressive income taxes to finance expenditures beneficial to the working class.  Conservatives believe that progressive taxation discourages business owners from striving to expand their businesses, invest in innovative improvements in technology, and create the need for employees:  Liberals deride this “trickle-down theory because it assumes that job creation is investment-driven.  Liberals believe job creation is consumer-demand driven and is stimulated by distributing money to lower income workers, who will spend it and, thus create consumer demand.

Piketty has not dissuaded me from these beliefs, but he has convinced me that progressive taxation is insufficient to solve the problem of wealth inequality.  Instead of proposing higher taxes on the wealthy, Piketty proposes to tax capital,  not income.  At first, I didn’t appreciate how fundamentally different this idea is.  If it were implemented, he has convinced me that it would forever change the nature of capitalism.

The free access to investment and encouragement of technological innovation would remain.  But the deception and anti-competition feature of capitalism would be severely thwarted.

Why?  Because, in order to implement the taxation of capital, it would be necessary for the location and existence of capital to become accessible to the taxing authority.  Stringent sanctions would become necessary to prevent the owners of capital from hiding both their property and their ownership.  International agencies, modeled after the International Monetary Fund and other multinational agencies would be employed to deny access to the means of cross-border financing and transfers of funds to any money-storage facility that refused access and disclosure to the capital-taxing authority.

Piketty recognized that taxation of capital would have to be administered multi-nationally.   He proposed a kind of “pilot program” to consist of the Eurozone.  Eventually, he proposed that the taxation be administered on a world-wide basis.  He recognized that this is not feasible now and that much political and educational work must precede such a radical change in the way business is taxed and conducted.

Piketty is like the Surgeon General, warning about cigarettes.  When the first timid warning was issued, nothing much changed.  Smoking was a worldwide habit and business.  It took decades of litigation, research and thousands of warnings and legislative battles before smoking started to decline.

Piketty has notified us that, unless we take steps to redistribute capitalistic wealth, most of us, or our grand-children or their grand-children will be working for, and at the sufferance of a very small group of very greedy people.  And, by that time, the media sources will have convinced everyone that such a system is preferable to all others.

This will not happen if the transparency contemplated by Piketty becomes a source of growing political demand.  The curious thing is that we already have a working model of how it works.  People typically don’t hide their ownership of real property because, if they are not the recorded owners, they cannot use it for collateral to borrow money and, if they don’t pay taxes on it and, thus identify themselves as the owners, the state or someone else may dispossess them.

This system developed here in the U.S.  beginning with the Homestead Act of 1862.  It tolled the end of the “open range” that has been featured in countless western novels and movies.  The history of the development of this system is related in a book, The Mystery of Capital, by Hernando de Soto Polar.  I described my reaction to the book in an essay posted a few years ago.  [See Keeping Up With the Jones’s]

The point is that a system requiring ownership disclosure can be created.  There is no reason why forms of capital other than land could not be subjected to disclosure.   Tax avoiders would not be so eager to transfer their capital to the Cayman Islands if Cayman banks were required to disclose the ownership of it to a multinational taxing authority.  The Piketty tax would be levied on the capital, not on its owner.  But the motivation to hide ownership would be attenuated if stealth could not prevent tax liability.

Perhaps corporate lawyers would transition from being wealth-hiders to property valuation experts.

I don’t want to be too naive about this.  Thomas Kuhn’s The Structure of Scientific Revolutions describes how reluctantly investors wedded to  status quo techniques and “conventional wisdom” yield to new information.  But, they do finally yield, if confronted with undeniable evidence.

Some “ah-ha” Piketty Moments

I know this essay reads like it was written by a college sophomore who just read Walden  or The Theory of the Leisure Class.  As I read Piketty’s book, I did have an echo of that kind of excitement, long since forgotten.  Brain re-wiring is no longer part of my usual intake of information.

1. Piketty has not made me change my moral judgments, but he has given me new ways to see some features of my world.  For example, he explains why he prefers taxation to deficit spending by government:  Deficit spending is paying wealthy investors for money to finance public needs, while taxation gets their money without paying for it.  Public borrowing is justifiable only when there is not enough time for the taxation process to occur.

2.  Inheritance of wealth is a major contributor of wealth inequality.  It is affected by the life expectancy of the population  So, when medical research extends life expectancy, it slows the trend toward wealth inequality.

3.  19th Century fiction featured inherited wealth as a major determinant of a wealthy life style.  20th and 21st Century fiction does not.  The reason is that land is no longer the main component of wealth.  Corporate wealth now dominates.

4.  Piketty writes that we are becoming a culture dominated by managers, not wealthy owners of land who no longer need to work.  He also observes that we now have an elite group of managers who can fix their own salaries, so the size of the salaries is not dependent on the value of the managers’ performance.  At the very top of the economic scale, meritocracy no longer prevails.

5.  One reason the return rate of capital exceeds the growth rate of the economy:  As the size of capital owned by an individual increases, the ability to hire expert financial management dramatically increases.  So, if a person, or a foundation or private fund group owns a billion dollars worth of capital, he or it can easily afford to hire a large team of economic advisers.    A  person owning  a few million dollars worth of capital cannot afford to hire that kind of super-managers with that kind of diverse talent.  And so on, until, as Piketty puts it, the guy with a few hundred thousand dollars to manage has to depend on a CPA and “his brother-in-law”, who furnishes market tips.

The top tier of owners have managers who can find investment opportunities not publicly traded or known to less knowledgeable and less “connected” sources of information.  Piketty cites data to show that the differences between the returns of different sizes of capital ownership are very significant.

Conclusion

I will be returning to the information in this book.  It has already provoked a whole new array of comments, books about it, online interviews and press articles.  I have not yet heard it discussed by politicians or featured on Sunday talk shows.  I may have missed it, because I have limited my weekend commentary to Fareed Zakaria and Steve Kornacki.

My conclusion is:  Piketty has convinced me that the problem he poses is real.  I don’t know how bad it will have to become before it becomes intolerable and his solution becomes feasible.

I am sure of one thing:  Marx’s vision of capitalism’s demise because of the collective outrage of the world’s workers was illusory because it was based on the motives and emotions of its victims.  Piketty’s prediction is based on the internal mechanics of the system.  The implosion will occur, not because of its victims, but because of flaws in the system unless Piketty’s tuneup saves it.

Bob

 

 

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§ 2 Responses to Capitalism’s Mortality Table

  • sid eschenbach says:

    Bob, many thanks for a really great summation both of Piketty’s book and your own ingestion and reflections on same. I would only add to your #1 above that I’ve often described Reagan’s impact on the U.S. as transformative because he changed us from a ‘tax and spend’ nation into a ‘borrow and spend’ nation… a thought which I’ve found is guaranteed to open Republican eyes and see his presidency in a new light. You explain the motive perfectly: “Deficit spending is paying wealthy investors for money to finance public needs, while taxation gets their money without paying for it.” … right up Ronnie’s alley.
    Again, many thanks, and best to you in your travails with mortality.

    Like

  • Dear Bob,

    I have also been taken by Piketty’s book, which is about half consumed on my Kindle. I pretty much agree with your commentary, and agree that taxes on capital would go some way to redressing issues. I also think that rebalancing by reforming the labour laws that have come into place since Reagan and Thatcher would make a considerable difference.

    There are other options that would make a difference, however, possible because of the revolution in digital communication. In my classes on social computing and economic development at the University of Kent I draw attention to the start of the age of “me and 10 million of my friends”, an allusion to the second economy that is developing around us.

    40 years ago I was a small time developer inventing microcomputer hardware and applications. Work consisted of inventing new applications for microprocessors, and then trying to sell these to large corporations. Product development was a very frustrating process, as you not only had to invent the thing, you had to convince layers and layers of different corporate folk of the significance, and in the end marketing could axe the whole project because the packaging was 1$ too expensive. Nine out of ten products never went to market.

    Now “crowd-funding” is routine, and many exciting products are developed funded by a few hundred to a few hundred thousand previously unknown internet partners that empower the developers to move forward with not only funders, but a pre-identified market.

    Bitcoin, a digital currency, has demonstrated that fundamental financial infrastructure can be instantiated without a hierarchical power structure controlling it, private or governmental, just from participant actions coordinated by the internet.

    If we combine the financial power of crowd funding and an adaptation of the governance mechanisms underlying Bitcoin, large consortiums could form spontaneously that not only raise the funds to take over existing public companies, but also to form new ones, and to govern these in a fundamentally new way, using existing legal structures. Public companies could become truly public, and the capital these accumulate be utilised in new ways.

    An idea I am toying with now is creating an online University on this basis, where faculty, students and a governing board of 10 million or so individuals strike new ground in life-long education.

    Ultimately, this could provide much of the infrastructure needed to run, say, a nation, where representatives truly were representatives.

    BTW, I am that Michael Fischer. Thanks in large part to you, I have had a marvellous life, and have never forgotten your role in this.

    Like

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