Understanding Piketty's Capital in the Twenty-First Century

Steven Pressman

• Publisher: Taylor & Francis
• Year: 2015
• Print ISBN: 9781138939745
• eBook ISBN: 9781317380023
• Edition: 1
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

Thomas Piketty's Capital in the Twenty-First Century reached the top of most best-seller lists last year shortly after it was released. Nonetheless, few people actually read the book. Yet reviewers have agreed that the book is important because it touches on one of the major problems facing the US economy, the UK economy and many developed nations: rising income and wealth inequality. It also provides an explanation of the problem and a policy solution: a global wealth tax.

This book is intended to do three things. First, it provides a summary of the argument of Piketty's book, which many people have bought and few people have read. Second, it fills in some of the gaps in the book, by providing readers with the background that is needed to understand the volume and the argument. This background information discusses economic data sources, measures of inequality and why income inequality is such an important issue today. Finally, the work provides a defense of Piketty's analysis and at times some criticism of his work.

Pressman explains why the problem of rising inequality is important, where Piketty's data comes from, and the strengths and weaknesses of that data. It defends Piketty's inequality, r>g, as the reason inequality has risen over the past several decades in many developed nations. Using Piketty's own data, this book argues that rising inequality is not just a characteristic of capitalism, but results from different growth rates for income and wealth, which can occur under any type of economic system.

Understanding Piketty's Capital in the Twenty-First Century is the ideal introduction to one of the most important books of recent years for anyone interested in Piketty's work and the inevitability of inequality.

1
Hello Piketty

“The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and income”

—J.M. Keynes (1936, p. 372)

Introduction

Keynes wrote those words during the middle of the Great Depression. They appear at the end of The General Theory of Employment, Interest and Money, which Keynes wrote to explain the causes of the depression and the policies required to end it. Mass unemployment was the problem of the day. During the 1930s unemployment in the US peaked at 25% and averaged nearly 20%. In Canada the unemployment rate reached 27%; in the UK it hit 20%. This was beyond anything the world had seen before. The economic slump at the end of the nineteenth century had been called “the Great Depression” (Capie & Wood 1997; Fels 1949), but the 1930s changed that. Extremely high unemployment continued for a decade; it seemed like it would last forever.

The takeaway from Keynes was that we can’t count on free markets to solve our economic problems. Government action was required to create jobs and stabilize capitalism. World War II provided empirical support for this view. Government spending on the war effort immediately put people to work. The unemployment rate in the US quickly fell from 14.6% in 1940 to 4.7% in 1942 and then to 1.2% in 1944. Similar declines took place in other developed countries.

Keynes did not favor a massive war to eliminate unemployment or even large military spending in preparation for a possible war. His preferred solution was government investment on things likes roads, bridges and schools—infrastructure. He also recognized that improving income distribution would lead to greater spending. Toward this end, he advocated more progressive income taxes (Pressman 1987, 1997). In earlier work, Keynes (1930) supported various social programs (such as family allowances and unemployment insurance) to put a floor on aggregate demand and improve income distribution. These, he thought, would stabilize consumer spending as well as increase and stabilize business profits. The result would be more spending, more robust growth and more jobs.

Keynes did not focus on income distribution a great deal in The General Theory. He had bigger fish to fry—the unemployment problem. Another reason for not tackling income distribution was the nature of economics itself. Standard microeconomic theory, stemming from the work of American economist John Bates Clark (1899), held that wages depended on the (marginal) productivity of workers. Each worker was thought to receive what they contributed to the revenues of their firm. Everyone got what they produced and what they deserved. Distributional issues could be ignored for both economic and moral reasons.

The issue of income distribution was thus left to Keynes’s followers to grapple with and address. Two of them, Joan Robinson and John Kenneth Galbraith (see Pressman 2013), took the lead here.

Robinson was a member of “the circus” at Cambridge that helped Keynes work out the ideas in The General Theory. Her Ely lecture to the American Economic Association, titled “The Second Crisis in Economics” focuses to a large extent on income distribution. Robinson (1972) argued that while Keynes solved the problems of growth and employment, he did not solve the problems of poverty or inequality. People need jobs not just because they like to stay busy; rather, they need the income to support themselves and their families. The second crisis in economics was that incomes were not sufficient to ensure everyone had a decent standard of living, or a standard of living that was not extremely different from that of other citizens.

Early in her career, Robinson (1953–54) sparked the Cambridge Capital Controversy (see Harcourt 1972) by raising a simple question—how can we measure capital? This rather simple question cast doubt on the marginal productivity theory of distribution. As is true of workers, marginal productivity theory assumes that capital gets paid its contribution to firm revenues. That contribution will depend on the amount of capital used and the rate of return on capital. Robinson recognized that this theory requires we know the demand for capital. A demand curve for capital would relate the profit rate and the quantity of capital, showing lower profit rates as firms invest more in capital equipment. The problem Robinson raised is that capital consists of large plants and small plants, automated assembly lines, hammers and screwdrivers, computers and computer software. These disparate goods have nothing in common that we can add up to find “a quantity of capital.” Another approach is necessary. The traditional means of measuring capital is through its value or future profitability. This works fine as a practical or accounting matter, but it is unsatisfactory as part of a theory that is supposed to explain what determines the rate of profit. As Robinson pointed out, if economic theory is supposed to explain the rate of profit, it cannot assume it knows the profitability of capital in order to measure the quantity of capital. This procedure is circular and so the marginal productivity theory of distribution must be abandoned.

Galbraith took things a step further. He argued (Galbraith 1996, p. 65) that the distribution of income was the result of power relationships rather than any economic principles. The economic power held by firms was the result of firms’ need to plan and their desire to grow and control the market (Galbraith 1967). Galbraith (1958, 1973) also wrote about the people left out of the post-war economic boom, bemoaning the poverty that existed in the US amidst rising affluence. He looked toward the government to provide what the market was not providing, and he wanted the government to employ policies that would help equalize incomes. He frequently argued that the tax revenues coming from the rich would not make them much worse off, while the benefits they funded would aid everyone else immensely.

Neither Keynes, nor Galbraith, nor Robinson, nor other followers of Keynes, went much further than pointing out the distribution problem. They wrote about the injustice of some people not partaking in the great increase in living standards following World War II. They wrote about the macroeconomic consequences of inequality and redistribution, and the redistributive policies needed to remedy the problems. But they did not carefully analyze the causes of inequality. One problem was the lack of good income distribution data. So Keynes and his followers had to circle around the problem, doing the best they could with the little information at their disposal. They had theories but, to sort of paraphrase the great German philosopher Immanuel Kant, theories without data are blind.

Income distribution data for the US was developed in the 1950s by Simon Kuznets, who won a Nobel Prize in Economics for his efforts. Based on tax return data, Kuznets (1953) estimated the fraction of total income received by each of ten income groups or deciles (the top 10% of income earners, the next 10%, the third 10%, etc.) for virtually every year between 1913 and 1948. He found that during the interwar years the top 1% of the US population received 15% of all national income and the top 5% of the US population received between 25% and 30% of all income. He also found a decline in income inequality in the US during and after World War II, so that in the post-war years the top 1% of the population got only 8.5% of all income and the top 5% got only 18% of all income.

Data on poverty did not exist until a little later. It wasn’t until the 1960s that the US had an official definition of poverty (Orshansky 1965, 1969) and the Census Bureau began to make annual estimates of the US poverty rate. The data source for this, household surveys, only began in the 1960s when the US Census Bureau first asked households about their income, and then used this information to report on distribution.

Most developed countries began taxing income in the first two decades of the twentieth century, so historical information about distribution exists in government tax data throughout the world; however, no one followed Kuznets by estimating income distribution in other nations as Kuznets did for the US. Household surveys also began much later in other countries.

Over several decades Thomas Piketty extended the pioneering work of Kuznets, moving forward in time and moving across space by including a large number of additional countries. Such data is necessary as a prelude to theory. To again sort of paraphrase Kant, data without theory is empty. Capital in the Twenty-First Century takes the next step. It provides an explanation for observed changes in inequality over the past century or more. Last but not least, it sets forth a set of reasonable policy solutions to address the problem it identifies.

Incredibly, a wonky book on economics with lots of graphs and some equations quickly became a best seller; and its author has become a sort of rock star despite having cured no economic ills. He has merely come up with an important insight into how economies work—in particular, how they distribute income and how income distribution will change over time. Before examining this, and the book that has generated so much controversy, let’s look at Piketty the man.

Who is Thomas Piketty?

Given the attention and the praise lavished on Capital in the Twenty-First Century, it is surprising that so little information is available regarding Thomas Piketty. This may be due to the fact that his fame is so recent and journalists haven’t had the chance to interview him extensively about his childhood, the influences on his economic ideas, and how he became interested in the problem of income inequality. Another reason for the paucity of information on Piketty may be that he lives in France, where the media spotlight does not magnify the lives of celebrities to the same extent it does in the US. Finally, Piketty is rather shy and his natural instincts are to avoid the limelight. Whatever the reason, here is what we know about Piketty.

He was born on May 7, 1971, in the Parisian suburb of Clichy. Clichy is located around four miles to the north of Paris. It houses the national headquarters of the world’s largest cosmetic company, L’Oréal. Although Piketty has denied being a Marxist (Chotiner 2014), there is no disputing that he was born with some radical DNA in his genes. His parents were part of the generation of French students who occupied the Paris universities in May 1968 to protest capitalism. What followed was a series of strikes across Paris. When President de Gaulle sought to stem the protest, this only inflamed the situation further (Singer 2002).

Piketty’s childhood heroes were left-of-center French historians Lucien Febvre and Fernand Braudel (Cassidy 2014). Febvre was a co-founder of EHESS (École des Hautes Études en Sciences Sociales or the School of Advanced Studies in the Social Sciences); his academic work sought to understand the lives of French villagers in the sixteenth century (Febvre 1978). Braudel (1979) is best known for his three-volume economic history of the world, Civilization and Capitalism, 15th–18th Centuries, which describes everyday life in the ancient world and in the developing capitalist world. It describes how ordinary people, producing for their own daily needs and also trading with others to improve their lives, led to the rise of towns and enabled economic life to flourish.

At the age of 18 Piketty entered the École Normale Supérieure (ENS), where he studied mathematics and economics. Founded as a school to train high school teachers, this private university (in a country where most universities are public) is one of the premier universities in France and the world. Its main goal today is to train professors, researchers and civil servants.

After graduating from the ENS, Piketty went to the London School of Economics (LSE) for his graduate education. Michio Morishima, a Japanese economist, was teaching there at the time. Morishima was interested in general equilibrium theory and practical political issues as well as the history of economic thought. His work sought to combine the insights of Walras and von Neumann on the possibility of simultaneous equilibrium throughout the economy with the insights of Marx on how production takes place in capitalist economies (Morishima 1973). Interested in both history and the practical side of public economics, as well as in mathematical economics, Piketty went to the LSE intending to work with Morishima. However, he soon came under the influence of Roger Guesnerie and began working with him on the problem of income distribution (Cassidy 2014). At the young age of 22, Piketty was awarded his PhD. His recent notoriety makes him the second most famous rock star to come out of the LSE—which may or may not get him any satisfaction. His doctoral thesis was on wealth redistribution. Piketty (p. 310) has described the dissertation as “several relatively abstract mathematical theorems.”

PhD in hand, Piketty landed a job teaching economics and doing research at the Massachusetts Institute of Technology (MIT) in Cambridge, Massachusetts. The MIT Economics Department was built by Paul Samuelson and Robert Solow in the 1950s and 1960s. Today it is regarded as one of the top two or three economics programs in the United States. It has been the home to a large number of Nobel Prize winners in economics. Some received the award as faculty members, including Peter Diamond, Robert Engel, Franco Modigliani and Myron Scholes. Others, such as Paul Krugman, taught there for several years before moving on to teach elsewhere and write for the New York Times. And several Nobel Laureates in Economics, including George Akerlof, Lawrence Klein, Robert Shiller, and Joseph Stiglitz, received their economic training and their PhD from MIT.

Piketty worked as an Assistant Professor at MIT between 1993 and 1995. Overall, he was not impressed with the school or its economics department. Piketty also disliked the US system of graduate education in economics. He thought it focused too much on mathematics and too little on trying to understand real world problems and develop policies to remedy them. He might have also been a little homesick for Paris and his home country. As reported in the UK newspaper, the Guardian (2014a): “after a spell in a swaggering, top-flight US department, he hankered to return home, where economists did not pretend they could explain everything but worked alongside sociologists, anthropologists and others in a social studies faculty.”

Whatever the reason, Piketty left MIT in 1995 to join the French National Centre for Scientific Research...

Table of contents

• Cover
• Title
• Copyright
• Dedication
• CONTENTS
• List of figures
• List of tables
• Preface
• 1 Hello Piketty
• 2 The fear of all sums: measuring income distribution
• 3 No tomfoolery: the costs of inequality
• 4 A big Piketty-ture (Part One: Introduction and chapters 1–2)
• 5 In a pretty Pikkel-ty (Part Two: chapters 3–6)
• 6 Pikket-ing income inequality (Part Three: chapters 7–12)
• 7 A taxing wealth of policy options (Part Four: chapters 13–16 and the Conclusion)
• 8 Giles goat boy?
• 9 Pikketing up the pieces
• Index