A group of political science and social policy faculty gathered at the LSE on March 9 to foster the conversation around politics and social policy in an era of widening inequalities. As I wrote in my last post, I have a review essay on this question for bioethics coming out in IJFAB, and was able to go down to London from my sabbatical perch in Birmingham to be at the session. This second post takes us into some detail about economists’ critiques of Piketty. If it’s too much, wait for the next posts and we’ll be back to politics and policy.
The political economist David Soskice kicked off the day asking whether Piketty was setting the discussion of inequality off on the right foot: does Piketty’s focus on the 1% distract us from where our concern should lie—with the poor and their needs? Other participants defended Piketty on this point: economists have long studied the poor as the problem to be solved, rather than turning their attention to the rich as the problem to be solved (others are turning the discussion in that direction, for example Paul Piff). While the global absolute poverty rate may be falling (not a topic of discussion in the afternoon), the share that the poor enjoy in wealthy countries gets smaller and smaller. Studying poverty as the problem is blaming the victim, in essence.
Soskice usefully explained some central points of controversy between Piketty and economists across the political spectrum—something he does also in his published critique. Piketty’s fundamental idea is that where the rate of return on capital is greater than the rate of growth, or r > g—which it usually is, but wasn’t for a period in the 20th century that we have now left behind, Piketty believes—wealth accumulates. The accumulation of wealth, without substantial inheritance taxes and other measures to counteract its intergenerational effects, already challenges meritocratic ideals, because existing resources—often inherited—have more weight in the world than the resources that each generation creates by its own efforts.
Economists complain that Piketty’s study is actually of wealth, not capital: that is, the accumulation of assets whether these are invested in further production or held in the form of paintings, mortgages, or pension plans. The former is “capital” in the classic sense, both for Marxists and for orthodox economists. If housing—real estate—is removed from Piketty’s measurements, β (the ratio of wealth to income in a society—how much society’s resources are inherited from the previous generation vs. how much we create resources for ourselves in each generation) seems constant, which is what economists traditionally have thought to be the case. This is not to say that Piketty is wrong about rising income inequality—these data and their relevance for public policy are admitted by many more economists studying inequality. But his fundamental and pessimistic laws of capital might not be true. It’s these laws that generate his prediction that β is rising towards 19th century levels. So we may be in the world of the supermanager who takes home an obscene paycheque, but this is not yet a harbinger of the world of Jane Austen and Honoré de Balzac—a world characterized by a high β, which is concentrated in the hands of a few.
Economists’ further diagnosis of Piketty’s error is that he doesn’t treat corporations as active agents in the economy: corporations just deliver returns of 5% or so, on average, over history, for individuals or families with wealth who invest in them. But economists very much treat corporations as actors, ones that make investment decisions based on things like how much economic growth they anticipate and how well capital substitutes for labour. It’s on this latter point that economists find Piketty “surprisingly loose,” as Soskice delicately put it. The “elasticity of substitution” is the relationship between technology and the labour that technology replaces, and economists, apart from Piketty, think it is less than 1. Summers criticized Piketty on this point in a well-known review here. Some have defended him, e.g. here. Whatever the role of this particular constant in generating predictions and explanations, Piketty’s claim that wealth, after its destruction in the 20th century by the world wars and policies like rent controls, is now growing; this is only supported empirically if we allow Piketty’s expanded definition of capital as wealth, including real estate.
When someone as strong in their field as Piketty makes an elementary error, I try to employ the principle of charity in interpretation, and ask whether there’s something else going on. Is he coming from a different perspective from the tradition, even if he is working within it?
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Piketty tells us over and over again that his concern is with the transition from a society where your resources are a reward for merit, to a society where economic status comes from inheritance. (We can discuss critically his faith in the former. For him, this is a snapshot description of what it is that makes society more fair now than it was in the 18th and 19th centuries, and indeed for most of human history.) Wealth accumulation (including real estate) is growing, but its distribution is different than in the 19th century: the “middle class” has more of it, in the form of real estate and pensions, and the 1% have less.
This term “middle class” is usually vague, but Piketty means precisely those in the the 50th to the 10th percentiles—the “40%,” including a range from those who are just above average to those who are just below the top 10%. Naturally, these numbers don’t indicate the same group of people when they refer to wealth and and when they refer to income. Some with high incomes have so much consumer and real estate debt that they are in the bottom half of wealth holders; some with low incomes (in the bottom half of income earners) may be pensioners with their mortgages paid off, for example, and in the 40% for wealth.
Wealth coming to that middle class in the 20th century must have some causal role in the boom in property prices, I would think. It’s not that houses got that much nicer over the last 30 years; it’s that more people had more money (in effect, given government policy focused on home ownership and given astonishingly low interest rates) to compete for the desirable houses, which are desirable on grounds of scarcity (in major urban centres close to good cultural and economic opportunities). This does have implications for life opportunities that matter: it’s reflected in the sense we feel now that we and our children will never be homeowners if no one helps with the downpayment, and (in the U.S.) that our children may not get the education they deserve unless we have a house on which to take out a second mortgage. The growth of this kind of wealth in society also has implications for the stability of the financial markets—I believe this would be an important message of the last financial crisis—and for the “financialization” of society, that is, the shift of cultural value and concrete rewards to the financial sector and those participating in it. It’s true I think that Piketty is focused on his longterm question, “are we headed back to the 19th century?” and doesn’t think as much as he might about the current distribution of capital, which is distinctive, and which creates particular vulnerabilities to exploitation. We see these vulnerabilities both in the capital we have—mortgages and pension plans—and in the capital we don’t have—i.e. consumer and other debt. In the U.S., a substantial proportion of that debt relates to limitations in catastrophic health care coverage.
The moral question that is Piketty’s focus (about merit vs. inheritance) may be his rationale for examining laws of wealth and not capital as such. I don’t have the economic chops to follow through whether this explains the “loose” way he treats his unusual views about elasticity of substitution.
Well—Piketty may not be right about his fundamental laws of wealth, or he may be. He does seem to be right about the data showing the growth in income inequality. Others assess growth in income inequality, but based on after-tax, after-transfer (food stamps, unemployment insurance, etc.) household income (vs. individual earnings), and their results differ somewhat from Piketty’s, but still document patterns of decreasing or stable inequality in the post-WWII era, and increasing inequality now (see Tony Atkinson’s 2013 Arrow Lecture at Stanford for some explanation here).
Apart from the economic issues, rich as they are, Soskice also raised the question of why Piketty’s own political analysis is so weak. In the rest of the afternoon, we turned to politics and policy.
