Piketty’s formula: its scope and limits

Source: Emmanuel Saez and Garbriel Zucmanhttp://www.hup.harvard.edu/features/capital-in-the-twenty-first-century-introduction.html

http://www.yjs.fi/wp-content/uploads/2013/12/Thomas-Piketty-pres..pdf  [Thomas Piketty’s Power Point presentation]

Click to access SaezZucman2014Slides.pdf

http://www.slate.com/blogs/moneybox/2014/04/02/wealth_inequality_is_it_worse_than_we_thought.html

The brilliant French economist Thomas Piketty has an economic formula which shows why, most of the time, the wealthy elite captures a larger and larger share of a nation’s income, and also why, some of the time, the rest of the nation catches up.

pikettybookcover00While my previous post about Piketty and his great book was long, I didn’t really explain his formula and how it works.

His formula, which he calls the fundamental law of capitalism, is as follows:

The capital income ratio (a) equals the rate of return on capital (r) times the national wealth (beta*),

That is, if the national wealth – every form of property that can produce an income for its owner, which is what Piketty calls capital – is six times, or 600 percent, of the nation’s annual output, and the average rate of return on capital is 2 percent, then owners of capital will receive 12 percent of the nation’s income in that year.

If a nation’s annual income is static and the owners of capital reinvest some of their income, then capital will be a larger multiple of the national income the following year, and the owners of capital will receive a larger share of national income.  If a nation’s annual income is growing, but the return on investment is a higher percentage than the growth rate, the owners of capital will get a larger share of national income the following year.

Once this is explained, it seems obviously true – at least to me.   And it seems to be a problem – at to me.   The graph above, prepared by Emmanuel Saez of the University of California (Piketty’s long-term collaborator) and Gabriel Zucman of the London School of Economics, shows how unequally wealth is distributed in the USA.  More than 1/5th of U.S. wealth is owned by 1/1000th of the population.  It is easy to see how the normal working of Piketty’s formula could cause them to suck up more and more of the nation’s income.

Thomas Piketty

Thomas Piketty

What do you do about it?   Piketty proposed graduated taxes on income, inheritance and wealth itself, sufficient to bring return on investment down to the rate of economic growth. 

I don’t see anything wrong in principle with a wealth tax.   I pay a property tax on my house.  Why shouldn’t a billionaire pay taxes on his investment portfolio?    But this is going to take a long time to bring about, even if everybody agrees.  For one thing, it will require the elimination of all the tax havens where the super-rich hide their money, which will require international agreement.  For another, increasing the government’s revenue does not necessarily benefit the public – if taxes are used to finance aggressive war, for example.

There are other possible solutions, because there are other factors in the equation.  If strong economic growth can be restarted, if the economic growth rate exceeds the return on investment rate, that would solve the problem.   Strong labor unions and minimum wage laws would increase the income share of working people and the middle class.   There are many possible approaches.

In theory, the solution could be wider ownership of capital by the public, such as by ESOPs (employee stock ownership plans) or by pension funds.  Back in the 1970s, the management analyst Peter Drucker noticed that pension funds were acquiring a bigger and bigger share on the U.S. stock market.  Eventually, he predicted, this would accomplish the Marxist dream of worker ownership of the means of production!

This didn’t happen because the corporations that controlled the pension funds didn’t allow it to happen.  But if workers controlled their pension funds, it would be a different story.  This would not be a practical reality any time soon, or perhaps ever.  The point is that tax policy is not the only means to deal with hyper-concentration of wealth.

The thing to remember about Piketty’s book is that it is good for what it is, but not to take it for what it isn’t.  What it is is the result of extensive historical research into concentration of wealth in capitalistic countries, and a theory of why this is so.  Piketty’s theory is a powerful theory with great explanatory power, but there is no one formula that explains everything.

What Piketty’s book is not is a solution to political-economic problems in general  — the role of government, the role of corporations, the role of labor unions, the nature of economic justice, the means of economic growth, conservation of natural resources and so on. 

There were extremely poor people in the United States in the 1950s and 1960s, when the majority of Americans were doing well. 

Breaking up extreme concentrations of wealth is essential to prevent the emergence of a hereditary ruling class.   But it won’t, in and of itself, solve any of these other economic problems, although it may make them easier to solve.

[*]  Piketty uses the actual Greek letter beta, but I can’t generate it on the computer I am presently using.

http://www.theatlantic.com/business/archive/2014/03/how-you-i-and-everyone-got-the-top-1-percent-all-wrong/359862/

http://www.theatlantic.com/business/archive/2014/04/why-dont-the-1-percent-feel-rich/360061/

https://philebersole.wordpress.com/2014/04/02/why-the-rich-will-probably-get-richer/

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