Posts Tagged ‘Capital’

Piketty on the power of inherited wealth

May 1, 2014

inheritanceflowpiketty_u

living-standards-in-france-by-birth-cohort-as-multiple-of-the-average-income-top-1-inheritors-top-1-labor-earners_chartbuilder-1

In Balzac’s story Pere Goriot, set in the early 1800s, the struggling law student Rastignac lives in the same boarding house as the master criminal Vautrin and the impoverished former millionaire Goriot.   Vautrin explains to Rastignac the odds against his ever achieving success sufficient to earn a life with dignity, and advises him to woo and wed a rich heiress instead.

In the charts above and below, Thomas Piketty, in his book Capital in the Twenty-First Century, showed the gap in those days between inherited wealth and wealth achieved through one’s own efforts.   He didn’t have comparable data for the United States, and doesn’t think the flow of inherited wealth was as great in the USA.

That gap has narrowed, Piketty warned that there is nothing to prevent those days from returning.  A Sam Walton may build a retail empire through his own efforts, but all his children and grand-children have to do in order to be rich is simply to mess up.  His research indicates that great wealth compounds faster than moderate wealth, because the ultra-rich can diversify their investments and call upon the best expert advice.

(more…)

Piketty’s Capital21: why is inequality rising?

April 28, 2014

Thomas Piketty’s Capital in the Twenty-First Century is a great book.  It consists of the working out of the implications of a simple principle, namely, that if the return on investment is a higher percentage rate than economic growth, wealth and income will become more and more concentrated in the hands of a tiny minority.

He said there is nothing to prevent wealth from becoming as concentrated in the hands of a tiny elite as it was in France and England in the 18th and 19th centuries — which is not the same thing as saying this is certain to occur.   I’m now re-reading Piketty’s book, from which I’m learning a lot, but l think it is important to be clear on what he’s saying and not saying,

He says that historically return on investment has exceeded the rate of economic growth, or, as he puts it, r > g,ut, like most economists, he writes of this as if it were the impersonal workings of the economy.  He lumps all income-producing forms of property together, which is legitimate for his purposes, but I make a distinction between (1) innovators who create value, (2) inheritors and passive investors and (3) usurers and manipulators.  The first deserve rich rewards, the second deserve average rewards, the third deserve to be unemployed or maybe in prison.   I think the rise of people in the third category is a big reason for the upward distribution of income in the USA.

Extreme inequality of income is a bad thing because it gives a small group of people too much power over the rest of us.  But curbing the excessive power of the top 0.1 percent or top 0.01 percent of income earners will not, in and of itself, create economic growth or end poverty.   These are not Piketty’s topics.

His preferred solution to excessive concentration of wealth is a progressive tax on capital along with progressive taxes on incomes and inheritances.  I’m not opposed to this, but I think there are other, better ways to change the r > g equation.  Promoting economic growth is one way.  Empowering wage-earners, such as by stronger labor unions or higher minimum wage laws, is another.

Below are links for those who want to know more, but don’t have time to read the 585 pages of his book and 78 pages of end notes.

(more…)

Piketty’s formula: its scope and limits

April 4, 2014

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.

(more…)

Why the rich will probably get richer

April 2, 2014

changingUSwealthc

CAPITAL IN THE TWENTY-FIRST CENTURY by Thomas Piketty (2013) translated by Arthur Goldhammer (2014)

Thomas Piketty of the University of Paris is the world’s foremost authority on income distribution and the super-rich. All the charts you see how income is being redistributed upward to the top 1 percent of income owners are based on work by him and his collaborators. In this new book, based on 20 years’ work, he concluded that it is not an aberration that ever-greater shares of income go to a tiny elite. Piketty said this is the natural working of a market system.

According to Piketty, the higher you go on the income scale, the larger the amount of income comes from investments rather than work. When the economic grows at a higher percentage rate than the average rate of return on investment, income becomes more widely distributed. When the average rate of return on investment is greater than the rate of economic growth, the owners of economic assets gain at the expense of everybody else.

His research is based on 200 years of data on income and wealth distribution in France, the UK, the USA and other countries, which now can be analyzed and processed with computer technology. His book would be a good supplement to David Graeber’s Debt: the First 5,000 Years, whichi is sketchy on precisely the past two centuries.

Piketty concluded that the average rate of economic growth since 1800 is about 1 percent a year for the countries he studied, and the average rate of return on investment is about 4 to 5 percent a year. Unless something happens to change one or the other figures, a wealthy elite will grow richer and richer at the expense of everyone else, until there is nothing left to invest in.

pikettybookcover00Piketty defines “capital” as anything you can own that will generate income. In the late 18th and early 19th centuries, capital (by his definition) consisted mainly of agricultural land and government bonds. Now it consists mainly of housing, industrial machinery and stocks and bonds of private corporations. Few economists would define “capital” in so broad a way, but if all you’re interested in is income distribution, it doesn’t matter what form “capital” takes.

If you read English and French novels set in the early 19th century, the characters consist mainly of members of what Piketty calls the “dominant” class, which are the 1 percent of the population who receive 30 to 60 times the average income, and the “well-to-do”, who consist of the next 9 percent. Characters in Balzac and Jane Austen seek wealth through inheritance, marriage and patronage of wealthier and more powerful people. Nobody in those novels thinks that wealth is acquired through hard work and superior talents. Piketty said there is nothing to prevent a reversion to this kind of world, although the difference between wealth and poverty wouldn’t be quite so extreme.

The reason the history of the 20th century was different, he wrote, is the great destruction of capital during the two world wars and the Great Depression. This cleared the deck for the great surge in prosperity of 1945-1975, which benefited all segments of the population. Since then, according to Piketty, the growth in income has been sucked up by the dominant and well-to-do classes.

Now I don’t think that someone born in 1900 would have thought the prosperity of 1945-1975 justified the catastrophes of 1915-1945. This points to an important limitation of Piketty’s book. It is full of fascinating information, drawn from a wide variety of sources, ranging from centuries of income and property tax records to social history, economic theory, literature and financial journalism.

Thomas Piketty

Thomas Piketty

But when you get right down to it, he deals with only one subject, the income share of the super-rich. He doesn’t have theories on how to eliminate poverty, promote economic growth, set priorities for public investment or any other important objective. This is not a criticism. It is just a description of what the book is and isn’t about.

His one subject – which is important – is the economic elite and how, short of violent revolution, to prevent from sucking up an undue share of society’s wealth and income. But as the experience of 1915-1945 shows, destroying the power of capital does not, in and of itself, make things better for everyone.

Piketty focuses on data from France and the UK because the United States is, in good and bad ways, exceptional compared to the rest of the world. During the past 200 years, the boundaries of France remained roughly the same and population grew from 30 million to 60 million. During the same period, the United States expanded from a narrow strip along the Atlantic to the Pacific coast, and its population grew from 5 million to 300 million.

Income distribution in the United States historically has been more equal than in Europe, he noted, at least for white men in the Northern states. The chief form of capital in the early United States was agricultural land, and this was very cheap compared to Europe. Early settlers and immigrants brought little wealth with them. What they created was the fruit of their labor. A great deal of the capital for building U.S. factories and railroads came from European investors. The great American hereditary fortunes did not emerge until the dawn of the 20th century.

The South was different from the North because the economic elite possessed enormous capital in the form of enslaved human beings. Piketty estimated that in the 1770-1810 period, the economic value of slaves in the South exceeded the value of all land, housing and other forms of wealth, and also exceeded the total wealth of the North. The result was a high concentration of wealth, and a large gap between rich and poor white people, which persists to this day.

Differences in earned income, while great in all countries, have seldom been as important as differences in income from wealth. The exception is the surge in corporate compensation in the United States and other English-speaking countries in the last generation. Piketty showed, by means of international comparisons, that the current size of executive compensation cannot be justified on the basis of merit or results. It is the result of executives being able to influence their own pay, and the lack of standards as to how much is enough.

The disturbing fact about investment income is that the more you have of it, the higher your rate of return. Piketty compared the returns on endowment funds of American universities, which are a public record, by size categories. The larger the fund category, the higher the percentage return, with Harvard by far outpacing all the rest.

This is because the larger the fund, the more the owner can afford to get expert investment advice, and the better able the owner is to invest small amounts in high risk, high return investments. Also, unlike an individual who has saved for retirement, the super-wealthy person or institution does not have to take out a significant percentage to live on.

The implication is that once you reach a certain level of wealth, your wealth becomes self-sustaining.  A Bill Gates or a Steve Jobs can simply coast. He not longer needs the entrepreneurial drive that brought him success in the first place. Piketty’s analysis of the Forbes 400 list indicates that inherited wealth is at least as important as entrepreneurial wealth, and he thinks Forbes vastly underestimates income from passive investments because of lack of access to tax havens.

Piketty’s solution is a tax on capital – which, remember, is by his definition any form of income-producing property – sufficient to bring the average return on investments down to the expected rate of economic growth. He pointed out that some forms of wealth, such as real estate and buildings, already are taxed. In principle, taxing stock portfolios is no different.

Since the average rate of return is greater for greater wealth, his proposed tax would be graduated, with a zero or 0.1 percent rate for fortunes below 1 million euros and perhaps rising as high as 2 percent above 5 million. These don’t seem high, but they are high compared to expected rates of return. He also favors continuation of the graduated income tax and inheritance taxes. His purpose is not to prevent people from getting rich. It is to prevent the rich as a group from getting richer at a faster rate than the economy is growing.

The revenue from the wealth tax should be spent in reducing government debt, which Piketty sees as a transfer of income from taxpayers to wealthy holders of government bonds. It is better to tax the rich than borrow from them, he said.

Piketty’s proposals require much better information about wealth and income than we have now. The first step would be for the international community to require reporting of financial information from places such as Switzerland and the Cayman Islands that act as tax havens.

The 577-page book and the 76 pages of notes are crammed with information of interest even to those who don’t accept his basic argument. It is not written in technical language, which is part of the reason it is so long; Piketty, like the late Isaac Asimov, explains everything from the groun up.  If you don’t have time to read the whole book, his core argument can be found in the Introduction or Conclusion.  Or click on some of the links below.

(more…)

The essence of capitalism is capital

February 4, 2013

The essence of capitalism is not free markets or free enterprise.  The essence of capitalist is capital, the use of existing wealth to create new wealth and thereby increase the amount of wealth in the world.

Click to enlarge

Click to enlarge

There have been enterprising merchants and traders in many cultures in many periods of history, but, according to my definition, they weren’t capitalists because they didn’t employ capital.  The modern capitalist era is the first period of history in which capital investment was the driving force in society.

If capital investment is the essence and justification for capitalism, then the main criticism to be made of today’s bankers and corporate executives is that they are not true capitalists.  Not all of them, but all too many of them use their wealth not for production of new wealth, but to extract wealth from others, by getting people into debt or by gaining control of organizations and milking them for their own advantage.

When I studied economics in college more than 50 years ago, I was taught that there are three factors of production: land, labor and capital, and three sources of income, the rent of land, the wages of labor and the interest or profit on capital.

Capital is a more subtle concept than land or labor.   It can mean capital goods, the tangible things that increase the productivity of land and labor—steam engines, railroads, computers—and it can mean financial assets that could be used to purchase those goods.

These three factors are not equal.  Landlords and other owners of natural resources do not, as such, create wealth.  They merely collect tribute.   It is no accident that “rent-seeking” is such a pejorative term among economists.   Labor does create wealth, but there are limits to what can be produced by the hardest-working of individuals.  It is capital that is the force multiplier—that turns a ditch digger into a steam shovel operator, a farmer behind a horse-drawn plow into a farmer on a tractor or petroleum from a noxious waste product into the basis of an industrial economy.

Click to enlarge

Click to enlarge

There is such a thing as human capital.   If you go to college and learn to be a chemist or an engineer, you become capable of creating more wealth than if you were a laborer or a cleck.

There is such a thing as state capitalism.   Government investment in airports, bridges, canals, dams and other infrastructure can add to the ability of society to create wealth.

Business corporations are necessary as a mechanism for capital formation.   The limited-liability public corporation provides a way for investors to turn their savings into capital with limited risk and potentially unlimited gain.  Few would invest if their risk also was potentially unlimited.   What this means is that the consequences of corporate failure are not limited to the investors, but are spread through all of society.   I think this is justifiable when corporations generate economic growth that also benefits all of society.

The accumulation of wealth by corporations and wealthy individuals represents a concentration of power that is dangerous to democracy.  But it is a necessary danger so long as we want to enjoy the advantages of economic growth.  The alternative is state capitalism, which is an even more dangerous concentration of power.

Someday continued economic growth may not be possible, or it may not be desirable (two different things).  Exhaustion of natural resources or the threat of global climate change may set limits on growth.  Or people in rich countries may decide they have enough possessions and would rather have leisure.  If and when such a day comes, a more cooperative form of economic organization may be desirable.  Or it may be that someone will discover an engine of economic growth that works without all the problems generated by capitalism.

At present, it seems to me that you have to say of capitalism that which Winston Churchill said of democracy—that it is the worst system except for all the others.

So it seems to me.  What do you think?