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Physicist, Startup Founder, Blogger, Dad

Wednesday, March 26, 2014

Piketty's Capital


One of the jarring figures in Piketty's book Capital in the Twenty-first Century shows the population fraction over time that inherited more money than the average laborer earns in a lifetime. This fraction is larger than I expected -- roughly 5-10 percent in France.

Piketty's grande idée is very simple: if returns to capital r exceed GDP growth g, and if ownership of capital is concentrated, then runaway inequality will result. He argues that throughout most of history, r > g. His solution: redistribution via a wealth tax. (Don't most countries already have inheritance taxes? Perhaps they just need to be tightened up.)

See also The Normaliens.
New Yorker: ... Piketty, who teaches at the Paris School of Economics, has spent nearly two decades studying inequality. In 1993, at the age of twenty-two, he moved to the United States to teach at M.I.T. A graduate of the élite École Normale Supérieure, he had recently completed his doctorate, a dense mathematical exploration of the theory behind tax policies. Plenty of bright young European scholars move across the Atlantic, of course, and many of them end up staying. Piketty was not to be one of them. “It was the first time I had set foot in the United States,” he recalls in the introduction, “and it felt good to have my work recognized so quickly. Here was a country that knew how to attract immigrants when it wanted to! Yet I also realized quite soon that I wanted to return to France and Europe, which I did when I was twenty-five. Since then, I have not left Paris, except for a few brief trips.”

... much of the economics that Piketty encountered at M.I.T. seemed arid and pointless. “I did not find the work of U.S. economists entirely convincing,” he writes. “To be sure, they were all very intelligent, and I still have many friends from that period of my life. But something strange happened: I was only too aware of the fact that I knew nothing at all about the world’s economic problems.”

... Eventually, Piketty says, we could see the reëmergence of a world familiar to nineteenth-century Europeans; he cites the novels of Austen and Balzac. In this “patrimonial society,” a small group of wealthy rentiers lives lavishly on the fruits of its inherited wealth, and the rest struggle to keep up. For the United States, in particular, this would be a cruel and ironic fate. “The egalitarian pioneer ideal has faded into oblivion,” Piketty writes, “and the New World may be on the verge of becoming the Old Europe of the twenty-first century’s globalized economy.”

... Some people claim that the takeoff at the very top reflects the emergence of a new class of “superstars”—entrepreneurs, entertainers, sports stars, authors, and the like—who have exploited new technologies, such as the Internet, to enlarge their earnings at the expense of others in their field. If this is true, high rates of inequality may reflect a harsh and unalterable reality: outsized spoils are going to go to Roger Federer, James Patterson, and the WhatsApp guys. Piketty rejects this account. The main factor, he insists, is that major companies are giving their top executives outlandish pay packages. His research shows that “supermanagers,” rather than “superstars,” account for up to seventy per cent of the top 0.1 per cent of the income distribution. ...

... Defenders of big pay packages like to claim that senior managers earn their vast salaries by boosting their firm’s profits and stock prices. But Piketty points out how hard it is to measure the contribution (the “marginal productivity”) of any one individual in a large corporation. The compensation of top managers is typically set by committees comprising other senior executives who earn comparable amounts. “It is only reasonable to assume that people in a position to set their own salaries have a natural incentive to treat themselves generously, or at the very least to be rather optimistic in gauging their marginal productivity,” Piketty writes.

... Income from capital has always played a key role in capitalism. Piketty claims that its role is growing even larger, and that this helps explain why inequality is rising so fast. Indeed, he argues that modern capitalism has an internal law of motion that leads, not inexorably but generally, toward less equal outcomes. The law is simple. When the rate of return on capital—the annual income it generates divided by its market value—is higher than the economy’s growth rate, capital income will tend to rise faster than wages and salaries, which rarely grow faster than G.D.P.

... Piketty takes some well-aimed shots at economists who seek to obfuscate this reality. “In studying the eighteenth and nineteenth centuries it is possible to think that the evolution of prices and wages, or incomes and wealth, obeys an autonomous economic logic having little or nothing to do with the logic of politics or culture,” he writes. “When one studies the twentieth century, however, such an illusion falls apart immediately. A quick glance at the curves describing income and wealth inequality or the capital/income ratio is enough to show that politics is ubiquitous and that economic and political changes are inextricably intertwined and must be studied together.” ...
See figures here and here.

40 comments:

LondonYoung said...

Indeed, France has a wealth tax of about 1.5% annually, an inheritance tax of 20-60%, and very high income taxes to boot. But, as you suggest, these taxes are not exactly tight. I wonder where Piketty got his data from given Swiss banking secrecy and what-not. Only the U.S. is serious about collecting taxes from the "1%" - they usually get a free ride everywhere else.

Jaakko Raipala said...

As someone who grew up shivering in a huge fancy old house, I'm naturally skeptical of all worries of wealth automatically concentrating in families. As long as you're splitting inheritance between more than 1 child, your family wealth is going to decay exponentially unless your children marry someone of at least equal inheritance (but then, the other family will be marrying down so...). With more than 2 children inheritance will automatically evaporate in a few generations unless your family follows some very strict clan building strategy.

This is why societies that manage to maintain a hereditary aristocracy of some sort usually dictate "first born son gets all" inheritance rules where younger sons of aristocrats are given options like military careers (and this type of society is unstable because when all those posts are filled with aristocratic promotions you just need one Napoleon...). Families that manage to maintain wealth and status without that setting need to build an exceptional clannish code of arranged marriages, disinheriting progeny who refuse to follow the clan codes and so on (look at eg the legendary cousin marrying among Rothschilds, all planned keep wealth concentrated). This is very hard to do as sons with inheritance will be overwhelmed by opportunities to marry pretty but not wealthy women.

Paradoxically, the best thing a society can do to prevent wealth concentration to clans might be to ban the practice of disinheriting. A billionaire in a country with freedom to disinherit is going to have massive power over his sons and daughters and he can use the threat of writing children out of his will to push his progeny towards clan building and away from hedonistic pursuits. This is what eg. Sweden is doing, there is no inheritance tax (!) but there is also no freedom to write wills, the law enforces an even split between children (they can agree to other splits but anyone can appeal to the state and demand the even split).

Douglas Knight said...

It is not just Sweden, but all of continental Europe, including France that Steve mentioned in the original post. Also, no money may go to charity in death, or even in the last few years of life.

Douglas Knight said...

I wonder if there is a slight of hand with this term "supermanager"? Is he implying that he is talking about ordinary companies, when he is secretly talking about finance? The expansion of finance as a proportion of the economy is a pretty good reason to believe that it is driving changes in inequality. This paper is only able to identify 1/6 of the 0.1%, but finds 3x as many financial workers as executives at ordinary companies. I suppose it's possible that the 50% that Piketty found that they didn't were all at ordinary companies, but I'm suspicious.

steve hsu said...

I think it's true that in the US most of the recent increase in income inequality is due to financiers and startup guys. But in France it may be high level corporate managers who are the culprits.

http://infoproc.blogspot.com/2006/09/us-income-inequality-caused-by.html

Douglas Knight said...

The New Yorker article you cite claims that he is talking about America.

steve hsu said...

Then I agree: he may be using an expansive definition of manager. (Money manager? :-)

Douglas Knight said...

The graph you mention is this one, right? They are all linked from here.

steve hsu said...

Wow, thanks! I guess the modern figure is even higher than I remembered -- over 10% It's really hard to believe ...

Douglas Knight said...

Finance is a big part, but it definitely isn't a slight of hand. He claims, following this, it is still 40% non-finance managers and 20% finance (up from 10% in 1980), and the important point is the increasing salaries, not change in composition. Also, that source claims that lawyers have remained steady at 7% of the 0.1%.

Iamthep said...

Within the cohorts born around 1970-1980, 12-14% of individuals receive in inheritance the equivalent of the lifetime labor income received by the bottom 50% less well paid workers.



The above seems to imply something different than what you seem to be implying.


It's more like: Order all people by amount of inheritance. The top 12% of this list inherit as much as the bottom 50% of laborers earn in their lifetime. But there is no way that 10% of the population inherits more than the median lifetime income of laborers. This would be on the order of $1,000,000.

chartreuse1737 said...

heretic!!!

the capitalist's labor is coordination of the means of production and his risking his capital. his wages are his return on capital.

get the soft cushions!!!

chartreuse1737 said...

“and the New World may be on the verge of becoming the Old Europe of the twenty-first century’s globalized economy.”


errr. that happened a long time ago in latin america, most of the new world. brazil is the country of the future and it always will be...well until america is brazil.

Douglas Knight said...

Piketty explicitly says 750k Euros in the text near the figure 11.11.

chartreuse1737 said...

especially considering that steve has posted data showing the top 1% in individual wealth in the us is just above 2m. for a household one might double it. that's a lot of people who just own a house in the bay area, but steve has also commented that the growth in inequality is not so great once certain zip codes are excluded.

chartreuse1737 said...

"...but I also don't like the fact that the rich pay lower percentage taxes on capital gains than the middle class pay on earnings..."


right. let's discourage labor relative to saving and investing;)


"...we should just accept extreme inequality since some people are so much more productive than others..."


as pointed out above, however, it is impossible in practice to measure someone's marginal product reliably and accurately.


perhaps strangely cap gains taxes are lower than ordinary income taxes everywhere. the reasoning may be that the capital's income is taxed at corporate level and at individual level already. the problem with this argument is that capital gains are income (increase in one's wealth), are the major source of income for the rich, and are counted on to be recurring just like dividends and coupons.

chartreuse1737 said...

even in finance and start-ups the founders have often achieved executive status working for someone else, and this is the rule for entrepreneurs in other fields.

the "i think i'll start a business today" guy doesn't exist or he's very rare.

chartreuse1737 said...

yet france is still much more unequal and less mobile than de, nl, scandinavia, etc.

steve hsu said...

I'm confused by this. In earlier studies (1990s data) I think almost all of the increase in inequality could be traced to just four counties in the Silicon Valley, Seattle, NYC-Greenwich areas. But perhaps things changed more recently.

http://infoproc.blogspot.com/2006/09/us-income-inequality-caused-by.html

chartreuse1737 said...

one might think that if spending weren't proportional to income return on capital would require an increase in consumption by the have nots. where's that increase in revenue coming from? perhaps there's been a reduction in labor expense? but then who's buying what you're selling?

the rich stopped spending like they used to. the poor made too little to give any return on capital above inflation.

so supplier financed buying and student loans and payday loans and china buying usts.

so credit crisis --- still yet to fully play out.

the business cycle is caused by underconsumption which is itself caused by gross inequality which is itself caused by a usually feckless but tight knit management class, inexcusably useless and inefficient educational services, and last and least innate inequality between individuals.

ChrisFahlman said...

What you write may make sense if for the inequality r>g, r was not much greater than g. The point of the book is that, for much of history r was substantially greater than g, but for the period between the great war and 1975 or so (les trentes glorieuses): the period that was just lived through, and shapes the economic discussion. But now we are reentering a low growth world in which signs again point to r>g by a substantial margin. And, as a result, even in a generational time frame, the rich, able to reinvest their earnings, will make more than sufficient funds to keep wealth quite concentrated.

5371 said...

According to descendants of the Code N., the split doesn't have be even, but no-one can be left less than a large percentage of what he would have got if it was.
It's easy to say that noble officers (like N. himself) are less competent on average than non-noble, but I don't find any historical evidence for it

5371 said...

So you prefer your own prejudices to the data.

Cornelius said...

So the whole r > g rationalization is why this is blogworthy?

Frenchman decries wealth inequality. Proposes the government steal more money from the wealthy. Also throws in a couple of jabs at the US and "overpaid" executives. The New Yorker publishes an article about this man's book.

Next week's top blog post - "Japanese People Eat a Lot of Rice"

chartreuse1737 said...

ly has no chinks in his achievement ideology or his american exceptionalism ideology. he takes ayn rand seriously and was crushed he couldn't get his foot in the door making better bombs for the us military.

he's the most patent case for the achievement ideology's being mere ideology.

TimothyBates said...

Just as patents ought not overly-privilege the first inventor over equally-able later inventors, ensuring that humans should not be disadvantaged by accidents of birth order is an important goal.

One simple change to policy could go a long way to to fixing this: Whenever someone is renting a house (paying a landlord a profit), the government should guarantee a mortgage payment for them: i.e., allow them to pay off the house with their own labour, as the owner is now paying off the house with their labour (plus his capital). Their rent would have to cover the interest on the full loan, so no traps. That way, the initial lack of capital (what the blog post is all about) is not a barrier to pursuing a major but safe form of capital investment pursued by the wealthy. It would also lower rents, and house prices, as the possibility of having someone else pay off the debt would greatly diminish - largely eliminating rent-seeking and the accompanying added value to property.

All things being equal, this would not completely avoid the first-in runaway, but it would get a lot of kids in the next generation inheriting a paid-off house equal in value to a life-time's rent: perhaps 30% of a worker's salary. Given the large amount of social mobility downwards (inheritance frittered away) and upwards (founding google etc.), this might be close enough.

The good thing is that there's no need to redistribute money long term, and it would drive capital out of rent-seeking into productivity discovery.

chartreuse1737 said...

born with the gift dumness and a sense that the world was fair.

chartreuse1737 said...

your last link has "williams'" and touts gold.

chartreuse1737 said...

Just as patents ought not overly-privilege the first inventor over
equally-able later inventors (because ability and not product is what should be rewarded), ensuring that humans should not be
disadvantaged by accidents of birth order is an important goal(or by accident of less ability or suitability).

One simple change to policy could go a long way to to fixing this:
Whenever someone is renting a house (paying a landlord a profit), the
government should guarantee a mortgage payment for them: i.e., allow
them to pay off the house with their own labour (pay off for whom? owner or renter? all rent must be rent to own?), as the owner is now
paying off the house with their labour (plus his capital). Their rent
would have to cover the interest on the full loan, so no traps [1]. That
way, the initial lack of capital (what the blog post is all about) is
not a barrier to pursuing a major but safe form of capital investment
pursued by the wealthy. It would also lower rents, and house prices, as
the possibility of having someone else pay off the debt (pay off whose debt?) would greatly
diminish - largely eliminating rent-seeking and the accompanying added
value to property.

All things being equal, this would not completely avoid the first-in
runaway, but it would get a lot of kids in the next generation
inheriting a paid-off house (which would never have been built as all landlords would only get the residual over interest and the tenant would get the house) equal in value to a life-time's rent:
perhaps 30% of a worker's salary. Given the large amount of social
mobility downwards (inheritance frittered away) and upwards (founding
google etc.), this might be close enough.

James Hedman said...

Like some other commodities physical gold can be a better choice during hyperinflation but those periods have always been and necessarily are of short duration. In the case of the subsequent concomitant collapse an even better choice is a fully paid for and solidly defensible place in the countryside with a years supply of food for the entire clan just as the Mormons do. As for financial assets, best to have them spread around a bit. I would never put more than 10% of my assets in physical gold (however much now seems like a good time to do so) but YMMV. The real bitch about the dynamics of deflationary depressions is that first inflation wipes out the value of the currency and then when everyone is broke, ALL prices drop.

I've seen estimates of the US federal government having to close the gap between revenue and expenditures by 35% in order to get us back on an even keel to meet all of its future obligations. It's certainly do-able but I don't see that happening without a major financial crisis at least as severe as the one we had in 1980 when interest rates approached 20% (gold peaked then too.) Unfortunately this will occur with our underlying economy in worse shape now than it was back then. Unless all the bad assets are written off I'm afraid the Federal Reserve will just continue to print unprecedented amounts of money in order to keep the big agglomerations of capital nominally afloat.

Our basic problem is the increasingly erratic boom-bust economic cycle (noted in the above articles) and the underlying cause of that is the fractional reserve banking system:

http://mises.org/document/614/Mystery-of-Banking

chartreuse1737 said...

no.

this is all too abstract.

america's problems aren't transient and aren't economic. it's problems are cultural and ethnic. it was way too late in 1776. the waves are washing over the gunwales.

there will never be a recovery.

Douglas Knight said...

Piketty's main innovation is to look beyond the 1%. Are you sure your link isn't top-coding with 1% granularity%? Why would Seattle contribute much to the 0.1%? Sure, lots of 1% at MS, but 0.1%?

James Hedman said...

Well money certainly is an abstraction. As far as food for a year and a place to live there is certainly nothing more concrete. I'll certainly concede you the possibility that it is too late in general though. There is no reason to believe that the human race is not susceptible to massive die offs in total numbers just like any other vertebrate species.


Han Chinese will most likely see the most of their kind die just because of the simple fact that there are more of them than there are the other current human subspecies, and they are in the lead in killing off fetuses in order to curb the explosive growth in numbers that they have recently endured during the 20th Century. This implies that any massive die off of the human race may very well be consciously self-inflicted for certain ethnic groups.


As for sub-Saharan Africa and other Negro populations like Haiti or Brazil, I would expect them to reach more traditional Malthusian limits due to lack of food and water should the populations of the developed world cease to maintain levels sufficient enough to continue to support them with aid.

LondonYoung said...

nah, I try to prefer data - that is why I wonder about the source (and have ordered the book, though in old fashioned medieval form)

LondonYoung said...

Expert - a tiny note on property tax that you might like - its institution may be thought of as a one-time tax with no further taxation. This goes back to the old economic theory of rents. Imagine land which produces $100k annually. If the demanded return on capital is 5%, then the land will sell for $2mm. However, if we institute an annual property tax of $50,000 on it, then its private value will fall to $1mm - a loss to the original owner. However, future owners are not really being taxed since they got the land cheap and are now just paying fair rent on the government's share of all rents.

chartreuse1737 said...

"However, future owners are not really being taxed..."

and the same goes for corporate and dividend taxes and cap gains taxes, so stop your bellyaching ly. you pay tax only on your cash salary. the rest is untaxed ;)

chartreuse1737 said...

"And this certainly is an economic discussion..."

i was trying to point out that economics, in the us at least, is arid and abstract and meaningless by design. (what is meaningless is impotent.) and that one shouldn't confuse his facility with economics jive talk for understanding of the real world. though this discourse, jive talk, is taken as such by mass media and the academy.

yet economics in another sense is the most concrete thing there is. economists in the us are rarely if ever technical savants manque. they're talkers. jive talkers. but wealth and poverty isn't jive. it's sometimes life and death.



economies like germany's will grow, are real. economies like the uk's are fake and sinking.

LondonYoung said...

yep, I agree. And this is why the tax code is complex and ever changing - each change creates winners and losers. Almost any stable tax regime is likely to be fair in the sense that the anticipated taxes will be priced into decisions.

Kennon Gilson said...

Thoughts:
>Income and wealth inequality as measured by money is not a bug but the whole point of relatively free societies with markets. These measurements in his book ignore the other side of wealth which is the enormous utility of the consumer products. I'm happy to pay a few dollars to Bill Gates for a computer that would have cost 1 Trillion dollars 20 years ago. This lopsided issue is never explored by what might be attacked as MIT nitwits, and I would like to see that.
>Libertarians are pushing to abolish all taxes as inherently immoral and uneconomic, and have made great advances in abolition and tax rate reduction in the last generation. Will be interesting to see how this plays out.

Richard Seiter said...

If anyone wants to investigate Piketty's data (e.g. run your own analyses in R) this is worth a look:
http://simplystatistics.org/2014/06/30/piketty-in-r-markdown-we-need-some-help-from-the-crowd/
https://github.com/jtleek/capitalIn21stCenturyinR/tree/gh-pages

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