Some misconceptions about Capital in the 21st Century

After reading Piketty’s book, I have run into a good number of comments from people about it.  Some of them appear to be based on some confusion about what the book is saying.  Below I’m going to note down some of the more popular ones, and point out why they are not backed by the central thesis in Capital.  This follows on from yesterday’s review.

This is not a criticism of any of the people making these claims – given the way the book has been discussed, and the nature of the text, I can understand where the confusion has come from.

“According to Piketty, the return on labour will grow more slowly than the return on capital”

No, this is not what he states.

He states that, given his assumptions, the share of total income going to capital owners will rise.  However, this is in a situation where the amount of capital rises significantly.  This process of capital deepening will actually make the ratio r/w (the return on capital relative to the return to labour – wages) fall.

He is assuming a point in the future with full employment, where the relative return to labour is higher.  His concern is instead about the fact that legacy assets will be giving a return to people who ‘do not have to work for it’ (this comes through most strongly in Chapter 11) – which is something he thinks is unfair and morally insidious.  This is an extremely different argument.

“This is a generational issue where baby boomers are getting more than their kids”

No, this is a total misreading of Piketty.  His concern is that current generations are deferring consumption to create a stock of assets their children can live off – a privilege for a small elite.  This has nothing to do with intergenerational welfare, it is an argument about the dispersion of income within generations.  To quote from pages 399-400:

It is perfectly possible to imagine a world in which all people would choose to convert all of their wealth into annuities and die with nothing.  If such behavior were to suddenly become predominant in the twenty-first century, inheritance flows would obviously shrink to virtually zero, regardless of the growth rate or return on capital.

If the baby boomers were to make strong use of schemes that allow them to ‘unlock equity’ in their property, then there would be an intergenerational transfer of resources – but it would also be a counterbalancing force to the one Piketty is describing.  The intergenerational claim and the claim of excessive inheritance incomes are contradictory claims – not complements!

“We will all be poorer in the future”

No.  Piketty points out that he is assuming long-run per capita income growth of 1.2%pa (page 100).  Furthermore, the return to labour has risen in this context due to a process of capital deepening – a transitory process that gives us greater growth than this (although Piketty’s assumptions limit the impact of this).  He is not assuming a zero-sum, or poorer, future.

“It is all rent seeking, not value creation”

No.  Piketty states that (pg 423):

Rent is not an imperfection in the market: it is rather the consequence of “pure and perfect” market for capital, as economists understand it

In this context, he is talking about rent as an earned return on investment – not as “rent seeking”.  Rent seeking is when someone expends resources to try to transfer resources to themselves.

He inadvertently uses the term “rent seeking” on page 116 – however, I am convinced this is a mistake.  The reason for this is his later discussion of the term rent on page 423:

It is particularly interesting to note that the word “rent” is often used nowadays in a very different sense: to denote an imperfection in the market (as in “monopoly rent”), or, more generally, to refer to any undue or unjustified income

He compares this to his usage

The problem posed by this use of the word “rent” is very simple: the fact that capital yields income … has absolutely nothing to do with the problem of imperfect competition or monopoly.  If capital plays a useful role in the process of production, it is natural that it should be paid.

This is certainly not “rent seeking”.  In fact, it is largely the fact that increments of capital are creating value, in a situation where the ‘stock of people’ is growing slowly that is driving the result.

“It is all about misallocation/unproductive investment (housing) instead of returns on real investment”

No.  Piketty is at pains to say how ridiculous the “unproductive” vs “productive” split in investment is.  From page 48:

Similarly I ruled out the idea of excluding residential real estate from capital on the ground that it is “unproductive” ….  The truth is that all these forms of wealth are useful and productive.

For him, it is about looking at investment and returns on the same basis, irrespective of what the investment is.  Then given that, he is discussing a process where he thinks incomes will become dispersed, a process he is concerned about.

“It shows we need more taxes and a larger government”

No.  Piketty explicitly states that he is talking about changing the tax mix, not increasing the level of taxation and the size of government.  From page 481

There is no significant support for continuing to expand the social state at its 1930-1980 growth rate

On the face of it this does not seem to say much.  But when combined with his push for all policy to be based on democratic support and the rest of chapter 13, noting that governments now use more of national income then they have at any point in the past (the fantasy of shrinking governments that some have makes very little sense), it leads us to his conclusion that we should about how to improve policy – rather than saying we should further shift resources from private to public hands.

“Piketty hates wealth”

No.  He is so keen on redistribution, because he does not believe that what he is suggesting would reduce wealth – he has no problem with wealth being created, his issue is with long dynasties that control resources.

And this comes from a concern about economic opportunity.  From page 523:

Protectionism does not produce wealth, and free trade and economic openness are ultimately in everyone’s interest, provided that some countries do not take advantage of their neighbors by siphoning off their tax base

This feeds into the general idea that Piketty is interested in protecting the positives of capitalism from some “natural tendency” he fears – not radically overthrowing capitalism.  This is why his work reminds me of Keynes:

 capitalism, wisely managed, can probably be made more efficient for attaining economic ends than any alternative system yet in sight.

“Piketty’s thesis is not only anti-wealth, but anti-globalisation”

No.  Not at all.  Piketty recognises that such openness is useful – and it is part of the reason he is forecasting 50 years of convergence in incomes between the poorest and richest nations on earth in the first part of his book.

In fact, Piketty expects significant convergence between rich and poor countries as a result of globalisation and free trade.  His concern is that this will come with falling taxes on mobile factors (specifically capital) and that this will be a “prisoner’s dilemma” for nations – as a result, a global agreement for a capital tax, if enforced, could improve outcomes in his view.  This is certainly not an argument against globalisation.

The quote for the above question (“Piketty hates wealth”) actually covers this question off quite well!

“Piketty is describing a world with increasing robotics and automation”

No.  I’m not sure where this one has come from, and I’ve heard it a couple of times.  This is very untrue.

Piketty is not interested in trying to pick the future of technology change.  Instead, he is trying to describe a general tendency that he believes will exist – relatively independently of the type of technological change we experience.

Increasing automation is a secular trend that might reinforce the dynamics that Piketty is discussing, but this isn’t something he discusses.