A response to Danyl on data and inequality

Over at Dim Post I see Danyl is discussing the latest (2014) Household Income Report and Piketty’s book Capital in the 21st Century.  Excellent – there are lots of important and interesting issues to discussing look at these sources.

However, in this instance the data he is using and his interpretation is sadly a bit off.  I thought I’d discuss why this is here. Read more

Tweetpic of the day

James sent me the following, I have nothing to add:

I’d also point out that Piketty has discussed claims of data mistakes here:

The key predictions did not rely on these perceived data errors in the first place – it is the framework for thinking about inequality that was of use, and which helped to create debate.  A debate that seems to have moved past his explanations, and looks like it will lead to a lot more research – which is choicetastic!

Can physicists please look at a basic textbook before releasing these things

FFS, this is probably the worst example of a physicist treating economists like idiots, and saying something both meaningless and already known, that I’ve seen for a while (via Marginal Revolution). Read more

Beware the seductive simplicity of the Spirit Level

I see that the Spirit Level authors are in town, and as a result there was a recent Herald article took aim at income inequality in New Zealand, relying strongly on the book ‘The Spirit Level’.  A conversation about the inequalities society believes are fair, or at least justifiable, is a good thing.  However, the Spirit Level’s claims that simply targeting measures like the Gini coefficient will make everyone better off is a misleading, and dangerous, place to start this conversation.

Read more

The housing bubble: Why implicit insurance may well be the real driver of Piketty’s concerns

Alex Tabarrok at Marginal Revolution points out that, without the run up in house prices, we do not get Piketty’s trend of rising capital to output ratios in the data.  This is very true, and was one of the key reasons why I wasn’t convinced that Piketty’s explanation of his data was the best available.

Now Piketty expressly discusses capital gains in his book – and he points out that he does not view the current increase in the value of capital as a bubble, instead it is the value of capital returning to its “real” level.  In that way, he views the idea of saying that we have a bubble as both wrong and beside the point.

Say that we accept the implied assumption he works with – that there isn’t (and hasn’t been) a bubble in housing markets.  Given this, it is important at this point to consider the narrative he has for history.  He discusses a period (pre-WWI) where governments offered a high risk free rate of return, where wealth was (in some ways) heavily insured by government, and where (as a result) the value of capital was high and the private risk premium was low [best example of this was his discussion of the UK, where government debt offered a high risk free yield for those who could invest in it].  WWI and WWII – with the combination of war and the change in government policies (towards appropriation and direct regulation) changed this – the private risk premium was now a lot higher, and the value of capital dropped as a result.  Government protection and regulation is BUILT INTO the price of an asset!

In Piketty’s data we are looking at a situation where government policies have changed, and as a result so has the inherent private risk premium associated with assets, pushing up the price of assets.  This description suggests that, if there is a failure, it is due to an “implicit subsidy” by governments to capital owners – it is in essence the same policy failure that those in financial/macroeconomics have been discussing for years now (a quick look on the blog for recent posts gives these 1,2,3,4 – more importantly don’t forget this and suggestions by Cochrane to make the financial system run free and remove this implicit subsidy).

If this is the real cause of the changing capital to output ratios, then it suggests economists have already been investigating the key cause – and that there is no natural tendency for capitalism to head this way.  Even if we don’t deal with the inherent injustice, capital/output ratios shouldn’t intensify.  And furthermore, this would suggest that there is no need for a capital tax to deal with the perceived injustice – instead we just need to remove an implicit subsidy, and it make investigation into financial regulation even higher on the research agenda!

This is an incredibly important issue to investigate with respect to Piketty’s central thesis – his data set is incredible, but there is a lot of work to be done teasing out what it actually means, let alone defining what correct policy is.  Even while I was reading this book, I could not get this alternative hypothesis out of my head – and Tabarrok’s post has just increased my belief that this alternative hypothesis is the correct one.

Quote of the Day: Kolm on inequality

One of the forefathers of modern income inequality analysis, Serge-Christophe Kolm, started one of his most famous papers (REPEC) in the following way:

Many people consider the reduction of economic inequalites as a basic aim of society. Such ideas are, however, largely nonoperational, sterile, and even meaningless, as long as what is called inequality is not stated with precision. This is so because, as well appear below, different measures of inequality give widely different, and even opposite, results. Such policy which diminishes some apparently reasonable measure increases other ones.

This is no small point.  While it is nice for us to bang on about “reducing inequalities”, it is nothing more than empty platitudes if we aren’t willing to discuss the trade-offs associated with individual policies.

Also, let’s not forget this quote:

Few concepts are as meaninglessly used as that of inequality.

But this is not because he thinks analysing issues of social justice don’t matter – in fact it is the complete opposite!  He believes that multi-dimensional ethical issues deserve careful and specific analysis, rather than being thrown into one broad, and close to meaningless, term.

Like exchange rates, productivity, GDP, and inflation, inequality is a broad macro(social/economic) term that can be used as a touch stone to go on to think about other real issues.  But it should not be allowed to become more important than these issues, and an understanding of the trade-offs that do exist when we go to make policy choices.