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.

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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.

Other reviews of Capital

Having looked into our own review of Capital, and discussed some of the common misconceptions of the book, now is the time to allow a bit more perspective.  Here are a bunch of other reviews of Capital in the 21st Century that I have hunted down.  There is no way I’m saying I agree with all the reviews here – as if I did, my opinions would constantly contradict!  Instead, I just want as broad a range of views here as possible.

There is no particular order, but it appears that the more critical ones are ‘on average’ at the top.  This is because they turned up later, and I tended to add things near the top of the list as I was too lazy to scroll down 🙂

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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.

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Book review: Capital

Here is my book review of Capital in the Twenty-First Century [Review of Capital].  I have tried to avoid other reviews, so that I can give a perspective based on my own reading of the book – the only bits I’ve noted before now are these discussions, this twitter post, these “reviews”, and this interview.  As a result, I have probably covered a lot of ground that has already been covered, just in a less informed fashion – my apologies!

My review is very long (20 pages).  Although it is still written as a blog post there are no hyperlinks or links to other blog posts, I’ve tried to go directly to literature instead.  Here is a pdf version of the review [Review of Capital].  So if, instead of reading this online, you’d prefer to make yourself a coffee, grab some dark chocolate, lie down on a bearskin rug in front of a roaring fire, and fall asleep to something, then this review should do the trick.

I will put down a cut down (and more accessible) version at some point well in the future – it already exists but is promised to other people.  In this post I will just put the “summary” section, if you want to read the full review you will have to click on the pdf version of the review.  My review is not very accessible, and I’m sorry about that.  However, I didn’t feel that I could discuss Piketty’s argument as “one thing” when it is very multifaceted – I hope this is clear from the summary at the start.  Going through the argument in the way I have, and then discussing assumptions involved individually, helped me to understand what is going on – so I may as well still share it 🙂

Note:  In the review there were two things I directly said, but I’m not sure if my language was clear enough – but as I can’t access the file prior to posting I’ll just stay here.  1) In the example, the higher MPL from higher K drives up w and drives down r, that is why I state w/r is higher – my language isn’t quite clear enough in it.  2) when discussing the average as the minimum wage worker, the point is that in reality individuals/households “move between” income deciles a lot, making this an awful benchmark – again my language may not be clear enough.

If you catch logical mistakes in the review, I’d love to hear from you – the reason I wrote this without reading anything else was to ensure that I gave the book an honest appraisal, on the basis of my actual understanding.  I’m more than happy to learn where my understanding is wrong.  Here is the introduction and summary:

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