DAVID HENDERSON ON PIKETTY: POVERTY MORE IMPORTANT THAN INEQUALITY

David Henderson on Piketty

David Henderson is posting extracts from his review of Thomas Pikcetty’s block buster book: “Captial in the 21st century”, Bellknap, Harvard.

HERE http://econlog.econlib.org and HERE 

1: “My long review of Thomas Piketty's Capital in Twenty-First Century is finally out. It is titled "An Unintended Case for More Capitalism." Unlike many free-market critics of Piketty's book, I find his big-picture statistical analysis somewhat compelling, although like the other critics I see some serious problems with it. But even if his analysis is correct, I still find it much less important than he does, and I find his policy proposals appalling. Beyond his big-picture analysis and policy proposals, he discusses many issues: Social Security, the history of tax policy in the United States and France, global warming policy, immigration, and many others. On some of these, his analysis is good. On others, it is weak or outright wrong. Sometimes he gets his history wrong, and in important ways. Finally, he has a bad habit of questioning the motives of those with whom he disagrees.

Start with the big picture. "It is long past the time," he writes in the Introduction, "when we should have put the question of inequality back at the center of economic analysis and begun asking questions first raised in the nineteenth century." The center? Really? But if we put inequality at the center, we can easily miss the tremendous growth in well-being for a huge percentage of people in the world and for almost everyone in the United States and Western Europe. Much later in the book, Piketty shows that he is aware of those improved conditions, writing:

Nevertheless, according to official indices, the average per capita purchasing power in Britain and France in 1800 was about one-tenth what it was in 2010. In other words, with 20 to 30 times the average income in 1800, a person would probably have lived no better than with 2 or 3 times the average income today. With 5-10 times the average income in 1800, one would have been in a situation somewhere between the minimum and average wage today.

In his own way, he is pointing out, albeit less dramatically, what University of California, Berkeley economist Brad DeLong noted in a study aptly titled "Cornucopia." In that well-argued and documented paper, DeLong examines the 20th century and shows that the price of almost every item we buy--if stated in hours of labor required to earn enough to pay for it--has fallen to a fraction of its cost in 1900. Moreover, that reduction in cost understates the improvement in well-being because many crucial items that we buy today did not exist in 1900. Antibiotics, for example, are a 20th century invention. Their price in 1900 was effectively infinite.

2 In Piketty's view, if someone's share of wealth stays constant, he cannot be better off, even if wealth has increased.

Yesterday I highlighted the opening of my lengthy published review of Thomas Piketty's Capital in the Twenty-First Century. Here's the next episode.

In my view, a steady increase in well-being for the vast majority of the world's inhabitants, as well as the policies necessary to achieve that, are what should be central to economic analysis. But Piketty chooses to put inequality front and center, and so be it. He states his conclusion up front:

When the rate of return on capital significantly exceeds the growth rate of the economy (as it did through much of history until the nineteenth century and as is likely to be the case again in the twenty-first century), then it logically follows that inherited wealth grows faster than output and income.

The reasoning is fairly straightforward: Assume that someone who owns capital earns an average annual real return of 5 percent and that the rate of growth of the economy is 3 percent. If the owner of capital can live on 1 percentage point of the annual return, his wealth will grow at 4 percent per year, which is higher than the economy's growth rate. We need only one more assumption: that the capital owner has only one son or daughter who, in turn, will live on that 1 percentage point per year. QED
.
In short, Piketty's conclusion follows logically, but only if we include assumptions about the number of heirs and their spending discipline. But if, for example, each wealthy person has three heirs who dissipate the wealth, those heirs will leave little to their heirs. So, based on just Piketty's skimpy assumptions, his claim does not follow logically. He, unfortunately, starts out by overstating his case. He could be right empirically, though, and he presents evidence for the growing share of income earned by owners of capital, much of which they inherited.

We are still left with the question: "So what?" Imagine--as Piketty has convinced me seems at least plausible--that the share of income going to owners of capital could rise over time, which means that the share of income going to labor would fall. Would that mean that laborers are worse off? Not at all. In fact, they are likely to be better off. Unfortunately, many people who read the book, especially those who are not economists, could easily miss this point for two reasons: (1) Piketty's emphasis on income shares rather than on real income; and (2) his misleading language. We would expect an emphasis on shares rather than real income from someone who believes that inequality of wealth and income, rather than improvements in standards of living, is "at the center of economic analysis."

What compounds the misleading impression is Piketty's misleading language. For example, in discussing his country, France, he writes, "Probate records also enable us to observe that the decrease in the upper decile's share of national wealth in the twentieth century benefited the middle 40 percent of the population exclusively." But as he well knows, French wealth per capita grew enormously in the 20th century, and so the decline in share of the wealthiest does not imply an absolute decline in wealth. Moreover, even if the wealthiest French people had lost wealth in absolute terms, the higher share of the people below them is not sufficient evidence that the wealthiest group's decline benefited the middle 40 percent. The middle 40 percent could have done better simply because of their own savings and investments.

Piketty's misleading explanation of the French case above is not an isolated weakness. Throughout the book, he writes as if he thinks that wealth is zero-sum and, thus, that increases in various groups' wealth must come at the expense of others. Writing about early 19th-century France, for example, he refers to a "transfer of 10 percent of national income to capital." But a look at his Figure 6.1, on which he bases this claim, shows no such transfer. All it shows is that the share of income going to capital rose. Similarly, in discussing the United States in the late 20th century, he calls an increase in the income share of the top 10 percent an "internal transfer between social groups." Never mind that on the very same page, he admits that income for the bottom 90 percent slowly grew over that same period.

Or consider Piketty's statement about the United States and France: "And the poorer half of the population are as poor today as they were in the past, with barely 5 percent of total wealth, just as in 1910." That is nonsense. If the poor have the same percentage of wealth as they had in 1910, they are much richer because wealth is much greater, as Piketty well knows. Here, he has gone beyond misleading language into actual error.”

Comment

I have my copy of Piketty’s book om my desk but I have not finished it yet.

However, from the start it clashes with my own considered views, summed in my insistence that poverty is a more important problem than inequality, as I have expressed several times on Lost Legacy. 

I have debated with David Henderson on Lost Legacy on the “invisible hand” metaphor, HERE  (29 November, 2005) so we do not see eye-to-eye on that subject at least, and perhaps others, but his review of Pikett’s book is spot on.

Inequality cennot be “solved” by a magic bullet, acts of government, political wishful thinking, “occupations”, or revolutions of any kind. It is an historical feature of all human societies since our much fewer ancestors left the forest and taht life will return in short-order if the good intentions of good people become twisted by those who have always emerged after whatever economic processes are destroyed.

Nowhere in all of human history have societies, prior to the 18th century in North Western Europe and prior to what emerged in North America in the 19th century, and continues today in the 20th and 21st centuries has inequality been abolished by design (Marx’s solution). 

The real undesigned transformation are now spreading across large population swathes in the fomerly “undeveloped” rest of the world, and we can seen rising per capita incomes up and down the income scales. 

There is a long ways to go, yet. And the desperately poor of the world know it. That’s why some of the desperately poor make hazardous and risky journeys in attempts to get into the ranks of the poor in what they regard as the rich countries. 

It is ironic that poor people in the poorest part of the world regard the poverty of the rich countries as infinitely better than their own poverty, even though the rise in per capita incomes and access to technologies, in recent and continuing decades, where they live or came from, are rising for the first time since humanity spontaneously started on that road less that 500 years ago - and with long ways to go yet.

Of course, for the humanitarian concerned people in the world, the pace of change is too slow. They want action to hurry-it up. A worthy goal, indeed. I share their aspirations and admire their self-sacrificing enthusiasm but I only worry that in trying to get what they wish for, they don’t bring the whole house down with them.