Given the excitement that Thomas Piketty’s new book, Capital in the Twenty-First Century, has stirred up within the political left, the French economist probably should have titled it Fifty Shades of Inequality.
In Capital, Piketty presents a painstakingly researched case for doing what progressives ranging from Paul Krugman to Barack Obama want to do anyway, which is to raise taxes and expand the power and reach of government. Unfortunately for liberals, Piketty gets almost everything wrong, starting with the numbers.
Piketty claims that capitalism is in crisis, because the importance of capital in our economy is growing, the “Top 10%” owns most (70%) of it, and the “Bottom 50%” owns almost none (5%) of it. However Piketty’s numbers ignore the capitalized value of Social Security, Medicare, and our other welfare state programs. These programs are huge, and they disproportionately benefit the “Bottom 50%.”
Social Security and Medicare are “pay as you go” social programs (which Piketty calls “PAYGO”). While Social Security and Medicare may not add anything to the physical capital of the economy as a whole, from the point of view of the individuals enrolled in the programs, they represent capital. Specifically, the Social Security and Medicare contributions function as forced savings, and the benefits function as annuities. And, Piketty certainly counts annuities owned by “the rich” as part of their wealth.
Social Security and Medicare are structured such that the capital accumulation from the forced savings of the lower income classes is heavily augmented by subsidies paid for by the higher income classes.
The ultimate example of this might be the case of the first Social Security benefits recipient, Ida May Fuller, who was definitely not in the “Top 10%.”
Ms. Fuller received about $180,000 in Social Security benefits, in return for a bit more than $400 in contributions (both numbers in today’s dollars). And, she also received 10 years of Medicare coverage for nothing.
Living requires income. In Piketty’s model, there are only two kinds of income: income from labor, and income from capital. Because Ms. Fuller didn’t work for the last 35 years of her life, she must have lived off income from capital. Ms. Fuller must therefore have owned significant capital (in the form of her claim on the Social Security Administration) when she retired in 1939. Because Piketty’s wealth distribution numbers do not take this form of capital into account, they are simply wrong.
But wait! Social programs are just promises by the government to pay, and they could be repudiated at any time.
Yes, but government bonds are also nothing more than government promises to pay, and Piketty counts them as private wealth. Government bonds can be (and have been) repudiated, both directly (Argentina, Greece) and via inflation (almost everywhere).
Because high earners receive a return on their contributions that is lower than the interest rate on federal debt, the entire “unfunded liabilities” of Social Security and Medicare must logically arise from the benefits promised to the “Bottom 50%.” Let’s see how taking these unfunded liabilities into account would affect Piketty’s numbers.
Piketty estimates that, in 2010, the U.S. had total national wealth of about $54 trillion. The “Top 10%” owned 70% of this, the “middle class” (the next 40%) held 25% of the total, and the “Bottom 50%” owned 5%.
If we assume that the (75-year) unfunded liabilities of Social Security and Medicare ($9.6 trillion as of 2010) will ultimately be dealt by taxing “the rich” (i.e., the “Top 10%”), then the true U.S. wealth distribution in 2010 was actually much different than the one that Piketty describes.
After adjustment for the capitalized value of Social Security and Medicare, in 2010, the “Top 10%” actually owned 52.2% of national wealth, not much more than the 50% observed for this group in 1970s – 1980s Scandinavia, which was the society with the lowest inequality that Piketty has ever found. And, the “Bottom 50%” really held 22.8% of total wealth, close to the 25% that Piketty believes would pertain in an “Ideal Society.” (See Table 7.2 in Capital.)
But wait! There’s more! Specifically, there is a lot more to the U.S. welfare state (which Piketty calls “the social state”) than just Social Security and Medicare.
Because Piketty presents (purportedly) comparable data from 1870 to 2010, and draws comparisons between the Belle Epoch (1870 to 1914) and the present, it is literally shocking that Piketty ignores the impact of welfare programs on the effective distribution of capital.
Piketty cites literature from around 1900 to make points about inequality of wealth. Many of the characters in the novels of Jane Austen and Honore de Balzac did not work, and never expected to work. Work was simply not a part of the lives of people in their social class.
This lifestyle was made possible by the Austen/Balzac characters’ ownership of capital, the rents from which provided them with annual incomes of 50 to 100 times that of the average citizen of the time. So, for Piketty, the big deal about owning capital is that it provides income that you don’t have to work for.
Well, the U.S. currently has more than 100 million working age people that don’t work. Many of these people are being supported by family members, but there are millions of adults (18 – 65) that are living off our welfare state (including Social Security Disability). Because these people don’t have labor income, in Piketty’s model, they must be paying their bills with capital income.
Hmmmm. People that are able to live for years, if not their entire lives, without working. Sounds like characters in a Jane Austin novel, doesn’t it?
But wait! Jane Austen’s characters were rich, and people on welfare in the U.S. are poor, right? Well, let’s see.
If America’s welfare population (along with their lifestyles) were put in a time machine and sent back to the France of 1870, they would be viewed by the ordinary people of that time as a strange new aristocracy.
Our welfare recipients would be envied for their (comparatively) ample and varied food, (comparatively) large dwelling units, (comparatively) huge selection of clothing, amazing creature comforts (e.g., electric lights, indoor plumbing, air conditioning, washing machines, etc.), ability to travel at 80 miles an hour, capability to communicate with each other at the speed of light, and access to dazzling entertainment via flat panels on their walls.
However, what the ordinary French citizens of 1870 would probably be most envious of regarding our welfare population is their immunity to common infectious diseases, as well as their ability to easily cure the ones that they did get. And, of course, the ordinary people of 1870 France would envy our welfare recipients for the fact that they enjoyed their incredible lifestyle without having to work.
We can stop this line of discussion here. The point is that Piketty’s painstakingly researched numbers are worthless, because they ignore the existence of the modern welfare state. Our various welfare programs redistribute a huge percentage of national income, and, therefore, for the purposes of Piketty’s comparisons across time, they redistribute the beneficial ownership of capital.
Now, let’s move on to the (many) other things that Piketty gets wrong.
Piketty seems to assert that it is possible (starting from here) to greatly increase the value of society’s capital without, at the same time, greatly increasing its income. This is the only way that the capital/income ratio could double, as Piketty predicts that it will in the 21st century. However, the “Produced Assets” numbers from the U.S Bureau of Economic Analysis (BEA) belie Piketty’s thesis.
As shown below, the GDP yield from nonresidential assets (valued at “market”) has remained fairly constant over the past 62 years, oscillating around a mean value of about 44%.
There is a lot to this chart. For now, just note that the BEA data contradicts Piketty’s prediction of an endlessly growing ratio of capital to national income. It also suggests that our growth rate is not limited to the 1.5%/year that Piketty projects. We could grow faster if we accumulated nonresidential assets faster. And, we could accomplish this by giving our companies and entrepreneurs an environment that is more conducive to investing capital within the U.S.
As an aside, residential assets produce a GDP return of about 8%. Even at this low rate of capital productivity, residential assets can produce the 5% return on capital for their owners that Piketty expects. This is because, as the BEA does the numbers, producing housing services (from existing residential assets) doesn’t require any labor.
Piketty predicts that a slowdown in population growth will reduce the maximum sustainable growth rate of GDP. In saying this, Piketty buys into the superstition that:
GDP growth rate = labor force growth rate + productivity growth rate
The equation above is an accounting identity, and it is true by definition. However it is not an accurate description of cause and effect. At least for real GDP growth rates between 0% and 4%, the correct equation is:
GDP growth = 0.44 nonresidential asset growth + 0.08 residential asset growth
Labor has little to do with economic growth. Capitalism is about capital and knowledge. If businesses have strong incentives to invest in the U.S., they will produce fast GDP growth here, with the available labor force.
Of course more investment and faster GDP growth will lead to rising wages, and the higher pay will pull more people into the labor force. This is why we have never actually observed sustained productivity growth of more than 2% per year.
Here is another important point to which Piketty seems oblivious. How can population growth limit GDP growth (at least anytime soon), when we currently have massive unemployment and underemployment in the U.S. (and even more of it in France)?
The U.S. working age population grew by 0.98% in 2013. Let’s assume that it continues to grow at this rate. In December 2013, the U.S. was 15.7 million full-time-equivalent* (FTE) jobs short of full employment (defined as the labor force conditions of April 2000). This means that total FTE employment could grow at 2% per year for 11 years before we would be approaching full employment. And, even at that point, we would still have 111 million working age adults that were not working for pay.
One obvious conclusion from reading Capital is that Piketty doesn’t believe in economic growth. Or rather, he believes that a certain amount of growth will “just happen,” whether marginal tax rates are 25% or 80%. Piketty’s own equations show that higher economic growth reduces inequality, but he doesn’t spend much time pondering how GDP growth could be increased.
In truth, Piketty isn’t interested in growth; he is interested in equality. Piketty believes that inequality is bad, and that it represents the “crisis of capitalism.” He also believes that tax rates don’t impact economic growth. Given this, (and the fact that he is a French leftist), it is not surprising that Piketty’s solution to inequality is even more progressive taxation.
Piketty’s fix for the current inequality “crisis” comprises an 80% marginal tax rate on incomes above (say) $500,000/year, plus a progressive global wealth tax (with a top rate of 5% per year, or perhaps even 10% per year for billionaires).
Since Piketty himself seems on track to earn $1,000,000 in 2014 from book sales and speaking engagements, we can only assume that he will be voluntarily handing over 80% of everything he earns over $500,000 to the French government. After all, having decried rising inequality in France, Piketty would hardly want to contribute to this scourge personally.
Piketty proudly predicts that his tax system would not only reduce wealth inequality, but would also cause “supermanagers” (CEOs and other high paid corporate executives) to agree to accept lower pretax pay. This would reduce inequality with respect to labor income.
Piketty claims that his tax system would not impact economic growth or entrepreneurial innovation. However a comparison between France and the U.S. renders this assertion laughable. For reference, France, already has a wealth tax, as well as a much higher marginal income tax rate than the U.S. (75% vs. about 43%).
Of the 100 most valuable corporations in the world, 44 are based in the U.S., and 5 are based in France. This means that the U.S., which has less than 5 times the population of France and less than 6 times the GDP, has created almost 9 times as many “Top 100” companies.
The comparison is even more lopsided in terms of the total market capitalizations of the two countries’ “Top 100” companies, with a ratio of more than 13:1 in favor of the U.S.
These comparisons are just the warm-up. The real shock comes when you look at when each country’s “Top 100” companies were started.
The last time that France created a “Top 100” company was 100 years ago: Total Petroleum, in 1924. And, Total was founded at the initiative of the French government. The most recent private French venture in today’s global “Top 100” is L’Oreal, which was founded in 1909.
In contrast, one U.S. “Top 100” company (Facebook) was founded only 10 years ago. Another, Google, which was started in 1998 by two guys in a dorm room at Stanford University, has a market cap approaching that of all 5 of France’s “Top 100” companies added together.
In the 90 years since Total was founded, the U.S. created 17 of its 44 “Top 100” companies, including 1 in the 2000s, 2 in the 1990s, 4 in the 1980s, and 4 in the 1970s.
The progressives want us to believe that high taxes don’t impact growth and innovation. Sure, Professor Piketty. Right. Uh-huh.
Piketty attributes two thirds of the increase in total income inequality since 1980 to the rise of what he calls “supermanagers,” which are highly paid corporate executives. Piketty then notes that, to date, the rise of the supermanagers has mainly been an Anglo-Saxon phenomenon, with the labor incomes of executives in the U.S., the U.K., Canada, and Australia far outpacing those of managers holding similar jobs in continental Europe and Japan.
Piketty examines and dismisses the possibility that the supermanagers’ pay could be based upon classical economics, i.e., their marginal productivity. Here, Piketty’s progressive ideology blinds him to his own data.
All of the things about supermanagers’ pay that Piketty puzzles and frets over are explained by Figure 5.6, on page 189 of Capital. This graph shows the “Tobin Q” (the ratio of the market value of a corporation to its book value) for companies in the U.S., the U.K., Canada, Japan, Germany, and France.
Figure 5.6 shows that, in 1980, the Tobin Q of corporations ranged between 22% (Germany) and 61% (Canada), with the U.S. at 42%.
Piketty doesn’t seem to realize that a Tobin Q value of less than 100% means that the markets believe that the corporation in question is destroying the economic value of its capital. He also doesn’t seem to get that the owners of such companies would want to hire CEOs that would fix this, and would be happy to reward them handsomely for doing so.
Piketty’s data shows that the supermanagers that took over the leadership of corporations in the U.S., the U.K., and Canada around the time that Ronald Reagan took office managed to raise the Tobin Q of their companies to levels over 100%, while the much-lower-paid executives in Japan, Germany, and France never even came close to accomplishing this feat.
Given that the “exorbitant” compensation of the Anglo-Saxon supermanagers was deducted before computing the profits that determined the market values of their companies, Piketty’s own data says that, in a purely economic sense, the English-speaking supermanagers were worth much more than they were paid. In contrast, the executives in Japan, Germany, and France failed in their most fundamental job, which was to enhance, rather than destroy, the value of the capital entrusted to them.
Before moving on to an extended discussion of another one of Professor Piketty’s major errors, let’s do a “Piketty Idiocy Lightning Round:”
- In Piketty’s world, it would be a bad thing if someone were to develop a drug that cured Alzheimer’s. This is because that person would certainly become a multi-billionaire, and that would increase inequality.
- The only thing worse than the scenario described above would be if, because his/her newfound riches hadn’t been confiscated by Piketty’s income and wealth taxes (as they certainly should be), he/she used the capital to develop a cure for cancer. Even more inequality!
- Under Piketty’s tax system, it would have been impossible for Elon Musk to leverage his success with PayPal to fund Tesla Motors.
- In Piketty’s model, it would be a disaster if 15 million unemployed Americans went out tomorrow and got jobs paying $8.00/hour. This because is creating new jobs that pay less than the average wage of the “Bottom 50%” will increase labor income inequality.
- In contrast, it would be good if all of America’s minimum wage workers quit their jobs and went on welfare, because then labor income inequality would be reduced.
- On page 309 of Capital, Piketty notes approvingly that the minimum wage in France has been higher than that of the U.S. since 1985. However, Piketty doesn’t mention that, since 1985, French unemployment has averaged about 9%, vs. about 6% for the U.S.
- Seizing all of the venture capital firms in America and giving the funds to Amtrak would be good, because it would not only reduce wealth inequality, but also allow the federal government to build much needed (in the opinion of progressive intellectuals, at least) high-speed rail infrastructure.
- To Piketty, a rising ratio of wealth to national income is bad, and a falling ratio is good. Accordingly, Piketty’s bad periods have names like “la Belle Epoch” (the beautiful era), the “Roaring Twenties,” and “the Soaring Sixties.” In contrast, his good times have names like “World War I,” “World War II,” and “the Great Depression.”
That’s enough for the Lightning Round. Now, let’s examine another one of Piketty’s core delusions, that unaccountable corporate managers and government bureaucrats can manage society’s capital as well or better than the rich individuals that control it today.
Piketty’s wealth tax would shrink large existing fortunes, and his 80% marginal income tax rate would prevent top executives from becoming truly rich. OK, but then what? As noted above, GDP growth is driven by the build-up of productive assets, and the assets have to be owned (and, even more importantly, managed) by someone.
A likely outcome of imposing Piketty’s system would be a new Great Depression. Anything you tax you get less of, and Piketty’s system would impose huge taxes on accumulating and maintaining assets, which are what drive GDP.
At the very least, Piketty’s system would make the U.S. more like France, where capital is controlled less by rich individuals, and more by corporate managers and the government (dirigisme). This is obviously what progressives like Piketty, Krugman, and Obama want, so let’s look at why they want this.
Returning to Piketty’s Figure 5.6, something happened in the U.S. shortly after 1980 that caused corporate Tobin Q ratios to start rising. Namely, some rich individuals (like Carl Icahn and T. Boone Pickens) created leveraged buyout (LBO) firms, which then proceeded to mount (or threaten) hostile takeovers of companies with low Tobin Q ratios.
The low-performing firms made tempting LBO targets, because they were earning low returns on their existing assets, and they were destroying capital when they reinvested their cash flows.
Often, the steps that were taken to improve the target firms’ returns on capital involved reducing headcount, breaking unions (Reagan created the precedent for this when he crushed the air traffic controller’s union, PATCO), and moving operations to lower-cost locales (e.g., the southern U.S., Mexico, China).
Progressives didn’t like the LBO boom. They want corporate managements to be responsive to non-owner “stakeholders” (like unions and environmentalists), so they would prefer that compliant CEOs not have to worry about being tossed out by corporate raiders.
If there had been no large private fortunes in 1980, there would have been no LBO firms. There would also have been no venture capital firms to fund “disruptive” technologies. Bureaucrats, whether in corporations or government, don’t like surprises.
The above notwithstanding, here is a quote from an April 25, 2014, New York Times Article (“A Walmart Fortune, Spreading Charter Schools”) that provides an example of what progressives probably hate the most about the existence of large concentrations of privately controlled wealth:
According to Marc Sternberg, who was appointed director of K-12 education reform at the Walton Family Foundation last September, Walton has given grants to one in every four charter start-ups in the country, for a total of $335 million.
"The Walton Family Foundation has been deeply committed to a theory of change, which is that we have a moral obligation to provide families with high quality choices,” said Mr. Sternberg. “We believe that in providing choices we are also compelling the other schools in an ecosystem to raise their game."
Progressives believe that education should be controlled by the state, and that the state should be controlled by progressives. The last thing that progressives would want would be for there to be individuals possessing sufficient wealth to be able to disrupt the progressives’ symbiotic relationship with the teachers’ unions. And, the last thing that the teachers’ unions would want would be to be forced to “raise their game.”
At the deepest philosophical level, American capitalism is rooted in the Declaration of Independence, and the wellspring of French economic thinking is the Declaration of the Rights of Man and the Citizen (as interpreted by generations of French intellectuals with a leftist agenda).
On page 480 of Capital, Piketty says:
…how far do equal rights extend? Do they simply guarantee the right to enter into free contract—the equality of the market, which at the time of the French Revolution, seemed quite revolutionary? And, if one includes equal rights to an education, to health care, and to a pension, as the twentieth century social state proposed, should one also include rights to culture, housing, and travel?
The second sentence to Article I of the Declaration of the Rights of Man of 1789 formulates a kind of answer to this question, since it in a sense reverses the burden of proof: equality is the norm, and inequality is acceptable only if based upon 'common utility.'"
Of course, this is not what Article I of the Declaration of the Rights of Man actually says. The actual text is:
- Men are born and remain free and equal in rights. Social distinctions may be founded only upon the general good.
The Declaration goes on to say some pretty conservative things:
- The aim of all political association is the preservation of the natural and imprescriptible (sic) rights of man. These rights are liberty, property, security, and resistance to oppression.
Obviously, similar to what American progressives have done with the U.S. Constitution, French progressives, like Piketty, have taken the Declaration of the Rights of Man and twisted it into something that the people that wrote it would probably not recognize. (A right to culture? At the expense of others? Really? What about the right to property?)
But, for the moment, let’s go with Piketty’s assertion that inequality has to be justified by generating “common utility.”
The key question, of course, is “common utility” in whose opinion? Who gets to be the judge of whether a proposed transaction benefits “common utility?”
Under American capitalism, the ultimate arbiter of “common utility” is the market. A free market is designed to maximize “common utility” by processing the preferences of 317,000,000 people, expressed in the form of voluntary offers to buy and sell, into an optimum allocation of resources and an efficient coordination of efforts.
When Piketty talks about “common utility,” what he means is, “common utility as judged by progressive French intellectuals like me.”
Piketty doesn’t understand why a system based upon voluntary transactions pays supermangers so much, so he assumes that there cannot be a valid reason. It then follows that government force can and should be applied to reduce the supermanager compensation that Piketty deems excessive, and that doing this will impose no costs on the economy.
In believing in their own omniscience, progressive intellectuals fall into the trap described so brilliantly by George Gilder in his book, Knowledge and Power. They seek to intervene in systems that they do not, and inherently cannot, understand.
In the final analysis, progressivism is simply the time-release form of communism. This is fine with progressives like Piketty, because they truly believe that the only thing wrong with soviet communism was that it was run by Stalin, rather than by them. Give them another chance (starting with an 80% marginal income tax rate and a global wealth tax), and this time they will get it right.
*FTE jobs = full-time jobs + 0.5 part-time jobs
