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Pier Luigi Porta


A Review of Le Capital au XXIe siècle by Thomas Piketty (Paris: Seuil, 2013). English edition: Capital in the 21st Century, Cambridge (Mass.), Harvard University Press, 2014.


A new language for the dismal science.

Thomas Piketty is a prominent French economist who works in Paris at the Paris School of Economics and at the École de Hautes Études en Sciences Sociales. Reading his latest book is a refreshing experience. In the first place the book focusses on distribution as the main problem of Economics. This is a welcome surprise. Barring the contributions from certain quarters - such as Amartya Sen, Tony Atkinson and few others - as far as mainstream Economics is concerned, it has long ceased dealing with income distribution as a major theoretical issue. The idea has gained currency that income distribution is an aspect and an outcome of the pricing mechanism. In the world of general economic equilibrium, as well as in the libertarian economic order, only commutative justice can find its place. Distributive justice is a spurious construct. At best (as Hayek once wrote) it is just a name, relished by the socially oriented, and a toy for econometricians in search of ‘facts': but it does not have a proper intellectual statute. In the severe quarters where economists live, there is hardly a place for multiple spheres of justice. To make of distribution a pillar of the economic discourse would appear to many as a step backwards to David Ricardo, who had in fact argued in that sense in the Classical period.
The history of economic thought is not popular with the hardline mainstream economists today, such as the desperately aggressive Noisefromamerika people, almost as popular and powerful as the Bocconi gurus, especially in Italy. Their impudent Americanism makes them ‘more papist than the Pope'. Piketty, who shares an American education and is certainly not a French nationalist, sensibly finds good reasons to keep extreme Americanism at bay, which also makes it easier for him to offer a balanced view on things that can be usefully drawn from the history of the discipline, a history so contemptuously ignored by the mainstream generally. At the same time the book is explicitly not a purely economic book. The history of the distribution of wealth is unescapably political - the author argues (p. 47 of the French edn.) - ; it cannot be reduced to the working of purely economic mechanisms. Thus distribution is a field where an economist needs the assistance of history, of social science and possibly other disciplines. This, of course, means taking a healthy distance from the current conventional wisdom of economics, which is rather prone to turn the discipline into an ‘imperial science', which - based on the two legs of balancing incentives coupled with methodological individualism (currently dubbed ‘microfounded' analysis) - proceeds to give exclusive privilege to a narrow focus on self-interested motivations of the agents. It then, of course, cavalierly extends that same kind of rationality as a safe and sound approach to any kind of human action.

Income distribution is back!

The book treats the subject extensively and makes pleasant reading. It seems possible to summarize the core argument in brief, taking advantage also from the outline given in the introductory chapter. The starting point is the famous ‘Kuznets curve'. That is based on the idea that both income and wealth inequalities increase during the initial stages of industrialization; at later stages, on the contrary, inequalities spontaneously diminish. Thus, through the growth process of a country there is, e.g. (as many would still argue), little need for a progressive system of taxation to foster greater equality. Piketty treats Kuznets with great respect. Kuznets is, in fact, definitely not one of our latter-day talibans, who pollute the intellectual atmosphere by pretending to know the ‘facts' in the first place, as they often shamelessly say. Kuznets knows perfectly well that, in the assessment of ‘facts', there is, as he writes, (see, here, p. 36) "perhaps 5% empirical information and 95% speculation".
Piketty is able to show two things. On the empirical side, Kuznets, writing in the early 1950s, had picked up a period (1914-1945) of historical diminution of inequality, probably not due to comfortable reasons at all, but due rather to devastating wars and disrupting shocks affecting the major economies: if we go on after that, doing the same job for the ensuing period (and that is Piketty's first move), the ‘facts' appear to be very different. Through the so-called glorious thirty years 1945-1975, Kuznets' optimistic drive still gained currency. But, later, less glorious years in terms of overall growth have come, at a time when inequalities have made a new appearance and have shown a strong drift toward the increase.
The result is that the measure of inequality in the rich countries at the beginning of the 21st century is very much the same as it was a century ago, before World War One.
It is therefore high time to take back at the centre of the stage the question of inequalities as was done by the economists of the 19th century. To do that, Piketty undertakes a vast research on the dynamics of income distribution between the factors of production, labour and capital. The emphasis, as the title dictates, is on capital. Sounds Marxian: but it is far from it in the substance. Here the central idea of the work comes out. Together with forces leading to convergence, there are other forces at work which pull in the opposite direction in a growing economy and the balance of the opposite forces is, at any period of time, the decisive element for an understanding of the link of growth with inequality of distribution. Among the forces leading to divergence Piketty mentions the soaring level of CEO's incomes and the working of the universality principle in the post war welfare state. But the main force behind rising inequality is a third one and that is the result of the historical fact of having a slow rate of growth together with high returns to capital. r > g is what Piketty calls the fundamental force of divergence. More precisely, the theoretical point is that, once the rate of return on capital for any reason turns significantly higher than the rate of growth, that divergence is likely to set in a cumulative process leading to greater divergence: stagnation cum increasing skewedness of distribution. Here is where the forces of divergence prevail. The contribution of the book lies in the demonstration that such and similar forces have nothing to do with market imperfections. On the contrary, the more you are successful in having capital markets that border on perfection, the greater the chance that the forces of divergence gather momentum.
The message conveyed by the book is a conjecture which strikes a chord to all those who are trying, more or less unsuccessfully, to understand the current crisis. It is also a message that sounds the death knell to the sect of those economists who have been fighting for free and perfect capital markets at all costs and above all purposes for the past 40-odd years and to the bandwagon of their silly followers, ever more numerous especially through the roaring 1990s. A subset of them seems to be made by the Euroenthusiasts, self-conscious or not, to whom Piketty directs perceptive and targeted critical arrows.
What is capital? We know what revenues are (pp. 82 ff.). National revenue is the sum of the revenue from capital plus labor revenue, which leaves us to discuss about capital. Piketty makes it clear from the start that ‘human' capital is left out of the picture. Capital is conceived to consist of the whole set of non-human assets that can be possessed and exchanged on a market. It simplifies the discourse - the a. adds - to take patrimoine, i.e. property or assets, i.e. wealth, and capital interchangeably. Now: national assets are the sum of private and public assets. In our days public assets are inconsiderable, which leaves us to focus on private capital. The ratio of capital revenue to total revenue is the product of the rate of return on capital multiplied by the capital output ratio. This is what is emphatically called in this book the first fundamental law of capitalism (p. 92). That leads to a detailed study of the historical vagaries of the capital output ratio. In a long period analysis, over two centuries approximately, the nature of capital has changed and landed property has gradually yielded to financial and industrial wealth. But the most important fact is that, in spite of the enormous transformations, the total value of the capital stock, measured in years of national revenue (i.e. the capital output ratio) does not seem to have appreciably changed. There is a decline through the inter-war period of the past century; but after that the movement is unequivocally on the increase.
It is here (p. 262) that Piketty introduces the second fundamental law of capitalism, whereby the capital output ratio equals the saving propensity divided by the growth rate of income. That is, of course, the identity basis, as it were, of the Harrod equation. The detailed analysis of the book ends up revolving around the ‘fact' that the return of capital in a slow growing world (e.g. p. 368 but indeed pervasively) remains above the overall growth rate: which, by the first law, secures an increasing share of capital returns on total income. At the same time the ‘second law' reminds us that in a slow growing world the assets inherited from the past grow in relative significance, i.e. as a ratio to income. On top of that the 20th century has given life to a number of mechanisms producing a wealthy monied class (e.g. p. 410): the rise of a "véritable ‘classe moyenne patrimoniale' constitue la principale transformation structurelle de la repartition des richesses dans le pays développés au XXe siècle".

Returns to capital and overall growth.

If Piketty is right, the world in which we live cries out for a new design of progressive taxation, which may effect (in particular) the ruling out of the exemptions enjoyed by financial and industrial assets. That new design should be coupled with some form of worldwide taxation of capital, with a view to fostering greater financial transparency. These two sets of fiscal propositions are made explicitly as a result of the analysis.
Some of us may still remember that tax exemptions of capital revenues have a serious background in good economic theory. Nicholas Kaldor - really in the footsteps of Luigi Einaudi - pleaded for an expenditure tax, which could help dodging the iniquitous burden of the double taxation of savings. The Kaldor-Pasinetti model and the debate about the ‘Cambridge equation' and the Pasinetti paradox is not popular with Piketty. He has a paragraph on the ‘two Cambridges' debate of the past century, and he attributes the Cambridge-England side some degree of confusion (p. 366) and a lack of a sufficient historical background analysis to set the debate on secure foundations.
However, this judgment is unsatisfactory. If anything Cambridge-England was a place for excellence and refined theorizing; so much so that even the Nobel prize committees were only able to understand part of it. Here it becomes essential to take that debate seriously, if we aim at a better understanding of the present predicament, where the supposedly favorable fiscal treatment of financial assets excites so much apprehension.
In the schemes of growth of those times capital was conceived as produced assets to be used in production, with a more restrictive definition, which is explicitly put aside by Piketty (p. 85). In that approach it was possible to conceive of the capital output ratio as fixed and the necessary adjustments (to meet the requirement of the second law) taking place through changes in the distribution of income with effect on the saving propensity. Those views were based on a definite conception of the working of the financial system as a set of mechanisms channeling savings to create new capital and thus fostering growth. The closest practical model was perhaps the US economy, where both private and public savings were next to nil and most of capital expansion was effected via ploughing back profits into production. Bosses were then keen on investing companies' savings or retained earnings, instead of strutting around after distributing hefty profits, as they have become used to do today.
Luigi Pasinetti is probably correct to argue that the relevant dire change of behavior was signaled by the success, in the 1960s, of the Modigliani-Miller theorem, which "has led to the belief that there is no difference between ... using [profits] internally by adding them to the existing capital stock, or ... immediately distributing the dividends to the shareholders". (Pasinetti, 2012, p. 1442). The consequences of the change of approach signaled by the Modigliani-Miller famous theorem are spelt out by Pasinetti. They are strikingly similar to the ills and dangers discussed by Piketty himself and stemming from a pronounced pervasive focus on financial growth instead of real growth. Of course the incentives to a lavish dividend policy are a major concern in the analysis of capitalism today, as also e.g. a recent book by Andrew Smithers points out. Piketty, surprisingly, does not appear to realize that he is equally set to point toward the same line of thinking, when he includes stock market capitalization in his notion of assets or wealth.
Piketty's analysis has been justly praised from most quarters. But he risks to focus too much on the symptoms rather than going direct to the heart of the matter and curing the illness. The direction of his enterprise is, indeed, sound and the book deserves close reading. A debate on his views would probably spur deeper analysis, which is at present lacking, on the causes of the present crisis. The recent debates on banking and financial regulation both in Europe and in America do show that we are still far from going to the heart of the matter.




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