Tag Archives: capitalism

Orthodoxy, radicalism and sanity

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Fans of his columns in the Financial Times will know there’s no danger of finishing reading a whole book by Martin Wolf in an optimistic frame of mind. So it is with his new book, [amazon_link id=”1846146976″ target=”_blank” ]The Shifts and The Shocks[/amazon_link]. The subtitle is ‘What we’ve learned – and still have to learn – from the financial crisis’, and the message of the book is that there is more still needing to be done than sorted out already.

[amazon_image id=”1846146976″ link=”true” target=”_blank” size=”medium” ]The Shifts and the Shocks: What we’ve learned – and have still to learn – from the financial crisis[/amazon_image]

The main thing the book argues has been learned (by some people) since the crisis is that pre-crisis ‘official’ macroeconomics comprehensively failed. To echo the title of the relevant chapter, orthodoxy has been overthrown. Props to Wolf for acknowledging his own change of mind in the light of events (after all, he wrote an earlier book called [amazon_link id=”0300102526″ target=”_blank” ]Why Globalization Works[/amazon_link].) He points out that the features of the global economy that turned out to matter in real life – the accumulation of debt and the growth of shadow banking – had been assumed to be unimportant or irrelevant. Wolf has become a wholehearted [amazon_link id=”0071592997″ target=”_blank” ]Minskian[/amazon_link], but you obviously don’t need to jump into any new camp to agree that pre-crisis dynamic stochastic general equilibrium models were a nonsense. What’s rather depressing is that some macroeconomists still seem to think these DSGE models just need a bit of tinkering, a little bit of financial ‘friction’ adding in. As the book’s introduction forcefully points out, a theory in which something that did happen is impossible is a rubbish theory.

The first chunk of the book is a high-level description and an analysis of the origins and unfolding of the financial crisis, with particular emphasis on the Eurozone. He has long been writing in his Financial Times columns about the problem global imbalances, particularly between the US and China. This book focuses more on Europe. Much of the description is familiar territory, but seen this time through Wolf’s new spectacles of the Minsky convert.This section culminates in the ‘orthodoxy overthrown’ chapter, which includes a quick rundown of the various alternatives, in a nice, brief summary of the history of macroeconomic thought including those turned into renegades by the DSGE triumphalists of the 1990s and 2000s. Wolf ends by concluding that in a system in which the state is the ultimate supplier of money but most money and credit in use is created by the private sector is a ‘pact with the devil’. “Moreover, the liberalization of finance seems to lead to crises almost automatically. Surely this suggests the need for a new kind of system.”

So what might a new system look like? To fix finance, he advocates – following Anat Admati and Martin Hellwig’s outstanding [amazon_link id=”0691162387″ target=”_blank” ]The Bankers’ New Clothes[/amazon_link] – a much higher equity ratio for banks, maybe 20%, and serious macro-prudential tools. These seem such no-brainers that the real question is why regulators are so hesitant about them – but this takes us into the analysis of power in the western economies. A chapter on the Eurozone concludes that it isn’t working but it isn’t clear either how to turn it into a ‘good marriage’. This chapter is surprisingly diffident – Wolf writes: “Germany’s insistence on retaining its huge external surplus, on keeping inflation so low, on national responsibility for bank debts and on ever tighter fiscal discipline will not work. The Eurozone needs to become something different.” I would have expected him to predict the unlikeliness of this happening – although he does also acknowledge how messy a divorce would be.

The final chapter has a key point: “Unless regulation and the supply of fiscal backstops is to be much more global, finance should be far less so.” Little would be lost by decreasing the global integration of banking, he argues. Wolf is more radical than what he describes as the ‘new orthodoxy’, which aims to preserve the globally integrated financial system through incremental reform – and, I would say, keeping fingers tightly crossed.This section echoes the chapter in Ian Goldin’s [amazon_link id=”0691154708″ target=”_blank” ]The Butterfly Defect[/amazon_link], which underlines the inherent risks in the complex, integrated financial network.

Wolf argues that western elites are continuing to let people down, to a dangerous degree. He accuses them of ‘three huge failures’ – misunderstanding the consequences of financial liberalization and fantasizing about the self-stabilizing features of finance; ignoring the consequences of the emergence of a plutocratic global elite for the civic glue that enables democracy to function; and turning what should have remained a mundane common currency or currency management plan in the EU into a German currency administered by unaccountable ECB and Commission officials without channels of accountability to other Eurozone countries and citizens.

If we cannot implement radical changes – more radical than most people recognize, Wolf says – then, well he doesn’t explicitly spell it out, but implies, economic and political disaster.

By and large, I agree. There’s no point just tinkering with a fundamentally broken system. There are some questions not covered in the book that would only add to the gloom. For example, the extent of outstanding debt left over from the crisis is ginormous. Without a growth miracle – no sign of that on the horizon – the options are explicit or implicit default. How will that happen? The large international banks have returned to pre-crisis behaviours with only marginally more capital – and are still being allowed to judge their own riskiness! What happens when a modest decline in some market somewhere sets us off on the downward spiral of liquidity and solvency we saw in 2008, but this time without any fiscal or monetary firepower left? And by the way, what about demographic and environmental challenges?

[amazon_link id=”1846146976″ target=”_blank” ]The Shifts and the Shocks[/amazon_link] is a dense and chunky book about economics, not a manifesto for the Occupy movement. I can’t quite picture Martin Wolf in a Guy Fawkes mask outside the ECB. Still, he makes a good case that the ‘new orthodoxy’ of minor reforms favoured by global finance is madness. Radicalism is the only sanity.

The eclipse of capitalism – or maybe not

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Jeremy Rifkin’s new book, [amazon_link id=”1137278463″ target=”_blank” ]The Zero Marginal Cost Society[/amazon_link], covers lots of interesting territory but isn’t my cup of tea. One reason for that is apparent in the subtitle: “The internet of things, the collaborative commons and the collapse of capitalism” – wide-ranging is good, but ranging wide over such a disparate set of topics is a bit of a stretch.

[amazon_image id=”1137278463″ link=”true” target=”_blank” size=”medium” ]The Zero Marginal Cost Society: The Internet of Things, the Collaborative Commons, and the Eclipse of Capitalism[/amazon_image]

Another reason is that near the start of the book there is an anti-economics rant, economics being characterised by “unquestioning acceptance, and refusal to envision alternative explanations, lead[ing] to a festering of inconsistencies that pile up.” While I certainly agree that economics too often sets environmental constraints to one side – which is what Rifkin’s rant builds up to – I always check the references and bibliography at this point to see how much modern economics the ranter has read. And as is always the case with such critics, Rifkin cites next to no work done in the past 25 years.

The main argument of this book is that near-zero marginal cost activities make up a growing proportion of economic activity, and this signals the inevitable decline of capitalism. Capitalist markets are not an efficient way to organize a society in which most things are free, because the socially efficient price is zero when marginal costs are zero. Rifkin draws on his last book [amazon_link id=”0230341977″ target=”_blank” ]The Third Industrial Revolution[/amazon_link] and adds in the effects of the Internet of Things and smart grids in optimising energy use to apply this argument to energy prices. He cites also MOOCs and 3D printing. It is not a new observation to point out that many activities involve high fixed costs and low marginal costs. Digital or digitally-enabled activities are adding to the roster of industries with this structure, shaking up business models in music, publishing, newspapers and – soon – education; but other industries from aerospace to pharma to broadcasting have long experienced increasing returns. These too challenge the model of small, perfectly competitive firms delivering efficient outcomes through the magic of the price mechanism and the market.

Rifkin does not, for my taste, adequately address the question of how the high fixed costs are to be covered in his post-capitalist world. “Within 10 years every building in America and Europe, as well as other countries around the world, will be equipped with smart meters,” he writes. He predicts huge cost as well as energy savings, citing a Cisco forecast that the Internet of Everything will generate $14.4 trillion in cost savings and revenues. So that’s selling smart meters plus the cost savings from using less energy once they are installed, I guess – and wouldn’t Cisco, purveyor of smart devices, say that anyway? The smart meter installation programme in the UK alone is estimated to have a: “positive net present benefit of £6.7 billion over the period to 2030, by delivering total benefits of around £18.8 billion and costs of around £12.1 billion.” (House of Commons Energy Select Committee estimates.) These order of magnitude smaller estimates for a longer period predate the actual existence of technical standards and operational meters, needing to be installed in every home and business in the country. I’m sure it’s worthwhile, but I’m sceptical about this happening within 10 years, all around the world.

The most interesting chapters in the book cover collaborative efforts and the switch “from ownership to access.” There have been interesting articles and stirrings around just this past week on the sharing economy – from The Economist, from Public CEO, this New York petition, John Kay in the FT. (HT to @johnfingleton1 for the links.) Parts 3 and 4 of Rifkin’s book provide an overview of this territory. By this stage, I had gone into irreversibly sceptical mode, and concluded that it is too early to say that none of the new digital businesses will find a viable business model.

This book would be a good airport read. Rifkin is a clever and widely-read writer. I don’t like the way he opts for polemic over analysis, but that’s me. Others might enjoy this high-level canter over a wide territory – but I’d caution you to take the claims with more than a pinch of salt.

Capital and destiny

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It is with some trepidation that I offer my review of Thomas Piketty’s [amazon_link id=”067443000X” target=”_blank” ]Capital in the 21st Century[/amazon_link], as so much has been written, almost all of it verging on the adulatory. Of course it’s an important book – who could disagree with that when almost everybody in my world is talking about it, and it has cemented the question of inequality of income and wealth on the economic policy agenda? The book has obviously plugged into the zeitgeist. It has some flaws too.

[amazon_image id=”067443000X” link=”true” target=”_blank” size=”medium” ]Capital in the Twenty-First Century[/amazon_image]

Piketty’s construction of a long-run multi-country World Top Incomes Database for income and wealth, along with Emmanuel Saez and Anthony Atkinson,’ is a magnificent achievement. As the book notes several times, the data – constructed from a range of sources including tax records – are likely to understate the very highest fortunes and incomes because of the failure to declare everything. The assembly of these statistics has helped put inequality at the centre of economic debate.

[amazon_link id=”067443000X” target=”_blank” ]Capital in the 21st Century[/amazon_link] concentrates on wealth and on the share of capital’s income in total national income. ‘Capital’ is defined as marketable assets, at their market price, including land, houses, shares and other financial instruments (but not for example bridges or factories). James Galbraith’s review of the book was critical of the definition. I think Galbraith is right to pick away at the data used and what the definitions actually mean.

Setting this aside, Piketty shows that the income share of (marketed financial) capital (at market values) declined substantially in the second half of the 20th century but is now climbing again. His argument is that this increase is a near-inexorable trend. The mid-20th century decline was essentially the result of Depression and war, or in other words, the massive destruction of assets and social dislocation; and the capital share stayed low for some decades because economic growth was unusually high, which – he argues – will no longer be the case. Specifically, population growth has slowed or turned negative, and Piketty is clearly gloomy about the prospect of productivity growth.

It’s clear that many readers have taken this argument as a given without concerning themselves about how it adds up. It is based on two equations (the only two in the book), which are asserted rather than given a clear rationale. I couldn’t work out the reasoning until I found Piketty’s lecture notes. So this is my explanation of the lecture notes.

One equation says that the share of capital in national income (α) is defined as the rate of return on capital (r) times the ratio of the capital stock to income (β). This is an accounting identity – it is how the concepts are defined and the figures calculated. If the capital stock is six times a year’s national income, and the rate of return on capital is 5%, the capital share is 30%. Historically, the rate of return on capital has been in the range 3-6%, which for that size of capital stock implies a capital share of 18% to 36% a year of national income, roughly one fifth to one third. Again, in the historical figures, the capital income ratio has typically been 5 or 6.

The second equation, which drives his argument about the upward trend in capital’s share, is a ‘steady state’ condition: when the economy settles down in a stable way in the very long run, at its long-term potential growth rate, the ratio of capital stock to income equals the savings rate (s) divided by the growth rate (g) – in other words, in the unchanging steady state, the ratio of the annual changes in capital growth (saving) and in income growth is the same as the ratio of the capital stock to the level of income.

This is not made all that clear in the book, but putting the two together, the capital share will tend to rise when the rate of return on capital is greater than the growth rate, assuming the saving rate does not decline to offset the impact of r > g. Piketty notes that in the long term data set, this inequality happens to have held: “The inequality r > g is a contingent historical proposition, which is true in some periods and political contexts and not in others.” The exception was the latter part of the 20th century.

This simple algebra based on an accounting identity and a balanced growth rule are the basis of the book’s argument – which has been pounced on by commentators – of an almost inexorable upward trend in the capital share. I am sceptical about the economy ever reaching the balanced growth state, although perhaps this is a useful tool for thinking about direction of travel, and I’m also doubtful that the saving rate would not adjust should the capital share in national grow ever-bigger. I also wish Piketty had spent more time discussing the rate of return on capital – both how it is constructed in the data set and what determines it – as the book treats it as a given at 4-5%. As Barry Eichengreen pointed out in a recent Project Syndicate article, there are some puzzles in saving and interest rate data, and real interest rates have been declining for 30 years. They are only one element of the rate of return series Piketty considers, but at 2-3%, this real interest rate is not too far above the potential growth rate of the major OECD economies. This takes us back to James Galbraith’s point about the definitions: is marketable capital consisting mainly of financial assets the right definition to plug into a balanced growth model?

I would like to have had more practical explanation of the data used in the book in general, as some of the charts are surprising. For instance, the charts suggest the housing stock in France is a bigger share of national income, and has grown faster, than in the UK. (As an aside, the charts are terrible – very hard to decipher, a decade on the x-axis given the same space as a half century or 60 years, multiple lines of equal weight with clashing symbols, much chart junk, Australia classed as ‘Anglo-Saxon’ when it looks like Germany in the data – I hope they all get redrawn for future editions.)

Of course I’m nit-picking by complaining about the impression of an inexorable trend towards an ever-greater capital share created by Piketty’s reliance on a growth model, because there is a deeper truth – as he puts it: “The inequality r > g in one sense implies that the past tends to devour the future: wealth originating in the past automatically grows more rapidly, even without labour, than wealth stemming from work, which can be saved.” In order for an economy to grow at all, the future must win the struggle against the past. But of course there have been several episodes when that has been the case – not just the aftermath of World War 2, highlighted in the book, but also much of the Victorian era, and the early Industrail Revolution (even though the charts here show r well in excess of g during those years too).

Still, the sense of inevitability or otherwise does matter. Piketty’s policy proposal is a global wealth tax. He’s acknowledged how unrealistic this is, but says it’s important to change the intellectual climate. True, but how about also debating the rigged markets in finance and the corporate legal framework that have contributed so significantly to the growth in very high incomes, which are quickly turned into new wealth? What about income and inheritance taxes? And rather than treating savings, the return on capital and the growth rate as givens, isn’t it worth thinking about what determines them, and what actually determines causality in the book’s simple algebra.

I’m glad [amazon_link id=”067443000X” target=”_blank” ]Capital in the 21st Century[/amazon_link] has succeeded in drawing such attention to inequality of wealth as well as incomes, and to our new era of patrimonial capitalism. (Another sobering illustration of this is Greg Clark’s recent book, [amazon_link id=”0691162549″ target=”_blank” ]The Son Also Rises[/amazon_link].) It’s just a bit of a shame it does so in such a deterministic – and therefore disempowering – way.

Nevertheless, pretty much every review I’ve read has raved about the book! Here are Paul Krugman, Branko Milanovic, John Cassidy, The Economist. No doubt there will be many more positive reviews to come.

Thinking about capital

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It’s clear that I’m one of the slowest readers of Thomas Piketty’s [amazon_link id=”067443000X” target=”_blank” ]Capital in the 21st Century [/amazon_link]around – only a bit over half way through, when other reviews are pouring out. Most are adulatory; Paul Krugman’s in the New York Review of Books the latest (Why We’re In a New Gilded Age). The problem is the size of the book – I do most of my reading while travelling, and just can’t read long e-books, as nothing sticks.

Anyway, the process got me ferreting about in my old books looking for earlier work on wealth and inheritance, so this morning I was browsing through J.A.Hobson’s [amazon_link id=”1440087180″ target=”_blank” ]The Science of Wealth[/amazon_link] (1911) and Josiah Wedgwood’s [amazon_link id=”1245803719″ target=”_blank” ]The Economics of Inheritance[/amazon_link] (1929).

Here is Hobson on ‘unproductive surplus’:

“The plain facts of modern business show that capital like land can get a share of unproductive surplus. But while land takes its surplus by natural scarcity, capital takes its surplus by making itself scare ie. by artificially restricting the flow of free capital into certain channels of employment. These restrictions, whether maintained by securing advantages of of raw materials, power or situation, by tariffs or other State aid, by trade agreements or combinations, all signify checks upon the free entry of capital into a trade which is thus enabled to secure a scarcity rate of interest for a limited supply.”

He immediately identifies the banking industry as a key locus of unproductive surplus. No change there, then.

Wedgwood has a fascinating chapter on inheritance in which he uses probate records to trace the extent to which large fortunes are passed down the generations. The chapter sets out to test the assertion that most fortunes are self-made and quickly dissipated; “from clogs to clogs in three generations,” in the northern saying. The exercise reported in the book does not support this and in fact is entirely consistent with the results of another truly important recent book, Greg Clark’s [amazon_link id=”0691162549″ target=”_blank” ]The Son Also Rises[/amazon_link]. Wedgwood writes:

“The fortunes of the different branches were largely pre-determined by the economic position of the family at least five generations back and in to some extent by that of ancestors nine generations back.”

What Clark’s book establishes is that ‘patrimonial capitalism’ (in Piketty’s terminology) never really went away even in seemingly egalitarian societies like Scandinavia – around the world and over many different periods, advantage is passed on down the generations, and social mobility has never been all that great.

With hindsight, ignoring wealth and inheritance for a generation or two looks like another of the blind spots of 20th century economics. Even without finishing [amazon_link id=”067443000X” target=”_blank” ]Capital in the 21st Century[/amazon_link] (and I have some reservations about it), it is clear that Piketty, and his colleagues Emmanuel Saez and Tony Atkinson, have done us a great service in their careful collection of income and wealth inequality data. This VoxEUexplainer of the database is a good place to start.

[amazon_image id=”067443000X” link=”true” target=”_blank” size=”medium” ]Capital in the Twenty-First Century[/amazon_image]  [amazon_image id=”1245803719″ link=”true” target=”_blank” size=”medium” ]The Economics Of Inheritance[/amazon_image]  [amazon_image id=”1440087180″ link=”true” target=”_blank” size=”medium” ]The Science of Wealth (Classic Reprint)[/amazon_image]  [amazon_image id=”0691162549″ link=”true” target=”_blank” size=”medium” ]The Son Also Rises: Surnames and the History of Social Mobility (The Princeton Economic History of the Western World)[/amazon_image]

A footnote: Hobson’s book has a wise note about the role of economics, concerning whether or not its conception of prosperity is too narrow, when what really matters is love, joy, meaning etc: “John Ruskin and some other prophets of this wider wealth have denied the validity and the utility of the narrower Political Economy.  … Other students of society have also questioned the validity of separating the study of economic processes from that of other social processes and making of them a ‘science’ of industry. This criticism, in so far as it has a point, is applicable to all scientific specialism. The whole world of phenomena is a unity of intimately connected parts, and every breaking off of any section for separate study is of necessity an act of mutilation. But such separate studies are essential to intellectual progress, and the mutilation is not fatal to their use, provided the subject of special study is not treated as a completely rounded whole.” It’s healthy for economists to engage in interdisciplinary work as a reminder of this point. There are still too many of my fellow economists who’re dismissive of other social sciences.

Capital in the 19th century

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During the mid-late 1970s era of high inflation, I was a teenager growing up in a household with two parents who worked, but not in jobs with unions that could deliver inflation-beating wage increases, and whose small savings were held in a building society account. Rising food and energy prices made things tough. Marked as we all our by personal experience, I’ve ever since believed inflation to be harmful for people on relatively low incomes, tending to mean declining real earnings and negative returns on savings.

The early section of Piketty’s [amazon_link id=”067443000X” target=”_blank” ]Capital in the 21st Century[/amazon_link] has given me pause for thought. He contrasts the Victorian and Edwardian era of stable prices and rentier wealth (in the form of land and then government bonds) with the post-1920s era of declining importance in inherited wealth. He writes:

“Capital is never quiet: it is always risk-oriented and entrepreneurial, at least at its inception, yet it always tends to transform itself into rents as it accumulates in large enough amounts.” (p115-116)

The point of accumulation is to build up enough to stop working, whether at the scale of a character in an Austen or [amazon_link id=”0140440178″ target=”_blank” ]Balzac novel[/amazon_link], or at the scale of a colonial power like France or Britain.

What changed with the onset of the violent 20th century was inflation. In the 19th century, when governments built up war debts, rentier classes bought the government bonds and could live securely on the repayments. “In the 20th century, a totally different view of public debt emerged, based on the conviction that debt could serve as an instrument of policy aimed at raising public spending and redistributing wealth for the benefit of the least well-off members of society. The difference between these two views is fairly simple: in the 19th century, lenders were handsomely reimbursed, thereby increasing private wealth; in the 20th century, debt was drowned by inflation and repaid with money of decreasing value.” (p132)

France inflated far more dramatically than the UK in the period 1913-1950, and French public debt dropped from 80% to 30% of national income over that period. The UK had a colossal 200% of GDP debt in 1950, but made up for it with inflation in the 1950s and especially the 1970s. In both cases, though, inflation was the means of expropriating the rentier classes and, Piketty argues, one of the key reasons the 20th century bucked the tendency of capitalism to create and enhance entrenched wealth inequality. So this is obviously a different perspective on inflation from my teenage perception.

I was chatting about this to Professor Dieter Helm, who chairs the UK’s Natural Capital Committee and is writing a book about valuing natural capital (which will be a must-read when it’s out). He pointed out that the shift towards an inflationary regime coincided with a generational rebellion against the Victorian emphasis on thrift and investment for the future, in favour of consumption and the present. In Britain, the Bloomsbury Group – including Keynes – exemplified this; see for example Michael Holroyd’s tome on [amazon_link id=”0099332914″ target=”_blank” ]Lytton Strachey[/amazon_link].

[amazon_image id=”1845951832″ link=”true” target=”_blank” size=”medium” ]Lytton Strachey: The New Biography[/amazon_image]

This all makes one wonder about the next few decades – I’d bet on a return to inflation and expropriation of the bond-holding classes (pensioners?), even though the pressing concern is deflation. But this is a bet, not a forecast. Besides, the future the Victorians built is the one we’re still living off, the infrastructure and institutions. Anybody who cares about sustainability (in its broadest sense) must surely be thinking in terms of tilting the balance away from consumption and towards investment. Towards capital, in fact, which makes its distribution all the more important.