Tag Archives: inequality

Inequality, economics and politics – Thomas Piketty at the Bank of England

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On Friday I attended an excellent conference at the Bank of England (organised by the Centre for Economic Policy Research) at which four speakers – Peter Lindert, Jaume Ventura, Orazio Attanasio and Tim Besley – gave presentations on aspects of [amazon_link id=”067443000X” target=”_blank” ]Capital in the 21st Century[/amazon_link], and Thomas Piketty responded to their comments and critiques. The presentations are due to go on the Bank’s website at some stage, although aren’t there yet.

[amazon_image id=”B00I2WNYJW” link=”true” target=”_blank” size=”medium” ]Capital in the Twenty-First Century[/amazon_image]

Peter Lindert drew on material from his forthcoming book with Jeffrey Williamson (and also has a working paper on the Piketty book), to characterise the long-run trends in inequality as the result of ‘lucky’ historical accidents that wipe out concentrations of wealth, combined with policies that help the society stay equal. The period 1910 to the 1970s was the ‘great levelling’, due to wars, and there has subsequently been a fanning out in countries’ experience but in many cases a rise in top incomes. In this, he agrees with Piketty’s book; but disagrees with the famous ‘r>g means rising inequality’ prediction. Demography, technology and politics (mainly education and inheritance tax) – with a role for geography in the case of frontier societies – are his favoured explanations. South Korea, for example, has an inheritance tax of 50%: in principle the heirs of the ailing Lee Kun-Hee of Samsung will be due to pay £4bn in tax when he dies.

Jaume Ventura focussed on the dynamics of economic growth that might explain inequality trends: a u-shaped long-run evolution in the capital-income ratio; the changing components of wealth, with land playing a decreasing part; a not-quite-u-shaped evolution in capital-labour shares (the capital share has risen but is not back to its historic highs); and a stable return to capital of 4-5%. Like Prof Lindert, Prof Ventura does not think the model implied in [amazon_link id=”B00I2WNYJW” target=”_blank” ]Capital in the 21st Century[/amazon_link], and the r>g inequality, stacks up. He argued that the assumptions in the book imply a world of multiple equilibria and cycles or chaotic dynamics, and also that the growth model ignores all the lessons of endogenous growth. He said: “There has been a change in the deep structure of capital in the 21st century.” Bubble-like capital gains now play a large part.

The two final papers moved on from diagnosis to solutions. Orazio Attanasio described the recent research confirming the importance of people’s early years, before the age of 3 and certainly before 10, for their lifetime earnings. Parents’ status and income is important but works through the early effects on a child’s cognitive and non-cognitive abilities. Early experiences even have epigenetic effects. He concluded that the biggest policy problem is the bottom 10% in society, not the top 1%. But also – optimistically – that individuals’ life outcomes can be changed by appropriate early interventions.Prof Attanasio also discussed the optimal level of the top tax rate – recent estimates range from 42% to 86% as the rate that would maximise revenue – to which Thomas Piketty replied that top tax rates should be seen as pollution taxes, the aim being to stop behaviour imposing an externality rather than maximising revenue. However, as 25% of UK income tax comes from the richest 1% (54% from the richest 10%), it would be a bold government that ignored tax revenues.

Tim Besley gave a fascinating talk about the political economy of inequality, referring to his most recent book with Torsten Persson, [amazon_link id=”0691158150″ target=”_blank” ]Pillars of Prosperity[/amazon_link]. He asked, does inequality undermine effective governance? In democracies there is normally thought to be a compact where the rich trade some redistribution in return for security of their property rights. But people don’t mind some kinds of high incomes – footballers vs bankers. And there is no link (looking across countries) between either top (marginal) tax rates and inequality. Quoting Lenin’s [amazon_link id=”014018435X” target=”_blank” ]The State and Revolution[/amazon_link], Prof Besley said there is no empirical support for the frequent claim that the median voter is decisive in political choices: “Democracy for an insignificant minority, democracy for the rich – that is the democracy of capitalist society.” He went on to show evidence that inequality limits the demands for social action, which over time reduces the capacity of the state to act – its legal capacity, fiscal capacity, and capacity to deliver public goods. Finally, he said, there is also evidence that from time to time the values of citizens shift markedly – after the war, for instance, in the overwhelming support for the NHS and welfare state. I couldn’t agree more with his final comment that there are three kinds of economics – the positive, the normative, and political economy.

When I read [amazon_link id=”B00I2WNYJW” target=”_blank” ]Capital in the 21st Century[/amazon_link], I found it hard to work out the growth model implicit in the book, so was reassured that much cleverer economists than me found fault with them. However, as several of the speakers said, that doesn’t make it any less important a book. It has changed the public debate and climate of opinion about inequality, in large part through the long years of hard work giving us the first ever (open) data base of historical figures, the World Top Incomes Database. Jaume Ventura said his advanced macro students have to read it, along with Angus Maddison’s [amazon_link id=”9264022619″ target=”_blank” ]The World Economy: A Millennial Perspective.[/amazon_link] I was also most impressed by Prof Piketty’s openness to the critiques: “Every conclusion in the book is a temporary conclusion, and subject to discussion,” he said.

[amazon_image id=”9264022619″ link=”true” target=”_blank” size=”medium” ]Development Centre Studies The World Economy: Volume 1: A Millennial Perspective and Volume 2: Historical Statistics: v. 1 & 2 combined[/amazon_image]

Inequality and value judgements

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I’m attending the annual conference of the New Zealand Association of Economists, and the first keynote was a terrific presentation by Professor John Creedy on inequality, or to be precise the history of economic thought on inequality and the light that sheds on the current resurgence of interest in distribution.

His starting point was the classic Tony Atkinson paper, On The Measurement of inequality. It was published in 1970, another time when inequality was a salient issue, and the talk moved onto [amazon_link id=”0674000781″ target=”_blank” ]Rawls[/amazon_link] and Sen as well. The theme was that any measure of inequality – income or wealth? Individuals or households? Gini coefficient or Atkinson’s own measure, or the simple 10/90 ratio? – incorporates some implicit value judgements. For example, do you care about individual well-being because of a principle of anonymity – who you are shouldnt matter to evaluating your distributional status? If so, then the Gini isn’t an appropriate measure because it depends on rankings of individuals relative to others. If you look at the 10/90 ratio, as [amazon_link id=”067443000X” target=”_blank” ]Piketty[/amazon_link] does, you’re saying the middle four fifths of the distribution isn’t relevant.

Prof Creedy ended cited Lionel Robbins’ famous [amazon_link id=”B001037AGS” target=”_blank” ]Essay on the Nature and Signifiance of Economic Science[/amazon_link], to the effect that economics can’t avoid making value judgements but its contribution is to shed a clear light on what the judgements are. Or at least, ought to be, but too rarely is. The word of caution about understanding the value judgements embedded in specific measures of inequality is timely given the fact that everybody from New Zealand to New York is talking about it now.

Working class heroes

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Sometimes life brings unexpected gifts. On Thursday evening I attended the launch of this year’s BBC Proms season, and had the pleasure of meeting the baritone Roderick Williams, who is singing on the Last Night, and is one of the most life-affirming and delightful people I’ve met. Do listen.

Yesterday the treat was visiting the UK HQ of Vice News. My reaction on walking in: I want to work here. My second: I’m way too old to do so! Just around the corner is the London HQ of the Workers’ Educational Association. Founded in 1903, my mother took some of its courses in the 1990s after she retired: wine appreciation and watercolour painting. It is a sign of progress that working people now have options like those.

The WEA is one of the many organisations featuring in Jonathan Rose’s brilliant book [amazon_link id=”0300153651″ target=”_blank” ]The Intellectual Life of the British Working Classes[/amazon_link]. All of them, and the many autodidacts among working class people, formed part of the social and political innovation that was a response to the profound structural dislocation caused by the industrial revolution. It isn’t yet clear at all what the modern response will be to automation and inequality, although we can be sure there will be one; I found Thomas Piketty disturbingly deterministic about these trends. (Incidentally, there have now been gazillions of reviews of [amazon_link id=”067443000X” target=”_blank” ]Capital in the 21st Century[/amazon_link] including my own, but I found this one by Joshua Gans one of the best, and this by Gillian Tett interesting on the social psychology of Piketty-mania.)

[amazon_image id=”0300153651″ link=”true” target=”_blank” size=”medium” ]The Intellectual Life of the British Working Classes[/amazon_image]

The reason for this ramble is the publication of [amazon_link id=”0747591849″ target=”_blank” ]The Valley: A Hundred Years in the Life of a Family[/amazon_link] by Richard Benson, which has had wonderful reviews – today in the FT, previously in The Guardian and elsewhere. The FT covers several other books – [amazon_link id=”1848548818″ target=”_blank” ]The People: The rise and fall of the working class 1910-2010[/amazon_link] by Selina Todd, [amazon_link id=”1846142784″ target=”_blank” ]Dreams of the Good Life: Flora Thompson and the Creation of Lark Rise to Candleford[/amazon_link] by Richard Mabey, and [amazon_link id=”030018784X” target=”_blank” ]The Gardens of The British Working Class[/amazon_link] by Margaret Wiles.

[amazon_image id=”0747591849″ link=”true” target=”_blank” size=”medium” ]The Valley: A Hundred Years in the Life of a Family[/amazon_image]

It’s interesting to see this batch of books on the subject of the working class. There is an issue here. Lynsey Hanley’s [amazon_link id=”1847087027″ target=”_blank” ]Estates[/amazon_link], Owen Jones’s [amazon_link id=”1844678644″ target=”_blank” ]Chavs[/amazon_link] and [amazon_link id=”1907994165″ target=”_blank” ]Why FIght Poverty?[/amazon_link] by Julia Unwin all address from different perspectives the theme of the fear and loathing among the elites for people with low incomes. The weakening in the public sphere of a once-vibrant working class culture and the rise in inequality are two facets of a significant phenomenon.

[amazon_image id=”1907994165″ link=”true” target=”_blank” size=”medium” ]Why Fight Poverty? (Perspectives)[/amazon_image]

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.