25 Apr 2014

Two Quick Questions on Piketty

Capital & Interest 31 Comments

Help me out here. I haven’t read the book yet, but I gather a really important insight is that we currently live in a world where r > g, meaning the real return on capital exceeds the real growth rate of the economy. Everyone takes this to imply that the 1% (or the 0.01%, if someone awkwardly points out that Krugman is in the 1%) will gain a larger and larger fraction of society’s wealth, and therefore we must act now to stop them before it’s too late.

I have two questions:

1) So far as I understand it, the argument isn’t that the 1% have access to investment products / strategies unavailable to everyone else. So if The Elite right now own (say) 95% of the assets, while The Masses own only 5%, and everybody earns the same return r on those assets… In 200 years, won’t The Elite still own 95% of the total assets, while The Masses will still own 5%? The only way to get around that, that I can see, is if you assume The Masses reproduce faster and so have more great-grandchildren, thus diluting their 5% of assets over more descendants than The Elite. But then, that’s an argument about inheritance and population growth, not about r or g.

2) I gather that part of the concern is that the real interest income (or dividends or profits or whatever you want to call it) must constitute a growing share of total real output over time, because by stipulation r > g. Thus, as the years progress, the share of real output going to “capital” increases at the expense of the share going to “labor.” But what happens at the point when K*r > F(K,L), in other words when the total capital stock times the real rate of return exceeds the total output of the economy? That’s impossible, the way people are discussing Piketty’s book, right? So doesn’t that mean that automatic forces must set in, which eventually make r < g? Note, I'm not saying there's something internally contradictory with the Solow growth model, or with Piketty's math. But I'm saying something doesn't sound right to me, in the way people are translating these results from a simplified model into conclusions about the real world.

31 Responses to “Two Quick Questions on Piketty”

  1. RPLong says:

    Disclaimer: I know nothing, and no one should pay attention to me.

    I think the idea is that capital displaces labor in the new economy, so not only are the plebes not acquiring additional capital, but they’re also getting locked out of participating in the new economy (cf. Becky Hargrove). The son of a landscaper will always be the son of a landscaper, never the son of an investment banker or whatever. So as large-scale investment and capital drives one segment of the economy, the poor are stuck doing manual labor, working as housekeepers (cf. Caplan), eating beans (cf. Cowen), etc.

    Something I just thought about this morning is that I learned Cobb-Douglas like this: Y = AK^aL^w. Piketty ignores A, but A is new technology and innovation, and isn’t that how Asia went from 0 to 100 in the last half of the 20th Century? Isn’t that how a bunch of middle-class nobodies became the giants of the information age economy?

    We’ve been waiting 100 years for a Schumpeterian demise of capitalism, and it hasn’t happened yet. Good empirical evidence for some Hendersonian optimism. 🙂

    • Dave says:

      We subsidize wealthy and poor old people alike, and thus, wealthy old people are more likely to maintain their wealth, rather than spend it to care for themselves when they cannot. I suppose that the old peoples’ families could care for them, and obtain their wealth in the process, but this still dilutes it within the next generation.

  2. Per Bylund says:

    As for (1), I think Piketty’s argument (as far as I can tell from the online reviews–I haven’t read the actual book) is that the capital-owning class gets more than the working class simply because capital earns a greater return than the increase of wages. So it seems you need the very blunt ideal types of “classes” as being capital-owners or labor-workers (where the former are not laborers and the latter are not capital-owners) to get the “analysis” right.

    Though Piketty, if the reviewers are correct, seems to also say that corporations’ executives earning extremely high wages are still in the capital-owner class. Perhaps it is because they “can afford” to and therefore do invest rather than live hand-to-mouth. I guess an assumption is that if you are wealthy (“wealth,” by the way, is Piketty’s definition of capital), whether because of inheritance, successful entrepreneurship, or because you’re a highly salaried executive, you invest–if you are not wealthy, you do not (and so rely solely on wage).

    As one reviewer pointed out, the U-shaped curve of r > g (r was not, in the data, much higher than g during the World Wars) is to a large extent explained by investments in retirement funds in recent decades. Something tells me executives and the wealthy don’t save in such funds to a much greater extent than “workers” (at least not sufficiently so to explain Piketty’s 100-year predictions).

    • Bob Murphy says:

      Per Bylund wrote:

      As for (1), I think Piketty’s argument (as far as I can tell from the online reviews–I haven’t read the actual book) is that the capital-owning class gets more than the working class simply because capital earns a greater return than the increase of wages.

      Right, and so what that means is that over time, a greater percentage of total output goes to the elites. But, I’m saying that the concentration of wealth has no reason to rise, based on this argument. If the top 1% own 95% (or whatever) of the assets in year 1, then the top 1% own 95% of the assets in year 200, if population doesn’t grow.


      • Major_Freedom says:

        Murphy, (I haven’t read the book yet) I think Piketty is assuming a class of workers who have NO invested, return making wealth.

        That is what Marxists do. They envision their critiques of capitalism to consist of workers who are not themselves capitalists.

        • Jonathan Finegold says:

          This time “what Marxists do” is also what is factually correct.

          • Major_Freedom says:

            Ok, but it is mitigated by the fact that in clean capitalism, currently wage only income earning individuals are legally permitted to save and invest.

            Given that Piketty doesn’t seem to want to argue against the theory that “workers still get a rising absolute chunk even if their relative share declines”, then this can be used to argue that no matter how poor the lowest wage income only class is in absolute terms, this can’t be a permanent barrier against the relatively poorest among the working class to invest the growing difference between earnings and minimum subsistence.

      • Per Bylund says:

        I’m with Major_Freedom here I think. The capital-owning and labor-working classes are defined by what they do: own capital OR sell their labor. I see what you’re saying in the example, but I think it adds way too much realism to Piketty’s analysis.

        But I can also think of another possible explanation. Think of capital-owners as being passive owners and simply benefitting from ownership. Think of laborers as selling their labor at a price that is lower than the value they produce. What you get is an analysis that is quite close to pure Marxism, exploitation theory and all. I’m not sure Piketty says that capital owners get higher returns *because* workers are exploited, but that’s a seemingly reasonable interpretation of his analysis…

        • Major_Freedom says:


          “I think it adds way too much realism to Piketty’s analysis.”

          On a side note, I have to say that this is a pretty terrific underhanded b%&chslap.

          Hope you don’t mind me pilfering it.

      • Per Bylund says:

        One reviewer states:

        “owners of ‘capital’—land, housing, buildings, businesses, and other income-producing property—will receive a rising share of income as they re-invest their returns. ”

        Perhaps that is what Piketty says? That the reinvested returns sort of spiral into (increased) inequality?


  3. Jonathan Finegold says:

    He makes a theoretical argument near the end of the second part of the book that’s not heavily discussed in the reviews, but seems important. He also doesn’t really get into it. But, he argues that if the elasticity of substitution between labor and capital is >1, then capital’s share of income will grow at the expense of labor’s. See p. 37 of the PDF embeded here.

    • Jonathan Finegold says:

      And, it’s capital:labor, my mistake.

    • Jonathan Finegold says:

      Also worth mentioning, in the third part of the book he actually says that modern inequality has less to do with capital than it used to. Up to around the last centile, income from labor makes up a greater share of total income than income from capital. It’s only for the last centile that capital really becomes more important than labor. He says that whereas 19th century France was a “hyperpatrimonial” society, the U.S. is a “hypermeritocratic” society.

      • Dan (DD5) says:

        This is a serious question.

        Does he say in the book that it is capital that ultimately pays for these wages?

        • Jonathan Finegold says:

          Not anywhere in the first 300 pages. (And human capital is considered labor under his definitions.)

          • Dan (DD5) says:

            Because I presume you haven’t read beyond that point yet and not that he mentions it later?

            But do you see how that would kind of ruin his entire thesis (as I understand it to be)? So he’s either disingenuous or he’s entirely ignorant about the matter. My guess would be the latter.

  4. Dan (DD5) says:

    This is not a “simplified model”. It’s a nonsensical model. Calling it “simplified” implies that it might at least have some scientific value or some connection to reality, albeit, an imperfect one or inaccurate one or whatever, but it might provide some insight into the real world. It does none of that. In fact, it does the opposite – it distorts reality. So it doesn’t just contribute nothing. It contributes a negative.

  5. Yancey Ward says:

    In its limit, Piketty’s argument sounds like it is describing a world where owners of capital have all the consumption goods they desire with the input of zero labor– robotics produce everything, including the replication and enhancement of itself.

    It is like an island where one man owns a Star Trek replicator, and a 99 men don’t. What is the most probable outcome of such a situation?

    Bob, I think you are right to feel something is deeply wrong.

    • Jonathan Finegold says:

      That’s a situation where the elasticity of substitution between capital and labor is infinity, right? He estimates the long run elasticity to be somewhere between 1.3 and 1.6. Not a world where capital accrues the entire share of income, but a world where capital accrues a growing share of income.

      The strange thing about it all is that Piketty almost leaves it at that and writes, “well, we really can’t be sure what the future elasticity of substitution will be.” No biggie.

    • Dan (DD5) says:

      Piketty’s argument could make sense if capital goods earned income. So your electric saw earns a wage. Your truck earns a wage. Your PC earns a wage. Then comes Piketty and says you know what: actually that saw, truck, and computer are all slaves of the Capitalist, so actually it’s all his! Brilliant if the above actually makes sense to anyone. But here in the real world, only people earn incomes. So all [real] capital investment must eventually reach some income earner. Now maybe it’s that CEO and CFO with that hefty paycheck, but then you’re back to the old income inequality argument – nothing new, nothing original. But no, here Piketty it seems is claiming to be doing something different.

  6. John says:

    This is perhaps not much of an observation but I wish I’d understood when I was younger and in school how interesting economics is. That’s actually something I’ve found much later in life from reading this site and (I know, yikes) Paul Krugman’s column. I downloaded the book you’re discussing but I haven’t read it and I doubt I can understand it because I can’t really understand what everyone’s talking about with regard to it here. Youth really is wasted on the young…..

  7. Ed says:

    Both seem like valid, sound criticisms. I think I’ve seen a form of 2.) a couple of other places. I can’t remember where it was, but the basic point was that r and g are not independent of one another, i.e. they’re endogenous (which is in part what you’re saying).

  8. Ed says:

    I’ve been thinking on #2, and I’m not sure now. It’s not really clear to me what “r” represents. My best guess follows from this example

    year 1: y=100; capital income=25; labor income=75

    year 2: y=110; cap. income=30; lab. income=80

    g=0.10; r=0.20; l=0.066

    I don’t think that this r is the same r that you’re talking about, which appears to be the growth rate of the capital stock (rather than the growth rate of the amount of *income* that goes to capital). The growth rate of the capital stock is determined by saving behavior.

    The Solow article has some of the best examples.

  9. Beard Face says:

    Is Piketty saying that the wealthiest will end up owning more and more of the capital stock? I’m struggling to comprehend how that would even be possible. I can’t put my finger on it, but there’s something seriously flawed with his argument.

  10. Tel says:

    That’s impossible, the way people are discussing Piketty’s book, right? So doesn’t that mean that automatic forces must set in, which eventually make r < g?

    I was trying to think in terms of Robinson Crusoe how you could get a situation where r > g with just one man working. Crusoe can build capital infrastructure (a hut, a fishing net, a well, etc) and this infrastructure makes him more effective at the things he does (e.g. gathers water faster from a well, gathers food faster with a fishing net). Thus, the economy grows because of the capital, but I would think that r = g exactly and by necessity.

    So if I haven’t screwed that up, then in a perfectly fair economy where any individual can trade freely, effectively each individual should (for accounting purposes) be the same as Crusoe… what you get out is what you put in, and the infrastructure allows growth by making your work more efficient. Thus, if r = g in the small, then when you add it up also r = g in the large as well.

    Of course a “perfectly fair economy” is difficult to define when different individuals have different preferences. Thus, by allowing specialized labour and by exchanging in ways that satisfy individual preferences there’s an additional profit to be made by division of labour. Maybe Piketty is saying that this additional division of labour profit is being shared unfairly? That’s about all I can make of it.

    • Yancey Ward says:

      Yeah, this bothered me, too. What good is an increasing return on capital if it doesn’t eventually lead to consumption. Why would someone accumulate, for example, 10,000 oil drilling rigs, if the output was only being used by himself?

      • Tel says:

        And more than that, how to continue getting good returns on those drilling rigs when you aren’t selling anything?

        • Yancey Ward says:

          Exactly. Even if one excepts Piketty’s assertion of r > g, it seems a problem with a built in solution.

  11. Major_Freedom says:

    Piketty doesn’t seem to appreciate the fact that all the wealth the elite own (in the form of factories, machines, equipment, tools, etc) are devoted to being used to produce goods for those with little wealth but who earn wages.

    I don’t consider all the factories and office buildings owned by Microsoft shareholders, for example, to be like their personal houses and cars that they themselves enjoy and consume until destroyed. The physical beneficiaries of all that wealth are everyone else, including the poor.

    I don’t get the worry Piketty has over wealth inequality, because the bigger and wealthier individual capitalists become, the more physical capital is available to be used to produce goods for everyone else’s physical benefit.

    I’d rather live in a world where absolute wealth is growing at 10% per year, where the wealthiest’s wealth is growing at far higher a rate than the poorest, than a world where absolute wealth is growing at 0.5% per year and everyone’s wealth is growing at the same rate.

    The division of labor isn’t like a feudal society. In a division of labor, the wealthier people get, the more others are benefiting in physical terms.

  12. Smack MacDougal says:

    Laborers’ compensation growth often exceeds GDP growth, that is, L > G too.




    Piketty is clueless.

  13. guest says:

    consultingbyrpm blog tag piketty

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