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Sunday, March 30, 2014


As I begin this third part of my discussion of Piketty's CAPITAL in the Twenty-First Century, I find myself overwhelmed by the sheer magnitude of the number of topics treated by Piketty.  Once again, I urge you to read the book rather than relying on my comments, or any of the many reviews now appearing, to inform you adequately about it.  This is one of those books that you really must make the effort to read for yourself.

Early in his book, Piketty states what he calls the First Fundamental Law of Capitalism, a "law" [really, as he explains, an accounting identity] that relates the ratio of capital to national income, β, to the national rate of return on capital, which he represents by the letter r, and the share of the income from capital in national income, which he represents as α.  If thirty percent of all the income received by anyone in a nation over the course of a year comes from capital -- in other words is profit rather than earned income -- then α = 30% or .3.  With these definitions, it follows necessarily that α = r x β, Piketty's First Fundamental Law. 

This may not be obvious to all of you [it was not to me when I first read it], so let me take just a moment to explain.  β is the ratio of the value of total national capital to the value of annual national income, so we may say that β = (national capital)/(annual national income).  If we multiply the total value of capital by the profit rate, r, we get the value in a year of the profits from capital [since r is the yield from capital per year].  So r x β is just [r x (total national capital)] / (total income in a year), or (income from capital)/(total income), and that is what Piketty is calling α.  In short, α = r x β.  The point of stating this accounting equality is not to prove anything by it, but rather to break out the components of α so that we can study what happens when one or another of them varies.  Later on, we shall see that Piketty is especially interested in examining the consequences of a long-term situation in  which the profit rate, r, is significantly greater than the growth rate of the economy, g, a situation that did not obtain during les trente glorieuses, but which Piketty thinks does obtain now and is likely to obtain for the remainder of the twenty-first century.  [The reason for this prediction, to get ahead of ourselves, is the rapid decline in the growth of population, but more that anon.]

Before I continue, let me on a lighter note pay homage to a simply lovely expositional device that Piketty has hit upon to flesh out the stark numbers of his graphs and charts.  Early in the book, Piketty observes that prices in the eighteenth and nineteenth centuries were quite stable, as was the return to capital [about 5%].  During this time, the two principal sources of income from capital in France, and even in England [where capitalism developed rather earlier] were land and government bonds.  One small segment of society -- the wealthiest and most powerful -- lived without working, as Liliane Betancourt would much later on, on their income from their capital holdings.  The stability of the prices meant that in 1720, 1770, 1810, 1850, and even 1890, the same standard of living could be purchased with a given annual income.  This made it possible for novelists to capture in a phrase the precise social standing of a character.  "He has ten thousand pounds a year" or "he has fifty thousand francs a year" was all a novelist needed to write, and readers could be counted on to understand the standard of living the character and his family could afford, right down to the number of his household servants, the sort of carriages in which his family rode, the clothes they wore, the elegance of the balls they attended, and the suitability of suitors for his daughters.  Running through Piketty's book is a delightful series of references to the characters of Jane Austen and Honoré Balzac.  It is, for me at least, a distinct pleasure to encounter a truly cultivated economist, who evokes the literary richness of the writings of Adam Smith and Karl Marx.  There is also a deeper purpose in Piketty's deployment of literary references, which he never mentions but which I am persuaded is consciously before his mind.  The literary allusions allow Piketty to capture the complex relationship between the underlying reality and the surface appearance of capitalist society, something that Marx achieves by his deployment of ironic discourse and classical allusion.

One hundred sixty-seven pages into his book, Piketty enunciates another "Fundamental Law of Capitalism" relating β, the ratio of national capital to annual national income, to the social savings rate, s, and the growth rate of the economy, g.  The law states that β = s/g.  This, however, is not an accounting equality but what may be called a tendential law.  That is to say, unless interrupted by some exogenous force -- a war, a depression, a regime of governmental taxation -- the ratio of national capital to national income will tend toward the ratio of savings to growth.  For example, "if a country saves 12 percent of its national income every year, and the rate of growth of its national economy is 2 percent, then in the long run the capital/income ratio will be equal to six hundred percent:  the country will have accumulated capital worth six years of national income."  [p. 166]

Why is this important?  Because if an economy grows very slowly, and if what is saved out of national income is for the most part held privately, then over time the country will come to be dominated by huge private capital holdings, which are passed on from generation to generation, resulting in what Piketty calls patrimonial capitalism.  Just to be clear, the relationship between capital formation and the (savings/growth rate) is necessary, and not especially tied to private ownership of capital.  Even if the capital is publicly owned, the ratio of capital to national income will be determined in the long run by the growth rate the society chooses and the savings rate it chooses.  But for the entire period under Piketty's investigation, capital has been privately owned.  Public capital holdings, as he shows, which are calculated by taking the total of public assets and subtracting the total of public debts, have oscillated around zero.  This remains true even when we take into account foreign assets and debts, surprising though this may be.  We are accustomed to panic-stricken talk about America being owned by the Japanese or the Chinese [depending on which decade you are living in], but the reality is quite other.

To summarize what I have tried to communicate thus far, Piketty argues that the period of the two world wars followed by a generation and a half of rapid growth was a temporary anomaly followed by a return to the long-term relationship between capital and national income.  And because the rapid population growth of recent decades is slowing and is almost certain to slow further, resulting in a return to a long-term secular economic growth rate of 1 % or a bit more, the logic of the law β = s/g compels us to conclude that in the absence of heroic governmental intervention [the subject of Part Four of the book], we can look forward to a re-emergence of patrimonial capitalism, the capitalism of inherited wealth celebrated and anatomized by Austen, Balzac, and their contemporaries.

In my effort to summarize Piketty's argument for you, inevitably I have omitted so much that I have managed to give a somewhat incorrect account, and at this point I need to correct that with regard to at least one important point.  This concerns the distribution of wealth in contemporary capitalist societies.  The best way to begin is with a paragraph-long quote from Piketty.  This comes from the start of Chapter Eleven, "Merit and Inheritance in the Long Run."

"The overall importance of capital today, as noted, is not very different from what it was in the eighteenth century.  Only its form has changed:  capital was once mainly land but is now industrial, financial, and real estate.  We also know that the concentration of wealth remains high, although it is noticeably less extreme than it was a century ago.  The poorest half of the population still owns nothing, but there is now a patrimonial middle class that owns between a middle and a third of total wealth, and the wealthiest ten percent now own only-two thirds of what there is to own rather than nine-tenths."  [p. 377]

The important point I have somewhat failed to capture is the emergence of a patrimonial middle class.  Why "patrimonial?"  Because the wealth of this large and politically significant middle class is for the most part inherited, in the form of housing, and also of financial assets.  The first generation may have come up "the old-fashioned way," by hard work and self-sacrifice, but life and death being what they are, the children of these strivers start life with hefty portfolios, paid-up homes, and other forms of accumulated capital.  Over time, the logic of the s/g ratio increases the predominance of inherited over earned income, resulting in ever sharper and more inflexible class divisions.  What is more, the Great Recession of 2008-9 and the consequent evaporation of the money set aside by this middle class for their Golden Years threatens to drive their children back down into the ranks of the propertyless, increasing the share of capital owned by the truly rich.

Well, that is enough for today.  Not all of you may find this quite as fascinating as I do.  Tomorrow I shall try to wrap things up, so that on Tuesday I can go off on my African adventure secure in the knowledge that I have given you something to chew on in my absence.


wallyverr said...

Two short points.

The decision to ignore human capital has potentially great significance. The British economist A.B. Atkinson recommended a decade ago that the UK statistics office should estimate human capital. The office attempted this and, while certainly not precise, came up with a human capital figure of more than twice the value of UK tangible assets (buildings, machinery, vehicles). cf ONS Website. Atkinson is not a Chicago-style economist, indeed he is a senior collaborator of Piketty in a related research project on income inequality.

George Stigler, who was a Chicago economist, argued that every accumulating fortune eventually is eroded by " a stupid or profligate heir" or "an unstable environment". (Theory of Price, 4th ed , p304). Does Piketty look at the first aspect, as he does the second? Btw, Stigler has p302 a related discussion of the potential interaction of inheritance and family investment in human capital.

Thanks for the notes so far, clearly an extremely important book.

Robert Paul Wolff said...

The decision about human capital is certainly an important one. I think it is correct, but that must obviously be argued. I am struggling to keep my discussion within manageable bounds and to finish before I leave tomorrow, but when I get back, I would be delighted to launch a discussion on my blog of this and other matters [within the narrow cofines of my competence, of course!]

wallyverr said...

Have a good safari holiday, I hope to have at least started reading the Piketty book by the time you get back.

Piketty also has some useful related material in his teaching notes for a course on the economics of inequality,