Is the Piketty Enthusiasm Bubble Subsiding?

Jeff Madrick

The Piketty bubble may be coming to an end. Economists are starting to criticize the heart of his argument. That is not to diminish important aspects of his book. But the most profound of his claims simply may not hold.

Arriving with a fanfare worthy of Caesar, Thomas Piketty’s long book, Capital in the 21st Century was at first welcomed almost uncritically by enthusiastic centrists and progressives both. Why not? As one read the first sections of the book, who wouldn’t have? I am an admirer and remain one. Here was an economist widely respected in the mainstream telling us point blank that the rich earned far more than they deserved, that economic theory regarding labor markets failed, that the most respected economists had little sense of the real world, and that inheritance was a source of persistent inequality.

Most impressive was the quantity and depth of empirical backing. Piketty scolded economists for depending on models with little empirical basis. This needed to be said by someone so respected. Piketty’s remarkably influential work on income inequality with his colleague Emmanuel Saez is what really revolutionized thinking about economics—and paved the way for his enthusiastic acceptance. Using tax records, they showed the remarkable concentration of wealth in the top 1%—basically they counted how many really rich people there were. Their findings about the extreme distribution of income towards the risk were shocking and confirmed anecdotal evidence.

The empirical analysis in the new book went further. It showed that the equality that existed since World War II and began to reverse in the early 1980s had been an aberration. Capital usually grew faster than incomes throughout history. And it would likely continue to do so! Piketty found that this relation in which r, the rate of return on capital, exceeded g, the growth rate of the economy, seemed permanently etched into not merely history but the future.

And he told us that the best way to deal with such a law of inequality was to tax the rich through a global wealth tax.

I’d hate to put a damper on the enthusiasm. Early critics included James Galbaith and Dean Baker. Galbraith was perhaps the first to question his empirical findings, arguing that Piketty mixed up the price of capital with actual physical capital. Even if Piketty’s right about capital, he and Dean Baker argued early on that there were many other way was to keep capital from rising so fast than to levy taxes. These included financial regulations, anti-trust enforcement, and weakened copyright laws.

But others still believed that Piketty was on to something. And they were right. Except in the mid-twentieth century, the return on capital, or r, he found, was usually—if not almost always—empirically higher than the rate of growth of national income. He defined capital as stocks, bonds, housing, plants, and even firewood if it led to returns. And if the return on investment in them would always grow faster than GDP, then inequality would grow inexorably. Had he found the fundamental weakness of capitalism—a quest Marx himself failed at?

It was exciting to find a strong refutation of the long-held mainstream view that the share of capital and the share of labor in GDP were stable. Workers and investors would split the economy’s bounty according to some unknown law of equality. Now Piketty was saying not so. Historically capital did much better. This is darned important.

But to get there, Piketty ironically returns to conventional mainstream economics without quite telling us he shifted. To him, the invisible hand failed in labor markets, but works in capital markets. Piketty hypothesized that the reason r stayed high was that the “elasticity of substitution between capital and labor” favored capital. To oversimplify a bit, it made sense to invest more in capital than to hire more workers.

But was this true historically, and forever after? Martin Wolf in The Financial Times said it was plausible. So did Jason Furman in a piece written from the White House. But none other than Larry Summers had his doubts. More technically, so did Robert Rowthorn of Cambridge University.

The simple question is: Why doesn’t r fall as returns necessarily diminish? Piketty’s mainstream answer is that new technologies, broadly defined, keep creating new profitable opportunities.

This leaves me at a loss. Pure free markets create r that is always greater than the growth rate of GDP? Fortunately, Lance Taylor, formerly at MIT and now emeritus of the New School, shows pretty clearly that the capital proportion can rise, fall or persist under varying conditions.

And, finally, even if capital rises, is it the central cause of income inequality? In the same piece cited above, Jason Furman breaks down the sources of inequality in recent decades. He finds that the rise in the capital ratio to GDP by no means accounted for the lion’s share of growing income inequality. It’s not clear to me, I should quickly add, that Furman not fully adjusted wage income for stock options that were affected by rising capital values. But neither did Piketty.

Most important, and most bothersome, I heard Piketty say at an assemblage about his book at CUNY that we may not agree with his solution in Part 4 of the book, but we may learn a lot in the first three parts. Some of those who criticized Piketty’s single solution of a high global tax on capital seemed to miss the point that the recommendation was a result of his analysis. If a rising capital ratio is inevitable (as his history empirically suggests), and capital markets work the way the neoclassical models says they do, then taxes are the only tool available.

But as Taylor has pointed out in some technical detail, and others have alluded to, there are many reasons other than the invisible hand for r to remain high. Much of this can involve market failure, which Piketty explicitly rejects. See page 424 if you don’t believe me. R greater than g has nothing to do with market imperfections.

James Galbraith opened his review noting that capital meant power. If Piketty’s empirical analyses are right, and r has been persistently high, I’d suggest it reflects the power of the rich, not the natural forces of a free market economy. Higher taxes would help stymie the rich, but so would financial regulations, anti-trust campaigns, and public financing of politics that could minimize their power and privilege.

I have compiled links to all these reviews on the Bernard L. Schwartz Rediscovering Government web site of the Century Foundation.

I hope this doesn’t sound too harsh. Piketty has done a more than admirable job to trace high capital ratios. He lays the groundwork for more analysis and a true attack on general equilibrium theory and its relevance in the real world. But in interviews I’ve read, he defends himself by saying he’s talked about market imperfections and political institutions in the book. But making many broad general comments is not analysis. His central assertion depends on faith in a general equilibrium model. As he has done in some interviews, arguing that people haven’t read a book as large as his fully is not a defense. It could be equally fairly charged that writing such a large book led him to too many inconsistencies.

In the long run, I think Piketty’s work will indeed prove seminal. It will force economists to deal with the remarkably wide range of issues he raises. But he hasn’t replaced Marx with a more well-founded model of capitalism’s unfairness. For me it is not capital that is power alone. Piketty’s persistently high r, a wonderful discovery, is likely a reflection of the power of wealth not of natural economic forces. With his empirical work we can begin to find solutions about how to constrain the power. But let’s follow his example in regard to income inequality and understand more fully the market failures in capital markets. A global tax would be a wonderful addition to the list of potential tools to bring down r. So let the arguments begin.

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