Further thoughts on Piketty and Capital

Posted on

I have been asked to comment on James Galbraith's review of Thomas Piketty's book, Capital in the twenty first century, because Galbraith is critical of both the ideas and policy recommendations made in the book unlike, for example, Paul Krugman, who is broadly in agreement with Piketty's thinking.

Now I should stress I have still not read all of Piketty, but I am accumulating a good collection of reviews. Others include Martin Wolf's review and Brad Delong's. There will, I have no doubt, be many more to come and I am not proposing to make this a review of reviews.

What it does appear to me that Piketty is supposedly guilty of is of proposing what Wolf calls 'a simple economic model'. That might appear odd in a work of 700 pages but as I mentioned in my own first blog on this issue, the essence of what Piketty is saying is that if the rate of return to capital is greater than the rate of growth in the economy then the result has to be increased inequality because that increased accumulation of capital has to arise as a result of a reduced return to labour. Piketty contends that this historically has been the case, and is again now after a period when this was not true.

The criticisms then appear to have four broad thrusts to them. Galbraith suggests that Piketty is using an inappropriate definition of capital. In Galbraith's view capital remains plant and machinery - the stuff with which the proverbial widget, much beloved of economic textbooks, are made. I have to say I think Galbraith is both naive in thinking that this is what capital is in an era when such assets make up a small proportion even of corporate balance sheets. Second, I think Galbraith is guilty of a standard macro-economist's failing: he simply has not comprehended the role or money and so of financial power within an economy. It is an astonishing fact that macroeconomics really does not have an adequate theory of money or of its impact in the real economy. As a consequence it has no way of managing the role of financial capital about which Piketty is rightly concerned because of its impact in the real world. Galbraith's economic criticisms largely fall apart at this point.

Delong's critique is potentially more interesting. He argues that Piketty has considered the wrong rate of interest. He says that of the four options for interest rates that could have been used Piketty considers what he calls r2' which is the real interest rate that is the actual average return on wealth in the society and economy when he should have considered r3' which Delong defines as the real interest rate that is the average risky net rate of accumulation--what capital receives, minus the risk of confiscation or destruction or taxation, plus appreciation in valuation multiples, minus what is spent in order to keep the world in the appropriate social position. I have not thought this through as yet, and need to, but suspect there is an issue here that does need to be explored if true, but which also might be capable of being dismissed entirely because I suspect that r2 and r3 tend to the same number in the long run which Piketty is considering.

Third, Wolf makes the criticism that Piketty asserts that inequality matters but does not say why. I reiterate, without having read it all I cannot say whether that is fair or not, but I also think it a red herring. Piketty does not, surely, need to cover ground already comprehensively covered by others and there is a growing literature on this issue that seems to me to more than comprehensively deal with this point.

Fourthly, the nature of Piketty's recommendations comes in for a lot of attention. You could say Piketty did not help himself here by saying that his propsoal for a worldwide wealth tax was unrealistic. I would disagree: in a platonic sense knowing the ideal form of a solution does not appear to me to be a bad thing even if that knowledge is then only of use in establishing a goal against which any pragmatic outcome can then be measured for effectiveness. As such I defend Piketty's idealism.

I also think Piketty is right to talk tax. He very clearly wrote this book to promote a paradigm shift in thinking, not least on this tax issue. For Galbraith to say that a tax solution is not possible because pre-paradigm shift thinking precludes it is to deny that this book is in itself a change agent. I confess I am surprised by this poverty of both aspiration and thinking on his part.

But that is not to say that Galbraith and Wolf, who also has concern regarding the recommendations, are wrong to say that more practical thinking may also be necessary. Some of that will be on how wealth taxes can be created. That is a task I certainly want to be involved in: I think that this book opens that opportunity just as it also creates an economic framework that justifies much of the work I and others have done on tax havens over the last decade or so. There is much to do here. Associated with other work with which Piketty has been involved in with regard to higher rate taxes, there is also work to do on that issue.

But I also accept that tax alone cannot deal with this issue or inequality and if that is the focus of most of Piketty's recommendations much as I welcome that pushing of an agenda with which I am involved I would also very clearly have to say that other regulation is essential. We do need living wages. We can cap higher pay. Land value taxation is clearly a way of addressing financialisation of capital, and resulting speculation. We need to redesign incentives in the tax system that reward capital growth such as low capital gains taxes and penalise labour, such as national insurance charges. We need to address issues that allow capital concentration, such as the free flow of capital. The fact that effective tax rates on investment income are so much lower than on wages is absurd. All these are issues to address, as are others.

Piketty is guilty of dreaming, but I do not criticise him for that. Dreamers change the world. But we should not necessarily expect him to deliver all the solutions. That would be unreasonable.

Piketty has provided a theoretical framework, which will no doubt develop, for considering this issue. That's an amazing achievement. Now it will need to be refined and, more pragmatically, thinkers with other experience will need to offer real world solutions for the issues he identifies. If his own solutions are but bench marks then they have use, as I have noted. But that use will be in assessing the relevance of offered solutions that can deliver real social change that permits the redistribution of wealth that I think Piketty is saying is now the condition for market economies and democracy surviving. Offering those solutions is now a task to be taken on. Galbraith has suggested some solutions, but i think there are more. The great merit of this work, if it proves to be enduring, is that it provides that opportunity for change. That, surely, is an enormous achievement? The rest may be nit-picking.