Mr. Piketty's Book

Will Democracy Control Capital, or Will Capital Control Democracy?

What I'm about to talk about is not exactly breaking news. Back in the 1920's there was a famous song called "Ain't We Got Fun." One of the more memorable lines is "The rich get richer and the poor get children." This line shows up in F. Scott Fitzgerald's The Great Gatsby.

The song is putting a humorous twist on an older, more depressing line: "The rich get richer and the poor get poorer." This is quite an old idea, and it precedes Karl Marx, whose writings seek to explore the mechanisms by which all this happens.

Calling people Marxists or communists is an easy way to dismiss those who write about the dynamic of inequality. After all, communism collapsed, Marxists are evil, and a market-based economy is always and everywhere a good thing.

The Osawatomie Speech
And yet, and yet. It is entirely possible that growing inequality is the defining issue of our time. President Obama addressed the subject in December 2011 (shortly after the recession that turned me into a retiree) in a speech he gave in Osawatomie, Kansas: "Long before the recession hit, hard work stopped paying off for too many people. Fewer and fewer of the folks who contributed to the success of our economy actually benefited from that success. Those at the very top grew wealthier from their incomes and their investments -- wealthier than ever before. But everybody else struggled with costs that were growing and paychecks that weren't -- and too many families found themselves racking up more and more debt just to keep up."

That bit comes fairly early in the speech.  Later on, he says, "Look at the statistics. In the last few decades, the average income of the top 1 percent has gone up by more than 250 percent to $1.2 million per year. I'm not talking about millionaires, people who have a million dollars. I'm saying people who make a million dollars every single year. For the top one hundredth of 1 percent, the average income is now $27 million per year. The typical CEO who used to earn about 30 times more than his or her worker now earns 110 times more. And yet, over the last decade the incomes of most Americans have actually fallen by about 6 percent."

Then Came Mr. Piketty
Enter Thomas Piketty, stage left. He'd been speaking from the wings for years, but the 2014 publication of his book Capital in the Twenty-First Century placed him center stage in the English-speaking world.

Piketty is not a Marxist, but he is French (the book was published in French in 2013). So the people who changed the name of French fries to "freedom fries" will probably mistrust him anyway. That's their loss. Mr. Piketty has done us all a great service, and attention should be paid.

That said, the book is 600 pages long, and it's about economics, so even though it's very well written, relatively few people are likely to read it (although quite a few have bought it, with translations appearing in 37 languages). So I decided, once again, to do a book report. I need to warn you, you've just started reading a long story. But it's a lot shorter than the book.

Organizing the Data
Mr. Piketty is less the heir of Marx than he is the heir of Kuznets. It's about the data. Simon Kuznets was the great pioneer in this regard. Working at the National Bureau of Economic Research, he was the first to develop a system of national accounts for the United States. This is an accounting system based on a wide variety of sources that eventually rolls up into our familiar Gross National Product (and its somewhat smaller sibling, Gross Domestic Product). Simon Kuznets was awarded the Nobel Prize for Economics in 1971.

As always, there is a prehistory. Piketty notes that attempts at estimating national wealth date back to the seventeenth century. One of the stalwarts of this prehistory is Sebastien Le Prestre de Vauban, a military engineer who worked for Louis XIV. (Piketty, Capital, pp. 56.) I was a little surprised that Piketty doesn't mention Domesday Book, the inventory of English national wealth prepared after the Norman Conquest in the eleventh century. But it's already a 600-page book. You have to leave something out. And the story doesn't really get going until the nineteenth century, when, as Piketty puts it, "estimates of national wealth proliferated." By World War I, "being an economist meant first and foremost being able to estimate the national capital of one's country; this was almost a rite of initiation." (Piketty, pp. 56-57.)

By the 1930's, improvements in the primary statistical sources allowed Kuznets and others to take the game to a new level. One of the monuments of this period was Kuznets's 1953 Shares of Upper Income Groups in Income and Savings. (Pp. 11, 57.)

Early in his career Piketty noticed "that there had been no significant effort to collect historical data on the dynamics of inequality since Kuznets," so he "set out to collect the missing data." As he puts it, "I began this work by collecting sources and establishing historical time series pertaining to the distribution of income and wealth." (Pp. 31- 33.) Piketty readily acknowledges his debt to Kuznets, saying, "To begin with income: in large part, my work has simply broadened the spatial and temporal limits of Kuznets's innovative and pioneering work on the evolution of income inequality in the United States between 1913 and 1948." (P. 16.)

Piketty began by applying Kuznets's approach to France, and then with colleagues to a large number of other countries. In addition, Piketty wanted to look back as far as he could. Of particular interest in this regard was the French estate tax established in 1791, during the time of the French Revolution. The results of all this work may be seen online in the World Top Incomes Database. (Pp. 17-18, 337.) The WTID, as it is known, was presented to the public for the first time in January 2011, and it continues to grow as new data series are added.

So Piketty has the data. In addition, his analysis controls the discourse on inequality that is currently rumbling around the globe. If you don't believe me on that second point, just watch the 2016 presidential election as it turns more and more to the subject of inequality. Grover Norquist ("Mr. No New Taxes") may well have lost his grip on our political class.

Attacks on Piketty
The appearance of Piketty's book received intelligent coverage in, among other places, The New Yorker and The New York Review of Books. The book was also attacked.

With a book like this, there are a number of standard avenues of attack. You can attack the data. Or you can attempt to shift the discourse by artful misdirection.

Shortly after Capital appeared, Chris Giles, the economics editor of London's Financial Times, wrote that Piketty had made a bucket-load of errors and that the data, properly considered, do not support a conclusion that the rich have been getting dramatically richer of late. To which Paul Krugman in the New York Times said, "Here we go again."

Turns out that Giles apparently forgot to read the footnotes, and also overlooked the vast amount of supporting and explanatory material that was available online in the Technical Appendix. "In short," writes Krugman. "this latest attempt to debunk the notion that we've become a vastly more unequal society has itself been debunked."

A little later, the World Economic Forum said Piketty had his eye on the wrong ball. The WEF is the group that meets in Davos, Switzerland, every year. It's a hot ticket if you're really rich. Not surprisingly WEF official Richard Samans found Piketty's view "way too narrow" and advocated "improving the investment climate and entrepreneurial climate." Gotta make those job creators happy so Archie Bunker's "tinkle-down" theory will finally work. The peons need only be patient. Let's call this inartful misdirection.

And then a British journal, the Economist, tried a third trick, which is usually saved for last because it essentially involves running up a white flag. On July 30, 2015, the Economist declared that it didn't matter whether Piketty was right, because it wouldn't change anything. This is called trivializing the outcome.

I'm rather fond of this story because it lays out a path to victory for Piketty's main policy proposal -- a tax on wealth. As the article puts it, "Suppose America's Congress were controlled by business-friendly Republicans keen to streamline the tax system and cut rates. And the White House were occupied by a Democrat open to tax reform but prepared to veto any bill without a strong progressive component. Congressional haggling could produce a wealth tax as the linchpin of a deal."

However, the article goes on, "A wealth tax that emerges in the absence of tectonic political change will not alter economic growth or the overall tax burden on the wealthy by very much." So relax, rich people. As long as you control the political system, you can prevent a return to the greater equality that characterized the twentieth century in so many countries. Keep crushing the unions and blocking access to the ballot box, and your lives will go on just fine.

The outcome of Mr. Piketty's reform will be trivial. Capitalism will continue to rule democracy.

I personally think that Piketty's ideas are more powerful than that, but there's no denying the ability of politics to stymie good economic ideas and promote bad ones (for instance, the Laffer Curve).

The Emperor's New Clothes: The Minimum Wage
One of the great values of Piketty's book are the moments when, as in Hans Christian Andersen's story, the emperor is leading a parade through town with no clothes on -- and these moments just flow seamlessly from the data. A good example is the minimum wage. Piketty tells the story of the minimum wage in two countries: France and the United States.

France first got the minimum wage in 1950, but for nearly two decades it stagnated, falling "farther and farther behind the average wage." (P. 289.) Then along came the upheaval of May 1968, a time of massive protests that started with university students and spread out from there.

(1968 was a watershed year in a number of countries around the world, including the United States. There's a very good book on it all: Mark Kurlansky's 1968: The Year that Rocked the World [2004]. The France chapter begins on page 209.)

(Okay, I can't resist. One of the lead protesters was Daniel Cohn-Bendit. Known as Dany the Red, he once said, "Je suis Marxiste tendance Groucho," or roughly, "I am a Marxist of the Groucho persuasion.")

At any rate, a main result of the events of 1968 in France was that the minimum wage, long stagnant, took off like a rocket. Between 1968 and 1983 it increased by more than 130 percent. (P. 289.)

Around 1980, the winds of politics changed. Margaret Thatcher became prime minister of Great Britain in 1979; Ronald Reagan was elected president of the United States in 1980; and shortly thereafter Gordon Gekko declared that "Greed is good." As opposed to being one of the seven deadly sins.

In France, the Socialists had returned to power in 1981, but the winds were too strong for them, and in 1982-1983 the government took a "turn toward austerity." Says Piketty, "The break was as sharp as that of 1968, but in the other direction." The minimum wage did continue to increase, but at a relatively low rate. (Pp. 289-290, 308-309.)

If you graph all this, the curve is flat until 1968, sharply up until the early 1980s, and then moderately up until the present.

Meanwhile, what's going on in the United States? The minimum wage got started in the 1930's and increased steadily until its peak in 1969, Richard Nixon's first year as president. Since then it has not kept up with inflation, although there have been occasional upward bumps. (P. 309.)

As Piketty puts it, "The United States used the minimum wage to increase lower-end wages in the 1950s and 1960s but abandoned this tool in the 1970s. In France, it was exactly the opposite: the minimum wage was frozen in the 1950s and 1960s but was used much more often in the 1970s. Figure 9.1 illustrates this striking contrast." (P. 310.)

Figure 9.1 is on page 309 of the book, but it is also in the online Technical Appendix; you can look at it by clicking here.

So what should we make of all this? Here's Piketty's rather professorial take: "To an even greater extent than other markets, the labor market is not a mathematical abstraction whose workings are entirely determined by natural and immutable mechanisms .... labor market regulations depend on each society's perceptions and norms of social justice and are intimately related to each country's social, political, and cultural history." (Pp. 308, 310.)

I am now going to, very freely, translate Mr. Piketty: Within certain broad limits, the minimum wage is not about economics; it is about politics. Fight for $15!

The Other End of the Pay Scale: Supermanagers and Their Pay
Meanwhile, at the other end of the pay scale, we have another graph that destroys an entire imperial wardrobe of false justification, prevarication, and artful misdirection. Figure 9.8 compares income for the top 10 percent in the United States versus Europe (in this case Great Britain, Sweden, France, and Germany). It's on page 324 of the book; it's also in the Technical Appendix: click here.

The chart goes back to 1900, but for our purposes the story begins around 1980, when salaries for what Piketty calls supermanagers started to skyrocket in the United States (pp. 291, 294). Top salaries also increased in Europe, but to a much lesser degree.

Piketty says "what primarily characterizes the United States at the moment is a record level of inequality of income from labor (probably higher than in any other society at any time in the past, anywhere in the world, including societies in which skill disparities were extremely large." (P. 265.)

He adds, "The increase was largely the result of an unprecedented increase in wage inequality and in particular the emergence of extremely high remunerations at the summit of the wage hierarchy, particularly among top managers of large firms." (P. 298.)

And he observes, "It is hard to imagine an economy and society that can continue functioning indefinitely with such extreme divergence between social groups." (P. 297.)

Piketty attributes this phenomenon to the dramatic reduction of top income tax rates during the Reagan Revolution (p. 509). In his view, executives then felt it was worthwhile to push for higher salaries (p. 510). Piketty and several colleagues have studied this issue in depth. "Our findings suggest that skyrocketing executive pay is fairly well explained by the bargaining model (lower marginal tax rates encourage executives to negotiate harder for higher pay) and does not have much to do with a hypothetical increase in managerial productivity." (Pp. 511-512.)

The biggest gains are crowded up at the very top level -- not the top 10 percent, not the top 1 percent, but the top 0.1 percent (pp. 296,  314).

The media direct a very substantial part of their attention on these issues to actors and athletes. They make up less than 5 percent of this high-income group -- the top 0.1 percent of the income hierarchy (p. 302). Artful misdirection, yet again.

Another dodge is to point to people in finance -- hedge fund managers, investment bankers. But the vast majority of these high earners are not in finance. They're out there at places like General Motors, just as American as apple pie. (Pp. 302-303.)

So how do you make it into the circle of the blessed? Well, as Piketty suggests above, it's not about performance. American managers as a group haven't grown their country any faster than the Europeans, who aren't seeing anywhere near the Americans' bushels of kale.  "Concretely," says Piketty, "the crucial fact is that the rate of per capita GDP growth has been almost exactly the same in all the rich countries since 1980." (P. 510.)

And when you take it to the firm level, the results are just as paradoxical. Senior managers seem to be paid largely for events beyond their control -- the general growth of the economy, the price of raw materials -- rather than things that are at least theoretically under their control. Researchers have referred to this phenomenon as "pay for luck." (Pp. 334-335.)

Piketty's conclusion: "It may be excessive to accuse senior executives of having their 'hands in the till', but the metaphor is probably more apt than Adam Smith's metaphor of the market's 'invisible hand'. In practice, the invisible hand does not exist, any more than 'pure and perfect' competition does, and the market is always embodied in specific institutions such as corporate hierarchies and compensation committees." (P. 332.)

All this puts me in mind of George Washington Plunkitt, the great Tammany Hall philosopher and practitioner of "honest graft" so many years ago. What did he say? "I seen my opportunities and I took 'em."

The Sorcerer's Apprentice: Piketty's Main Idea
Most of the discussion about Mr. Piketty's book has appropriately focused on his main idea, which is that wealth tends to flow to the top and stay there. As Piketty puts it on page 1 of his book, "When the rate of return on capital exceeds the rate of growth of output and income, as it did in the nineteenth century and seems quite likely to do again in the twenty-first, capitalism automatically generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based."

This sentence requires some unpacking. Piketty unpacks for 600 pages. I will unpack more briefly.

The fundamental issue has to do with the rate of return on investments -- real estate, the stock market, you name it -- and the rate of growth of the overall economy. When the rate of return on investments is higher than growth of the economy, something strange happens.

Piketty's description of the mechanism that takes hold put me in mind of the old story "The Sorcerer's Apprentice." The original here is actually a poem by Goethe, but Americans probably know it best as a segment of Walt Disney's Fantasia, starring Mickey Mouse. It involves a sorcerer's apprentice (Mickey), his boss the sorcerer, and a broom. The boss decides to go out for a while, and he tells Mickey to clean up while he's gone. Mickey, who is learning magic, decides to try out a labor-saving spell on the broom, which comes to life and starts fetching water from the well and dumping it on the floor. The only problem is the broom won't stop. Mickey cuts the broom in two with an axe, but this just causes the broom to start replicating itself, and things quickly spin out of control -- until the sorcerer returns and cancels the spell.

Piketty uses a mathematical expression, r > g, to describe the situation where return on investments (r) is greater than economic growth (g). His data indicate that r has been greater than g at all times -- except in the twentieth century, when two world wars and related events caused a reversal.

One last chart: Figure  10.11, page 357. To see it in the Technical Appendix, click here.

The world I grew up in was after World War II, when growth was rapid and the rewards were being spread fairly widely. It is difficult for me, on an emotional level, to accept that the world of my childhood was an anomaly. And yet this is where Piketty's data lead us.

This is a complicated topic. Here's the best summary of Piketty's argument that I have run across. It's from the New York Times:

"The book's argument in a nutshell is this: Capitalism has a natural drift toward high inequality, as assets like real estate and stocks disproportionately held by the wealthy (capital) rise faster than the economy (growth). This process was temporarily reversed by the world wars of the first half of the 20th century, but now inequality in the United States and Europe is rising back toward pre-World War I levels. This is a bad thing, which should be fought through radical policy measures like a global tax on wealth."

About that Wealth Tax
I've mentioned Piketty's proposal for a wealth tax several times. It is his response to the r > g conundrum -- think of it as the sorcerer who shows up at the end of "The Sorcerer's Apprentice." In Piketty's opinion, the spell can be broken.

But probably not by an income tax. The wealthy have had about a century to tame the income tax, and it seems they've been quite successful.

Take the case of Liliane Bettencourt, heiress to the L'Oreal fortune and the richest person in France. Notes Piketty, "According to information published in the press and revealed by Bettencourt herself, her declared income was never more than 5 million a year, a little more than one ten-thousandth of her wealth (which is currently more than 30 billion euros)." Obviously those 30 billion euros were generating a lot more than 5 million a year, but Bettencourt apparently managed to get along on the 5 mill, and presumably the rest was reinvested. Piketty calculates that the income declared for tax purposes was "less than a hundredth of the taxpayer's economic income." (P. 525.)

I have trouble imagining a fortune this large, and Piketty says I'm not alone. "For millions of people, 'wealth' amounts to little more than a few weeks' wages in a checking account or low-interest savings account, a cat, and a few pieces of furniture." For these people, "the very notions of wealth and capital are relatively abstract." (P. 259.)

I sometimes wonder if Bettencourt herself might find the notion of 30 billion euros somewhat abstract. Anyway, it seems likely that she would find a tax on the 30 billion, at the rates that Piketty is proposing, to be relatively painless. (I'm sure her lawyers would disagree.)

Piketty emphasizes that his primary goal in proposing this tax is not to raise money, but rather to regulate the otherwise exponential growth of large fortunes (p. 518). As he puts it, "beyond a certain threshold, capital tends to reproduce itself and accumulates exponentially." (P. 395.)

Left to itself, the r > g syndrome leads to a society that is, as Piketty says of France before World War I, "prodigiously and persistently inegalitarian." (P. 370.)

Over the last thirty years or so, I think we've come to see what such a world might look like in America. It's not the basically middle-class world that I grew up in. Frankly, it strikes me as something of a dystopia.

The French fought their revolution for liberty, equality, and fraternity. We fought ours because we thought all men were created equal. If we're serious about holding on to our democracy, we need to take a harder look at the forces that are pressing us into greater and greater inequality, and we need to do something that points us back to our original vision.