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Thomas Piketty's Capital in the Twenty-First Century FRASER BOOKREVIEW September 2014 A Failure on Several Counts: Thomas Piketty’s Capital in the Twenty-First Century by Philip Cross Some books enjoy unexpected success because tried to initiate a dialogue on inequality only to they resonate with an emerging preoccupation dissipate within a year, there are reasons to think of a generation. The Limits to Growth expressed sales of Capital will not translate into a wider a pessimism about the economy and the envi- public debate. Nevertheless, the book’s popular- ronment “that captured and reinforced this ity and its potential implications for public policy worldview” (Gold, 2014: 94). On the Road by require a careful evaluation of its message and Jack Kerouac vented the growing frustration methods. with the Eisenhower years of the Beat Genera- tion, which mushroomed into the youth rebel- There are some things to like about Capital. Its lion in the 1960s. ambition to change the discourse and method- ology of economics is welcome compared with The publishing success of Thomas Piketty’s Capi- the small-minded advancing of the chainsticks tal in the Twenty-First Century, unusual for an that grips most academic work. He is scathing economics book, suggests it articulates the infat- in his critique of the methodology of economic uation of a segment of our society with inequal- analysis and “its childish passion for mathemat- ity and a sullen acceptance of a “new normal” ics and for purely theoretical and often highly of chronically weak growth. However, unlike ideological speculation at the expense of histori- the environmental movement of the 1970s or cal research” (Piketty: 32). The book’s study of the youth rebellion of the 1960s, only a sliver of inheritance in France is an important contribu- North America is preoccupied with distributional tion to our understanding of the importance of issues. In Canada, a 2011 Harris/Decima poll intra-family transfers that economists should found that only 6% mentioned any issue related remember when speculating on future trends in to social equity as the most important policy pri- ority.1 Just as the Occupy Wall Street movement ging even the share that cited foreign aid; moreover, “even a tutorial presenting inequality as harmful had little or no 1 A 2011 Gallup poll found that just 1% of Americans effect on attitudes but did reduce respondents’ trust in believed inequality was the most important problem, lag- government” (cited in Schuck, 2014: 111). fraserinstitute.org FRASER BOOK REVIEW 1 A Review of Thomas Piketty’s Capital income and pensions. Piketty usefully provides a of resources subject to constraints. The classical reminder of how his Law of Cumulative Growth school of economics regards innovation and the ensures that small changes add up to important explosive growth of incomes starting in the nine- trends over long periods of time, something that teenth century as the focus of economic analysis, should be required reading at the Bank of Can- as outlined by David Simpson in his 2013 book ada as it encourages inflation beyond 2%. The Rediscovery of Classical Economics.3 Simp- son argues that “the ability to sustain growth However, the analysis in Capital is fundamentally in aggregate productivity over long periods of flawed. This paper reviews the major themes time… is a unique feature of the market econ- in Capital, two of which are recurrent. One, of omy: no other form of economic organisation course, is inequality and whether it is destined has been able to deliver sustained increases in to increase significantly. The other is the pessi- living standards for masses of people” (Simpson, mism engulfing most of Europe today. Trapped 2013: 2). The most striking feature of the market in a long-term stagnation of incomes caused by economy is “incessant change,” the very oppo- chronic structural impediments to growth and a site of equilibrium (Simpson, 2013: 3). For classi- debilitating level of debt, most European coun- cal economists, the true “hockey stick” graph is tries face a lost decade of falling living standards. GDP per capita plotted over centuries.4 Without growth, the public debate has shifted to a futile focus on redistributing income. For North The key relationship in Capital is whether the American readers, it is hard to relate to this Euro- rate of return on capital (r) is greater than real sclerotic view of the world, where “old money” economic growth (g). For Piketty, the focus is on festers in pools undisturbed by the competition capital and its rate of return, the left hand side of new ideas and new people that characterize of his fundamental equation (r>g). For classical our economy. economists, the focus is on economic growth, the right hand side of the equation. The two are What is the central question of related: Piketty admits that attempts to restrict economics? the return on capital may end up damaging the economy’s growth. Still, he makes the argu- Piketty has based his career on the analysis of ment that if the return on capital exceeds total income distribution, including path breaking income growth, wealth will inevitably be accu- research with Emanuel Saez on the concentra- mulated by a small number of people, creating a 2 tion of inequality among the top 1%. There- level of inequality in society that is dangerous for fore, it is not surprising he states early on that democracy and that will lower class mobility. his main purpose in Capital is to “put the ques- tion of inequality back at the center of economic 3 analysis” (Piketty: 16). However, he does not Simpson (p. 13) also quotes another definition of econom- ics, from Alfred Marshall: “Economics is a study of men as clarify what supplanted inequality at the center they live and move and think in the ordinary business of of economic analysis. Most mainstream neoclas- life.” Ronald Coase also had severe reservations about defin- sical equilibrium economists define the central ing economics as a theory of choice, arguing instead it was preoccupation of economics as the allocation “the study of the working of the economic system, a system in which we earn and spend our incomes” (from Lemieux, 2014: 55). 2 For a summary of the contribution of the research of 4 Most people associate the “hockey stick” graph with the Piketty and Saez, see Noah, 2012: 145. IPCC’s graph of global warming. fraserinstitute.org FRASER BOOK REVIEW 2 A Review of Thomas Piketty’s Capital Piketty’s assertion that r exceeds g is based on rich are earning in their new country. This is one an exaggerated view of the return on capital reason why inequality is not a public policy prior- (r) and a pessimistic view of economic growth ity for most North Americans. (g). He argues that economic growth inevitably Picketty offers no justification in Capital for why will slow in coming decades and it is futile to he uses real and not the nominal measure of attempt to boost economic growth to minimize GDP.5 Nominal incomes are best when compar- rising inequality resulting from r>g. Economic ing economic growth to variables like the return growth reflects the growth of population and of on capital and saving, which include the effect real per capita income. It is argued that popula- of price changes. One motivation for removing tions will soon stall and then decline, a process inflation from growth could be to exclude pro- already underway in Europe and Japan, with lit- jections of higher inflation in the future from tle prospect that productivity will increase. This equalizing r and g. Many economists expect process results in projected long-term growth of some upturn in inflation in the years to come only 1.5%, or less than half its post-war average as a result of the “ultra-easy” money policies of 3.5% (Piketty: 101). adopted by central banks throughout the West- However, this pessimism about long-term growth ern World after the 2008 recession. At a mini- reflects a Euro-centric view of the world. Under mum, the reason Piketty focuses only on real no scenario will the population of Canada or the income should have been discussed in a book US stagnate in the coming decades, because of that claims to be rigorously fact-based. both a higher birth rate and more immigration On the other side of the equation, there are than in either Europe or Japan. In the US, for questions about the forecast return on capital example, the Congressional Budget Office proj- (r). In particular, one reason Piketty asserts that ects long-term annual growth of 2.3% over the the return on capital will stay high at 4% is an next 25 years (it has averaged 1.8% since 2000), assumption that taxes on capital will fall to zero based on 0.5% population growth and a 1.8% due to “fiscal competition” (Piketty: 354). How- increase in productivity. Piketty demonstrates ever, if the tax on capital remains near 30%, some awareness of his European-based view of which seems much more likely given the rate at the world, acknowledging that the evolution which investments and corporate income are of capital in the US has been different because taxed, then r drops to 2.8%, not much greater large scale immigration was “the stabilizing force than g and a differential that could conceivably that prevents accumulated capital from acquiring be addressed by more human capital either from the importance it has in Europe” (Piketty: 538). immigration or higher education. As stated in This statement acknowledges that inequality is what he calls his “Law of Cumulative Growth,” not just the product of the differential between small differences add up.
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