Henderson on Piketty, Part 2
By David Henderson
In Piketty’s view, if someone’s share of wealth stays constant, he cannot be better off, even if wealth has increased.
Yesterday I highlighted the opening of my lengthy published review of Thomas Piketty’s Capital in the Twenty-First Century. Here’s the next episode.
In my view, a steady increase in well-being for the vast majority of the world’s inhabitants, as well as the policies necessary to achieve that, are what should be central to economic analysis. But Piketty chooses to put inequality front and center, and so be it. He states his conclusion up front:
When the rate of return on capital significantly exceeds the growth rate of the economy (as it did through much of history until the nineteenth century and as is likely to be the case again in the twenty-first century), then it logically follows that inherited wealth grows faster than output and income.
The reasoning is fairly straightforward: Assume that someone who owns capital earns an average annual real return of 5 percent and that the rate of growth of the economy is 3 percent. If the owner of capital can live on 1 percentage point of the annual return, his wealth will grow at 4 percent per year, which is higher than the economy’s growth rate. We need only one more assumption: that the capital owner has only one son or daughter who, in turn, will live on that 1 percentage point per year. QED
In short, Piketty’s conclusion follows logically, but only if we include assumptions about the number of heirs and their spending discipline. But if, for example, each wealthy person has three heirs who dissipate the wealth, those heirs will leave little to their heirs. So, based on just Piketty’s skimpy assumptions, his claim does not follow logically. He, unfortunately, starts out by overstating his case. He could be right empirically, though, and he presents evidence for the growing share of income earned by owners of capital, much of which they inherited.
We are still left with the question: “So what?” Imagine–as Piketty has convinced me seems at least plausible–that the share of income going to owners of capital could rise over time, which means that the share of income going to labor would fall. Would that mean that laborers are worse off? Not at all. In fact, they are likely to be better off. Unfortunately, many people who read the book, especially those who are not economists, could easily miss this point for two reasons: (1) Piketty’s emphasis on income shares rather than on real income; and (2) his misleading language. We would expect an emphasis on shares rather than real income from someone who believes that inequality of wealth and income, rather than improvements in standards of living, is “at the center of economic analysis.”
What compounds the misleading impression is Piketty’s misleading language. For example, in discussing his country, France, he writes, “Probate records also enable us to observe that the decrease in the upper decile’s share of national wealth in the twentieth century benefited the middle 40 percent of the population exclusively.” But as he well knows, French wealth per capita grew enormously in the 20th century, and so the decline in share of the wealthiest does not imply an absolute decline in wealth. Moreover, even if the wealthiest French people had lost wealth in absolute terms, the higher share of the people below them is not sufficient evidence that the wealthiest group’s decline benefited the middle 40 percent. The middle 40 percent could have done better simply because of their own savings and investments.
Piketty’s misleading explanation of the French case above is not an isolated weakness. Throughout the book, he writes as if he thinks that wealth is zero-sum and, thus, that increases in various groups’ wealth must come at the expense of others. Writing about early 19th-century France, for example, he refers to a “transfer of 10 percent of national income to capital.” But a look at his Figure 6.1, on which he bases this claim, shows no such transfer. All it shows is that the share of income going to capital rose. Similarly, in discussing the United States in the late 20th century, he calls an increase in the income share of the top 10 percent an “internal transfer between social groups.” Never mind that on the very same page, he admits that income for the bottom 90 percent slowly grew over that same period.
Or consider Piketty’s statement about the United States and France: “And the poorer half of the population are as poor today as they were in the past, with barely 5 percent of total wealth, just as in 1910.” That is nonsense. If the poor have the same percentage of wealth as they had in 1910, they are much richer because wealth is much greater, as Piketty well knows. Here, he has gone beyond misleading language into actual error.