"The People" Vs. Piketty

Submitted by Erico Matias Tavares via Sinclair & Co.,

Thomas Piketty is getting a lot of attention these days. The French economist has seen the recognition for his lifelong work on the study of inequality skyrocket after publishing “Capital in the Twenty-First Century” in August 2013. The book is a best-seller, which is quite an achievement for anything with 696 pages on economics (even if by some accounts the majority of readers don’t make it much beyond page 12).

Here’s what Paul Krugman, the don of neo-Keynesian economics, had to say about Piketty’s book back in April 2014:

“Other books on economics have been best sellers, but Mr. Piketty’s contribution is serious, discourse-changing scholarship in a way most best sellers aren’t. And conservatives are terrified. (…)The really striking thing about the debate so far is that the right seems unable to mount any kind of substantive counterattack to Mr. Piketty’s thesis.”

That turned out to be incorrect. Barely a month after his glowing review of Piketty’s opus magnum, Krugman had to come out in his defense after several scholars and commentators highlighted some “clear errors” in facts and figures.

And it wasn’t just from the right either. Yanis Varoufakis, economics professor turned finance minister of Greece – and self-proclaimed Marxist – is also a critic of Piketty’s work.

Undeterred, Piketty has joined forces with other like-minded economists to come up with actual proposals to tackle the inequality issues he wrote so extensively about.

As that brave intellectual effort takes shape, we would venture a sneak preview: assemble a huge ledger of all financial transactions, tax the “rich” and their unfair capital gains and make sure that they leave nothing for their kids.

This of course is music to any politician’s ears. It provides an aura of tackling one of humanity's great problems, while providing yet another reason to tax private property.

So in spite of all the publicity, there are two sides of the story here. Should we the People be in favor or against Piketty’s argument?

Inequality and Economic Systems

Where would you prefer to live: in a society with obvious economic and social inequalities but with an abundance of choices and opportunities, or in another with much greater equality and less choices?

The answer greatly influences why societies end up adopting a particular economic and political system – although not always by choice. Of course there are societies that neither feature equality nor opportunity, but in most cases there is a prevalence of one over the other.

To see why we can use a simple example that illustrates this dynamic. An economic system is in fact a set of incentives that drive behaviour, with varying degrees of personal input and liberty. Let’s assume that there are four tribes in a large forest (we did say it was simple) trying to get from point A to point B. Each tribe has the same mix of individuals with different physical and psychological attributes but decides to adopt a different economic system in pursuit of their goal:

  • The first tribe adopts capitalism in its “rawest” form: those who can run the fastest (or by sheer luck find a great shortcut) are allowed to get ahead quickly, while the others in spite of their efforts are progressively left behind. This is how inequality is measured in this example: basically the distance between those who are ahead versus hose who are behind. This tribe on the whole will cover a lot of ground, although very unevenly: the fast runners will get very far (possibly even well beyond point B, if they so desire), while the ones in the back hope that the trail which has been blazed before them will somehow help them get through.
  • The second tribe adopts similar principles, but with more inclusive incentives. People still largely run in accordance with their capabilities, but the fast runners are encouraged to help those further out in the back through social and financial rewards. They will likely not get as far as the fast runners of the first tribe, but the group as a whole will be much more compact.
  • The third tribe adopts socialism. Those who run fast must pay a penalty in favor of those further behind (they are just lucky to have those genes after all). Now the fast runners have to think twice about how fast they should run, because the quicker they run the bigger the penalty. They may end up resenting the slow runners as a result, who may resent them in turn because they should be doing more to help them move along. That tribe will move forward at a more even pace, although clearly slower than the first two tribes and arguably less harmoniously. It's unlikely that anyone will try to go past point B.
  • Finally, the fourth tribe adopts communism, where everyone is running in accordance with the same beat. There is no broad inequality since most cover the same ground. However, the fast runners must either accept a much slower pace or, if they dissent, “take one for the team”. The slow ones are not necessarily better off either. If the leaders (the guys beating the drums) want to enhance their collective pace to match the other tribes they may not be able to make it after all.

This was a long way of saying that inequality arises in economic systems where individuals are largely given the freedom to act in accordance with their capabilities and desires. We can certainly force society to be more equal, but this will come at some cost to individual freedoms and opportunities in general.

The fact is that we are all born with different capabilities and attributes. So when someone starts complaining about inequality, we need to understand what they are talking about. Is it because some are more capable than others? Luckier? More cunning? Are they obligated to bring everybody along?

We can say it is unfair that some of us are world class football players, others Hall of Fame actors, and others top tier fund managers. We can complain that they make way too much money. But this is a consequence of the economic system we have adopted in the West. And we're not necessarily poorer because these folks are richer.

In other societies they may have not fared as well. The best baseball players in Cuba are clearly much worse off on a relative basis in comparison to their peers in the US (and many are just as good). And since there are no savings (i.e. capital) there aren’t any fund managers either.

So there, much less inequality, but would you want to live in Cuba?

Piketty’s Argument

Having seen that freer societies tend to have greater inequalities, let’s quickly review Piketty’s argument (especially if you also haven’t made it beyond page 12 of his book).

As a disclaimer, for sure a lot of work went into the book and far from us wanting to oversimplify or denigrate what appears to be an honest attempt to tackle a recurring concern of society (over thousands of years in fact). On the whole Piketty comes across as a decent and sincere fellow.

But being sincere does not mean he's right; anyone can be sincerely wrong. And because of the fame bestowed upon him, his ideas may get widely accepted without due scrutiny or, as we shall see, little basis on fact. Worse, they can serve as justification for some truly repressive and appalling economic policies, which should concern us all.

So here’s the main thrust of Capitalism’s 696 pages: examining over 200 years of return on capital data in twenty Western world countries, Piketty concluded that because such returns have historically exceeded the rate of economic growth the holders of capital will get rich faster than anybody else.

In other words, inequality does not stem from differences in individual ability and achievement as we have discussed above, but rather through the mere ownership of capital. The system is rigged. Moreover, because capital can be inherited, this inequality can persist over many generations.

Piketty claims that the inevitable outcome from capitalism is perpetual misery, social violence and wars.

Incidentally (or not), this is eerily similar to the argument that John Maynard Keynes put forward to advocate the euthanasia of the “rentiers” in the 1930s (a great example of a repressive economic theory that has been adopted by the world’s central bankers and is now causing misery to millions of people, particularly to our elderly). Plus ça change Monsieur Piketty.

We would also have liked to pinpoint the similarities with Karl Marx's thinking (although his bag was mostly the perpetual exploitation of labor by capital, or something like that) but we also never got past page 12 of his book. Apparently a lot of pages are needed to explain something that should have been obvious to us all.

In a June 2014 interview with the jovial Stephen Colbert, Piketty provided some context to his thinking. People like Colbert became rich because capitalism is unfair; and because he became rich Colbert is depriving others from the opportunity to also become rich. The rich are out to get us! Not to worry, the French economist has a solution: tax all earnings above US$500,000 at 80%.

We can start getting a sense as to why Facebook and Spanx were created and mass-adopted in the “unequal” US and not “egalitarian” France, Piketty’s home country. Let's look at some facts.

The Unequal Land of the Free

Without even getting into the time-tested damage an 80% tax rate does to an economy, the US – the habitual poster child for inequality – provides robust evidence that inequality is oftentimes ephemeral and generally misunderstood. This is where facts start getting in the way of Piketty's grand vision for society.

Thomas Sowell, the prominent American economist from the Chicago School, has extensively researched this topic. He found that 56% of US households will join the richest 10% at some point in their lives, usually when they are older. So much for the rich versus the poor; this is much more likely a debate with our own selves at different stages of our lives.

When looking into the composition of the much vilified 1%, the statistics are even more revealing: over the course of a decade, the great majority of Americans only stay at that level for one year, and less than 13% for two years. Basically these are temporary spikes in wealth from things like asset sales. It certainly doesn’t seem like the wealthiest 1% are out to screw everyone else.

We have also written about inequality in the past. The Pikettys of the world obsess about the dispersion of income levels, where we believe that a much better measure of general prosperity is the percentage of people earning above a minimal threshold that achieves the fulfilment of basic needs (and then some). Using this metric US prosperity peaked in 1999, but the subsequent decline is certainly not attributable to ownership of capital.

History shows us that prosperity is best achieved in societies with a strong rule of law, enforceable property rights, good education and... access to capital!!! Try starting a business with no money and see how far you get. To vilify capital and the people who own it is truly myopic, not to say misguided.

So what if dozens of new Mark Zuckerbergs and Sara Blakelys also emerge from that system and greatly distort the income statistics because of their phenomenal wealth? But according to Piketty, Zuckerberg’s “fair” compensation for co-founding Facebook, a social media vehicle used by over a billion people around the world, and Blakely for starting Spanx, which sells undergarments to millions of women, should be a little over US$500,000 per year. Does this sound fair to you?

For all its virtues, we are not saying that the US is a perfect country. Many millions of people are still struggling after the last recession, and for them the American Dream is proving to be ever more elusive. Our point is that whatever valid grievances we may have with inequality, the ownership of capital is not the culprit. And hurting the people most likely to create it is not a solution either.

The Poor vs Piketty

One of the most robust critiques we have seen of Piketty’s work comes from Hernando de Soto, the Peruvian economist. His critique is not based on models or theory but rather on hard facts accumulated by his research team in the very countries where Piketty’s perpetual scourges of inequality – misery, social violence and wars – are prevalent.

He used Egypt as an example, which in 2011 was undergoing a profound social change with the emergence of the Arab Spring movement. What better testing ground to assess people's grievances? His findings were the polar opposite of what Piketty contends: people in those countries “actually want more rather than less capital, and they want their capital to be real and not fictitious”.

In fact, de Soto even points out that the very first "martyrs" of this movement were mostly small entrepreneurs desperate because they did not have access to the capital to sustain their businesses.

Piketty did not have reliable data for developing countries, but rather than conducting his own on-the-ground research he merely extrapolated his findings to the whole globe using data from Western countries. And voilá!

How was Muhammad Yunus able to improve the livelihoods of thousands of families in his native Bangladesh? By providing microcredit to them; in other words, access to capital.

How did China become such an economic powerhouse? Certainly not by restricting its citizens' access to capital and taxing them at 80%. On the contrary, it sucked as much foreign capital and know-how as it possibly could. At the start of their great march towards prosperity in the 1980s, Deng Xiaoping (supposedly) proclaimed "to get rich is glorious". They were tired of Mao-Tse Tung wanting to make everyone equal.

Piketty clearly knows something people in emerging markets don't. Or maybe what he was really describing is capital in the nineteenth century, not the twenty-first.

Unintended but Predictable Consequences

We have rich people, poor people, right-wing economists, left-wing economists and even revolutionaries, all contesting Piketty’s argument. It seems we the People do have a point against him. But will it prevail?

We’re not optimistic on this one. It is far more likely that Piketty's ideas will gain traction rather than fade away. Why? Because it gives politicians and their Keynesian consorts yet another framework and justification as to why the state should be the key allocator of resources in society.

In other words, it’s another "soak the rich" argument, this time propagated by a soft-spoken best-selling author. And to think that the state will be any more benevolent and altruistic when it is done soaking them is another example of academic theory which is contradicted by the historical record. Power corrupts everything, especially a more aggressive and intrusive state. Perhaps unintended, but clearly a predictable consequence.

The state does play a very important role in society, but not how Piketty, Krugman and their pals envisage it. Unfortunately, it seems we may be saddled with yet another set of dubious economic ideologies governing our lives and our livelihoods.

If you are one of those fast runners, we can only wish you the best of luck in your journey across the forest