Tuesday, 10 June 2014

Why inequality will be worse than Thomas Piketty thinks

‘Chief’ Bromden, the native-American Indian narrator of Ken Kesey’s novel, One Flew Over the Cuckoo’s Nest, is assumed, by those running the mental hospital in which he is confined, to be deaf and mute.

He can, in reality, hear everything that goes on around him. But it isn’t that he is fooling everyone. “It wasn’t me that started acting deaf,” he says, “it was people that first started acting like I was too dumb to hear or see or say anything at all.”

He recalls a time from his youth when a deputation from the government visits his village. He tries speaking to them but they don’t respond. He can almost see the apparatus inside them try and make sense of his words, “and when they find the words don’t have any place ready-made where they’ll fit, the machinery disposes of the words like they weren’t even spoken.”

There is something of this curious ability to hear only selectively apparent in the reaction to Thomas Piketty’s book, Capital in the 21st Century.

Judging by the adoration of many, you’d think Piketty had made a gasping, Einsteinian leap in understanding. Top Cat Keynesian, Paul Krugman, says that Capital in the 21st Century is an “awesome work”, whose author has “transformed our economic discourse”.  Adair Turner, the former chairman of Britain’s former finance regulator, the FSA, lauds the book as “a remarkable piece of work”. The economics editor of the Guardian newspaper, Larry Elliot, says Piketty’s 557-page tome “speaks to the Occupy movement”.

I think there are other, more modest, works that speak more eloquently. Moreover, although Piketty has statistically proved something significant, and in that sense deserves plaudits, he is isn’t saying anything that hasn’t been said before. It was just that, before, nobody important was listening.

The reason for the rapt attention is that Piketty is a “defender of free markets” and dismissive of the “lazy rhetoric of anti-capitalism”.

Piketty’s message is that returns to capital, forms of ownership that are often inherited, provide a stream of wealth far in excess of what can be amassed by a lifetime of labour. The conventional justification of capitalism, that everything materially depends on the activities of wealth-creating entrepreneurs, disappears in a puff of smoke.

But this kind of subversive, truth-telling is not new and I’m not talking about Karl Marx. Consider David Schweickart’s 2002 book, After Capitalism. David Who? Exactly.

I reviewed the book in 2012 and here are some positively ‘Pikettyan’ excerpts:

"What do capitalists do? The answer, says Schweickart, is very little. They have an entirely passive role. They watch their wealth compound by virtue of the fact that they have quite a lot in the first place. “In a capitalist society, enormous sums are paid to people who do not engage in any entrepreneurial activity or take any significant risk with their capital,” he writes … An entire economic system is justified by virtue of its vital role in creating wealth when it is primarily about the receiving of wealth by a small minority that other people create ."

We also have to be careful to understand what Piketty is actually saying and how it is, in fact, only half of the story. Many people have interpreted Piketty as warning that inequality will spiral when returns on capital exceed the rise in incomes.  But the crucial factor is national income, or the sum of incomes. Economic growth, in other words.

The “fundamental inequality”, writes Piketty, occurs when r > g, “where r stands for the average annual rate of return on capital, including profits, dividends, interest, rents and other income from capital, expressed as a percentage of its total value, and g stands for the rate of growth of the economy, that is the annual increase in income or output.”

Here is Piketty being interviewed:

It is important to remember that “national income” can hide a great deal of inequality. Piketty does not dispute this and spends a good deal of time analysing this feature, in particular how inequality in the US is buttressed by the astronomical salaries paid to senior managers in companies that bear no relation to their productivity. “The average national income per capita,” he says, “is simply the amount that one could distribute to each individual if it were possible to equalise the income distribution without altering the total output or national income.”

The trend Piketty has identified is that, in the 21st century, returns on capital are highly likely, in an era of slow growth, to be significantly above the level of economic growth. But an equally discernable trend is for real (adjusted for inflation), median incomes to be significantly below the level of economic growth. Real wages rose in the UK, for example, by 1.5% in the 1990s, while GDP growth registered 2.2%. In the noughties, wages increased by 1.2% in contrast to GDP rising by 1.8%. Between 2010 and 2014, average incomes have fallen by 2.2% just as GDP growth has shown a modest rise of 1.32%. Economic growth is not impressive, it should be said. It is declining, but average incomes are declining by more.

It is not historically inevitable for average incomes to be lower than economic growth. Office for National Statistics data, which I used to compile the statistics above, shows that real wage growth was higher than economic growth in Britain during the 1970s and 1980s.

But the more recent trend is for average incomes to trail economic growth, and this is not confined to the UK. A 2011 report from the UK Resolution Foundation, Painful Separation, demonstrates an extreme “decoupling” of average incomes from the rate of economic growth. Since the 1970s, the report says, median pay has grown at less than half the rate of economic output in the US, Canada and Australia. In Britain, France and Germany, median pay tracked economic growth for a long period, but, in the past decade, has increased by less than half the growth rate. Only in Scandinavia and Japan has the divergence between economic growth and average pay been “mild”, the report concludes.

So why, therefore, isn’t economic inequality going to be much worse than Thomas Piketty claims? His “central thesis” is when the rate of return on capital is greater than the rate of economic growth, inequality will mushroom. But an equally apparent trend in the 21st century is for economic growth, though slowing, to be significantly above average incomes. So inequality is compounded. Piketty has acknowledged only half a problem.

In other ways, too, his analysis appears only partially correct. To be true, Piketty’s equation of r > g, requires growth to be slow. If growth is rapid, as it was in Europe and elsewhere after World War Two, r is not greater than g and inequality does not intensify. And growth, Piketty says, has slowed and will be, he predicts, slow during the rest of the century. The crucial question is why? Piketty’s answer is that, as more and more countries have hit the “technological frontier”, economic growth has run out of steam. Western Europe enjoyed historically very high economic growth in the decades after World War Two, the so-called ‘thirty glorious years, while it caught up, technologically speaking, with the US. Once catch up has occurred, growth naturally slows. Outside Europe, the technological catch up of China and other Asian countries, buttressed economic growth in the 1990s and 2000s.

 To back up what he says, Piketty reproduces the following table on per capita (per head) economic growth:

Per capita growth

The difficulty is that these statistics don’t justify what Piketty is saying. Technological advance is one reason why economic growth is slowing, but it isn’t the whole story. Growth has slowed everywhere. Did Africa, for example, which registers growth of 0.8% from 1980 to 2012 compared to 1.8% from 1950 to 1980, really hit a technological frontier in 1980? And Asian economic growth was actually slightly higher in the decades after World War Two than it has been post-1980, the period when China and South Korea et al, have been playing catch up with the West. Why is that?

The reasons for stuttering growth are hotly debated. Some believe neoliberalism has hit demand so that consumers’ ability to buy goods is inhibited. Others believe that there is less demand for both capital and labour. An interpretation by some Marxists is the rate of profit has steadily fallen, hitting economic growth. But I think it’s clear that you can’t attribute it totally, as Piketty seems to, to technological advance.

But even if you do swallow whole the technological advance argument, then problems still arise. As economies advance, manufacturing is displaced more and more by services. Piketty accepts that services are much less capital intensive than manufacturing. But then what does all the ‘redundant’ capital do? If there is no demand for it investing in manufacturing, won’t finance and speculation be the natural place it will seek a return? Isn’t this a pertinent question for a book about Capital in the 21st Century? One economist has spoken of a ‘wall of money’ incessantly seeking financial returns. But Piketty does not consider the fate of all this excess capital and for a person who is credited with exploring the ‘brutal aftermath of the Great Recession’, it is conspicuous that he doesn’t attempt to explain why the Great Recession occurred in the first place beyond noting that “financial capitalism has ran amok”.

Piketty has provoked the ire of conservatives by pointing out that inequality is largely a result of unearned income not because of individual brilliance, risk-taking or hard graft. But Capital in the 21st Century is not a book to ‘transform our economic discourse’. We are still waiting for that.