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Topic: Economics (Read 53471 times)
Re: Geithner's Government to the rescue!
Reply #300 on:
May 13, 2014, 06:13:06 PM »
"Respect to Geithner for forthrightly stating his hypothesis. Let's discuss it: "
I say he is corrupt and dishonest. Let's discuss it anyway.
"Aggressive government intervention will lead to a stronger financial system less dependent on the taxpayer."
Uh, we don't know that. He is so clairvoyant, yet did not see this coming, could not and did not name the causes, doesn't know the solutions, and could care less about constitutional limits that might have restricted his authority to act.
"there will be shantytowns and soup lines across the country [if he had not acted so boldly]"
- Really? No. Most ordinary investors would still own their home, their portfolio at a lower value. Values might have gone further down and then would have come back just like they did. Why wouldn't they? What stoped the crash in 1987?
"We were in the midst of a classic financial panic"
- Really, what is a "classic" financial panic to someone of Geithner's age, experience or education? "similar to the bank runs in the Great Depression" No, it wasn't similar to the bank runs of the 1930s. There was no bank run. Because of policies he supports, people mostly have no savings in banks.
"The losses suffered on Wall Street seemed welcome and deserved, and of no consequence to the vast majority of Americans." - Because of the politics he supports.
"There was little memory of how panics kill economies, but the panic was already killing ours. American households lost 16% of their wealth in 2008 alone, several times as large as the losses at the start of the Great Depression, during which unemployment rose to 25% and total output fell more than 25%."
- Again, when did panic kill an economy and why did these losses occur? He doesn't know.
"Financial crises are devastating, but unlike threats to national security, Americans don't give their presidents much in the way of emergency authority to fight them."
- He mocks congressional and constitutional limits.
"That reluctance stems from the fear of "moral hazard"—the valid concern that market actors who can expect a bailout in case things go wrong will be encouraged to take too many risks. That same fear typically makes governments, even when they do have the authority, too slow to act."
- He mocks the dangers of establishing moral hazards, while softening with the words: valid concern. It IS a valid concern.
"And so the government had very limited weapons with which to combat the financial crisis of 2008. On "Lehman weekend" (Sept. 13-14), it had no ability, in the absence of a willing buyer, to prevent the investment bank from collapse."
- OMG, not the loss of an investment bank! We have friends there!
"And that's why Presidents Bush and Obama
ask Congress for successive waves of emergency authority."
- He perhaps never raised a kindergardner. We don't say "had to" for what was really "chose to".
Ultimately, Congress provided both presidents with the authority to prevent the collapse of the financial system and get the economy growing again. Yet the actions we took were highly controversial, deeply unpopular on the left and the right, and met by vocal skepticism from academics and the public.
That was partly because
what one has to do in a panic
is the opposite of what seems fair and just. In a financial crisis, the natural instinct is to let creditors suffer losses, let firms fail, and protect taxpayers from any risk of loss. But in a financial panic, a strategy based on those instincts
will lead to depression-level unemployment
Instead, the government and the central bank
step in and take risks on a scale that the private sector can't and won't. They
reduce the incentive for investors, lenders and depositors to run and liquidate assets in panic selling. They
raise the confidence of businesses and individuals that there will not be a systemwide collapse—breaking a vicious cycle in which the fear of a financial-system collapse and a deep recession feed on each other and become self-fulfilling.
- What is the heroic and "creative" thing he did if we
do it all. Where is the evidence that it would all go to zero if investment houses went under. Why were investment houses going under??
Breaking this cycle
a massive injection of cash into the economy, as directly as possible into the hands of those who will spend it, to offset the loss of private earnings and the collapse in private demand. It also
doing whatever it takes to keep the financial system from collapse.
- He refers to the cycle as if he recognizes it, it happens all the time and we know the result if we don't flood it with funny money. How about one example from the past that he learned from?
The banking system is like the power grid; the economy simply can't function if the lights go out and people can't get access to credit.
- Looks like the power grid is another subject he knows nothing about. Power gets re-routed when segment or sector fails. I think what he means is an over-loaded, out of date power grid. They should be proud of their political win, shooting down VP Cheney's grid modernization plan a dozen years ago. Sets up the panic.
In a true financial panic, the moral imperative is to ignore moral hazard and first put out the fire. This is counterintuitive. It feels deeply unfair. And it creates some unfortunate collateral beneficiaries in terms of the firms protected from their mistakes. But
this is the only way
to ultimately protect the innocent victims of the crisis from the calamitous damage of economic depressions.
Because two presidents were willing to put politics aside and deploy a massive and creative rescue,
we prevented economic catastrophe
and got the economy growing again in about six months. We kept the ATMs working, saved the auto industry, fixed the broken credit channels so that the economy could grow, recapitalized the banking system, and restored much of the damage to America's savings.
"The conventional wisdom in early 2009 was that the financial rescue would cost $1-$2 trillion. In fact, the financial system paid for the protection we provided "
- No, we don't know the full damage that was done.
"and taxpayers have already earned tens of billions of dollars in profits on these programs."
- Did I mention up front that he is dishonest?
Herein lies the central paradox: The more aggressive the government is in designing a rescue plan, the easier it is to force more restructuring in the financial sector, and the better the chances of leaving the surviving system stronger and less dependent on the taxpayer.
- Oh Good Grief! Yes there should be crisis management, but as he brags of his power as the head of the NY Fed, all of the leadup to the crisis including the implosion of the financial sector happened under his watch without him ever uttering that he had a clue. Does Geithner know what went wrong leading us into this crisis? What re-structuring did Geithner propose prior? Nothing. What he supported with his "designing a rescue plan" was everything that caused the crisis needing the rescue.
"It is true that we were not able to do all that was important or desirable. The rescue was unorthodox and messy, and the country is still living with the deep scars of the crisis. Long-term unemployment remains alarmingly high. There are very high levels of poverty and appalling inequality, not just in income and wealth, but in the opportunities Americans have for a quality education or economic mobility."
- Bunk. The crisis eased inequality by destroying wealth. The recovery 'worsened' inequality. Education was UNAFFECTED. Concern for inequality and mobility is the opposite of supporting the policies that only bails out the wealthiest and most poliically connected among us.
"But we did
do the essential thing
, which was to
prevent another Great Depression
, with its
decade of shantytowns and bread lines
. We put out the financial fire, not because we wanted to protect the bankers, but because we wanted to prevent mass unemployment.
"we are a stronger country today and in a much stronger position to confront those challenges because America passed its stress test."
- We don't know that.
, he indicates that he knows with such certainty what we
had to do
and exactly how bad it would have been if we hadn't. In fact, the reason both sides acted was because we faced total
certainty about those unknowns. What we do know is that after the fall and recovery we would not be carrying forward this precedent, that there is no real risk taking at the highest and richest levels of this country. With risk taking gone, all that is left is to stomp out the rewards of
"You never let a serious crisis go to waste. And what I mean by that it's an opportunity to do things you think you could not do before." - Rahm Emanuel
What they wanted before the crisis was a bigger, stronger, more powerful government. What they wanted
the crisis was a bigger, stronger, more powerful government. What they wanted
the crisis was a bigger, stronger, more powerful government. Are we sure the crisis had anything to do with the actions they took?
ps. I did not fault the bailouts at the time, but find it sickening to see the disease brag about the cure.
Last Edit: May 13, 2014, 06:21:36 PM by DougMacG
Reply #301 on:
May 13, 2014, 07:56:39 PM »
Excellent discussion Doug!
" I did not fault the bailouts at the time"
What about now? This seems to me to be perhaps THE central question-- what DOES one do in such moments?
Reply #302 on:
May 14, 2014, 10:02:42 PM »
Quote from: Crafty_Dog on May 13, 2014, 07:56:39 PM
" I did not fault the bailouts at the time"
What about now? This seems to me to be perhaps THE central question-- what DOES one do in such moments?
Avoid such moments!
Important questions. I hope others join in.
a) These crises are government policy failures, not market failures. Why didn't the government correct all that it was doing wrong once it finally knew we were headed into a crisis. Instead, when we saw we were bleeding we kept cutting in our open wounds and ordered more and more band-aids.
b) The Federal Reserve and Federal Govt have no business bailing out private businesses and investments selectively, other than those insured by the federal government.
c) I have no idea why the mortgage business is 90+% federal, or why we make any other federal private sector loan or equity guarantees. Partnering up with some businesses and not others violates my sense of equal protection under the law. Now it is the rule rather than the exception.
d) All that said, elections have consequences and we need to put some trust in our leaders to act in our best interests in an emergency, then face the scrutiny of history in the aftermath. Geithner is partly right in the hypothetical: It is possible for there to be a situation where an injection of money or temporary stoppage of trading or other emergency action could conceivably be in the public's best interest, limit the losses, break the momentum and allow sanity creep back into the markets. Was he right in this instance? I have no idea. Nor does he. Should we now pass enabling legislation to grant greater emergency powers, greater bailout powers that go wider, deeper and make money printing and distribution even easier in a crisis? No. We should address the underlying problems and welcome the role of risk, up and down, in all private investments and transactions.
e) Back to point a, this collapse was avoidable. It was set up by multiple years of free interest. We were already in a crisis-rescue pattern, making things far worse, crying wolf. But pre-2008 was not the crisis, it was the bubble. Why weren't interest rates at market rates then? And then why call it market failure? What a cruel irony.The financial collapse was powered by a poorly thought-out federal government policy of bullying federally backed lenders into extending credit based on criteria other than creditworthiness. It was a recipe for disaster.
Last Edit: May 14, 2014, 10:12:11 PM by DougMacG
Reply #303 on:
May 15, 2014, 08:46:47 AM »
Anytime government distorts markets, it creates a future crisis.
Reply #304 on:
May 16, 2014, 12:29:45 AM »
Agreed, BUT what is to be done when one takes office and faces such a fustercluck?
Reply #305 on:
May 16, 2014, 08:03:10 AM »
The longer you kick the can down the road, the worse the reckoning will be. Better to bite the bullet early on. They didn't save us, they made the price much worse by putting it off.
Reply #306 on:
May 16, 2014, 11:12:06 AM »
Forgive the relentless here:
You take office as the inevitable bubble burst occurs. What do you do?
a) Nothing, let the market work it out. What if mass panic does occur? Do you ride it out, , , , or , , ,?
b) you point out the true cause, but grit your teeth and flood the system with money, but do your best that those at fault personally do not get bailed out,?
c) or , , ,?
Reply #307 on:
May 16, 2014, 01:00:44 PM »
A. No one is too big to fail. We shouldn't be picking winners and losers. Let the creative destruction take place.
Reply #308 on:
May 16, 2014, 04:27:48 PM »
Quote from: G M on May 16, 2014, 01:00:44 PM
A. No one is too big to fail. We shouldn't be picking winners and losers. Let the creative destruction take place.
It is unfortunate that a person who rose up as high up as Geithner (Peter Principle) and has no idea that creative destruction is a positive term describing the foundation of growth in a dynamic economy. The thinking behind his book and policy is the opposite - that people (and markets) left to themselves will fail and only the smartest and most clever of elite central planners can save us.
Why would investors let prices fall to zero, if real value remains. What stopped the 1987 crash? The market dropped from over 2700 to 1700s, but did not fall further as investors caught their breath and jumped back in. I remember a big, local investor was on Nightline the night of the crash and calmly said that he intended to be making some buys the next morning as it looked like there were some good values out there. Why should it fall to zero?
The DJIA was positive for the 1987 calendar year...and regained its pre-crash peak in less than years.
If something is fundamentally wrong in the market or in the economy, fix what is fundamentally wrong. Not just plug holes.
May 16, 2014, "Obama to loosen lending standards to boost home ownership."
Reply #309 on:
May 16, 2014, 08:28:27 PM »
As you guys know, I am very big on having sound bite answers as part of the process of persuasion. I'm thinking the reference to the crash of '87 is a good one. A 1000 drop from 2700 is a 37%! Although this point probably won't be enough by itself, it seems to me a useful one as part of a conversation.
Economist on Marx de jour's economics
Reply #310 on:
May 17, 2014, 08:43:52 PM »
Bigger than Marx
A wonky book on inequality becomes a blockbuster
May 3rd 2014 | From the print edition
Making equations cool again
IT IS the closest thing to a pop-culture sensation heavyweight economics will ever provide. “Capital in the Twenty-First Century”, a vast work on the past and future of inequality by Thomas Piketty, a French economist, has become the best-selling title at Amazon.com. In America the online retailer has run out of the 700-page hardcover, which it sells for $25.
“Capital” has many virtues. It is a clear and thorough analysis of one of the foremost economic concerns of the day. It provides readers with a simple explanation for rising inequality. Wealth generally grows faster than the economy, Mr Piketty argues. What is more, there are few economic forces that counteract its natural tendency to become concentrated, as greater wealth brings greater opportunity to save and invest. In the absence of exceptionally rapid growth or a nasty period of geopolitical instability like that between 1914 and 1945, inequality therefore grows.
The book has attracted much criticism, however. The most common complaints fall into four broad categories. The first concerns Mr Piketty’s tone, beginning with the title. A deliberate allusion to Karl Marx’s magnum opus, it suggests both immodesty and an innate antipathy to markets. Some critics object to Mr Piketty’s use of words like “appropriation” to describe the rising share of income going to the rich. Writing in the Wall Street Journal, Daniel Shuchman, a fund manager, fumed at the book’s “medieval hostility to the notion that financial capital earns a return”.
This is not just a matter of presentation. There is no disguising that Mr Piketty is keener on redistribution than many of his critics. Clive Crook, a columnist at Bloomberg (and former deputy editor of The Economist), asks whether the levels of future inequality the book predicts are really as “terrifying” as Mr Piketty claims.
Others find fault with the book’s economics. The statement “r > g” (meaning that the rate of return on capital is generally higher than the rate of economic growth) is central to the book’s argument that wealth tends to accumulate over time. But some complain that r is too mushily defined, especially by comparison with the calculus-strewn pages of much economics research. Writing in Foreign Affairs, Tyler Cowen of George Mason University reckons Mr Piketty sees capital as a “growing, homogeneous blob”, and so fails to take account of the variation, across time and investments, in the returns to wealth.
Happily, “Capital” is not written in economist-ese. There is relatively little mathematics; Mr Piketty uses 19th-century literature to illustrate many of his points. He freely acknowledges that riskier ventures are more lucrative than safer bets like government bonds. But he is less interested in individual investment choices than in the overall growth in value of an economy’s wealth, including everything from industrial machinery to summer homes and art collections. His data suggest that, with the exceptions mentioned, wealth of this sort does tend to grow faster than the economy as a whole. Since 1700, he reckons, wealth globally has enjoyed a typical pre-tax return of between 4% and 5% a year—considerably faster than average economic growth.
Other critics claim that Mr Piketty ignores bedrock principles of economics. Those dictate that the return on capital should fall as it accumulates. The 100th industrial robot does not provide nearly the same boost to production as the first. Kevin Hassett, of the American Enterprise Institute, a free-market think-tank, reckons the return should fall fast enough as wealth builds that the share of income that goes to the owners of capital should not rise (as Mr Piketty suggests it does).
This disagreement is partly a problem of definitions. Capital in Mr Piketty’s book includes forms of wealth, such as land, that would not figure in economists’ models of production; his rate of return is the pace at which such wealth grows rather than the benefit to firms of investing it. Mr Piketty’s data appear to justify this approach: in the past, at least, the rich have been able to shift resources into higher-yielding forms of wealth when over-investment slashes the return. Mr Piketty also argues that the return on capital can be propped up by technology, which could lead to new ways of substituting machines for people.
A third category of criticism focuses on whether Mr Piketty overstates the extent to which the future is likely to resemble the past. Mr Cowen wonders whether r, however defined, is likely to continue to be higher than the rate of economic growth. Writing in the National Review, Jim Pethokoukis predicts that the same excessive pessimism about economies’ capacity for growth that sank Marx’s prophecies would also undermine Mr Piketty’s.
In a similar vein, some critics question the parallel between today’s wealth (which is mostly the product of soaring labour incomes) and that of the “idle rich” of the 19th century, living off inheritance. The long-run relationship between r and g has little to do with the fortunes accumulated by Bill Gates and Jeff Bezos.
Mr Piketty acknowledges the point, but does not let it distract him from his broader emphasis on the long-run returns to wealth. That is not an absurd decision. Some fortunes, like Warren Buffett’s, seem a confirmation of the contention that r is greater than g. Mr Piketty rightly points out that self-made riches may become tomorrow’s family fortune, given the propensity of wealth to perpetuate itself.
The book’s final section, on how policy should respond to rising inequality, has provoked the most disagreement. Mr Piketty’s proposal for a global tax on wealth is widely written off as politically impossible (which he concedes). Critics like Mr Cowen and Greg Mankiw, an economist at Harvard University, argue that his recommendations are motivated by ideology more than economics.
“Capital” does give unduly short shrift to conservative concerns. Mr Piketty glosses over the question of whether attempts to redistribute wealth will weaken growth. He also assumes, rather blithely, that growing inequality leads to instability. Yet that is not always the case: many democracies have managed such challenges without upheaval. Given the mass of data Mr Piketty has assembled, he might profitably have analysed in what circumstances inequality generates conflict. Then again, the success of his book, and the ever-expanding commentary it has provoked, will doubtless inspire others to do so soon.
From the print edition: Finance and economics
Last Edit: May 18, 2014, 12:18:38 PM by Crafty_Dog
Re: Economics, Founder of Brookings, An Honest Liberal on Progressive Taxation
Reply #311 on:
May 19, 2014, 02:16:30 PM »
“Within limits, the system of progressive taxation is defensible and effective.
Beyond a certain point, however, it dulls incentives, and may destroy the principal source of funds for new enterprises involving exceptional risks
–Harold G. Moulton, founder of the (liberal) Brookings Institution, Controlling Factors in Economic Development, The Brookings Institution, 1949, p. 292.
Economics: Of Course 70% Tax Rates Are Counterproductive!
Reply #312 on:
May 19, 2014, 02:57:15 PM »
Alan Reynolds was debating and refuting Piketty long before political Washington had heard of him. This is from 2 years ago and gives a good prebuttal to the sloppy methodology that Thomas Piketty uses to evaluate his own reckless proposals. Piketty and others use an ETI (elasticity of taxable income) of 0.2 for what Reynolds believes ought to be 1.3 or higher. In other words, if you tax 'taxable income' at 70%, 75% or 83% as proposed, how much LESS taxable income will top earners earn and report? Remember, the highest earners have the greatest ability to move, change or reduce their taxable income.
Sure enough, France added a 75% tax bracket in 2013 as one more burden on its feeble (plowhorse) economy.
"French budget misses target on
lower tax revenues" Who knew?
"lower corporate tax revenues and lower income revenues, while revenues from the value-added tax (a regressive tax) were actually up"
Reynolds 2012: "If anyone still imagines the proposed "socially optimal" tax rates of 73%-83% on the top 1% would raise revenues and have no effect on economic growth, what about that 100% rate?"
Of Course 70% Tax Rates Are Counterproductive
Some scholars argue that top rates can be raised drastically with no loss of revenue. Their arguments are flawed.
By ALAN REYNOLDS
May 7, 2012 7:25 p.m. ET
President Obama and others are demanding that we raise taxes on the "rich," and two recent academic papers that have gotten a lot of attention claim to show that there will be no ill effects if we do.
The first paper, by Peter Diamond of MIT and Emmanuel Saez of the University of California, Berkeley, appeared in the Journal of Economic Perspectives last August. The second, by Mr. Saez, along with Thomas Piketty of the Paris School of Economics and Stefanie Stantcheva of MIT, was published by the National Bureau of Economic Research three months later. Both suggested that federal tax revenues would not decline even if the rate on the top 1% of earners were raised to 73%-83%.
Can the apex of the Laffer Curve—which shows that the revenue-maximizing tax rate is not the highest possible tax rate—really be that high?
The authors arrive at their conclusion through an unusual calculation of the "elasticity" (responsiveness) of taxable income to changes in marginal tax rates. According to a formula devised by Mr. Saez, if the elasticity is 1.0, the revenue-maximizing top tax rate would be 40% including state and Medicare taxes. That means the elasticity of taxable income (ETI) would have to be an unbelievably low 0.2 to 0.25 if the revenue-maximizing top tax rates were 73%-83% for the top 1%. The authors of both papers reach this conclusion with creative, if wholly unpersuasive, statistical arguments.
Most of the older elasticity estimates are for all taxpayers, regardless of income. Thus a recent survey of 30 studies by the Canadian Department of Finance found that "The central ETI estimate in the international empirical literature is about 0.40."
But the ETI for all taxpayers is going to be lower than for higher-income earners, simply because people with modest incomes and modest taxes are not willing or able to vary their income much in response to small tax changes. So the real question is the ETI of the top 1%.
Harvard's Raj Chetty observed in 2009 that "The empirical literature on the taxable income elasticity has generally found that elasticities are large (0.5 to 1.5) for individuals in the top percentile of the income distribution." In that same year, Treasury Department economist Bradley Heim estimated that the ETI is 1.2 for incomes above $500,000 (the top 1% today starts around $350,000).
A 2010 study by Anthony Atkinson (Oxford) and Andrew Leigh (Australian National University) about changes in tax rates on the top 1% in five Anglo-Saxon countries came up with an ETI of 1.2 to 1.6. In a 2000 book edited by University of Michigan economist Joel Slemrod ("Does Atlas Shrug?"), Robert A. Moffitt (Johns Hopkins) and Mark Wilhelm (Indiana) estimated an elasticity of 1.76 to 1.99 for gross income. And at the bottom of the range, Mr. Saez in 2004 estimated an elasticity of 0.62 for gross income for the top 1%.
A midpoint between the estimates would be an elasticity for gross income of 1.3 for the top 1%, and presumably an even higher elasticity for taxable income (since taxpayers can claim larger deductions if tax rates go up.)
But let's stick with an ETI of 1.3 for the top 1%. This implies that the revenue-maximizing top marginal rate would be 33.9% for all taxes, and below 27% for the federal income tax.
To avoid reaching that conclusion, Messrs. Diamond and Saez's 2011 paper ignores all studies of elasticity among the top 1%, and instead chooses a midpoint of 0.25 between one uniquely low estimate of 0.12 for gross income among all taxpayers (from a 2004 study by Mr. Saez and Jonathan Gruber of MIT) and the 0.40 ETI norm from 30 other studies.
That made-up estimate of 0.25 is the sole basis for the claim by Messrs. Diamond and Saez in their 2011 paper that tax rates could reach 73% without losing revenue.
The Saez-Piketty-Stantcheva paper does not confound a lowball estimate for all taxpayers with a midpoint estimate for the top 1%. On the contrary, the authors say that "the long-run total elasticity of top incomes with respect to the net-of-tax rate is large."
Nevertheless, to cut this "large" elasticity down, the authors begin by combining the U.S. with 17 other affluent economies, telling us that elasticity estimates for top incomes are lower for Europe and Japan. The resulting mélange—an 18-country "overall elasticity of around 0.5"—has zero relevance to U.S. tax policy.
Still, it is twice as large as the ETI of Messrs. Diamond and Saez, so the three authors appear compelled to further pare their 0.5 estimate down to 0.2 in order to predict a "socially optimal" top tax rate of 83%. Using "admittedly only suggestive" evidence, they assert that only 0.2 of their 0.5 ETI can be attributed to real supply-side responses to changes in tax rates.
The other three-fifths of ETI can just be ignored, according to Messrs. Saez and Piketty, and Ms. Stantcheva, because it is the result of, among other factors, easily-plugged tax loopholes resulting from lower rates on corporations and capital gains.
Plugging these so-called loopholes, they say, requires "aligning the tax rates on realized capital gains with those on ordinary income" and enacting "neutrality in the effective tax rates across organizational forms." In plain English: Tax rates on U.S. corporate profits, dividends and capital gains must also be 83%.
This raises another question: At that level, would there be any profits, capital gains or top incomes left to tax?
"The optimal top tax," the three authors also say, "actually goes to 100% if the real supply-side elasticity is very small." If anyone still imagines the proposed "socially optimal" tax rates of 73%-83% on the top 1% would raise revenues and have no effect on economic growth, what about that 100% rate?
Mr. Reynolds is a senior fellow with the Cato Institute and the author of "Income and Wealth" (Greenwood Press, 2006).
Reply #313 on:
May 20, 2014, 01:46:51 AM »
Alan Reynolds is a very good economist. He has my respect.
Reply #314 on:
May 25, 2014, 11:25:03 AM »
More on why Piketty is wrong
Reply #315 on:
May 29, 2014, 06:32:31 AM »
The point made herein about the Reagan tax cuts appearing to concentrate wealth by causing more money to allow itself to be exposed to taxes is one I have made a number of times on this forum-- probably in the Taxes thread.
Re: More on why Piketty is wrong
Reply #316 on:
May 29, 2014, 09:27:42 AM »
Quote from: Crafty_Dog on May 29, 2014, 06:32:31 AM
The point made herein about the Reagan tax cuts appearing to concentrate wealth by causing more money to allow itself to be exposed to taxes is one I have made a number of times on this forum-- probably in the Taxes thread.
Thank you to Crafty and GM for continuing coverage on the flaws of Piketty. It turns out his data is wrong and deceptive, his analysis of the false data is flawed, and his prescription for a 'solution' is pure nonsense. Yet he became a far-left sensation before his book was read. (shocking)
If the rate of return on investments is greater than the growth rate in the economy and that is perceived to be a problem on a par with climate change(!), why not pursue policies that accelerate the growth rate instead of pursuing policies that destroy job-supporting investment?
Wesbury's analysis of the cause of 2008
Reply #317 on:
May 29, 2014, 10:49:10 AM »
Explaining what caused 2008 is a matter of great importance; the currently dominant meme is both wrong and hostile to a belief in the free market.
Here is Wesbury's analysis:
If correct, it could be very helpful to our cause. Is it?
In response, my very savvy friend Rick writes:
Nothing was changed. FASB simply clarified the rule a second time. Read the excerpt below.
The new FASB rules could help boost banks' earnings by making it clear that institutions can account for mortgage-backed securities and other assets based on their internal estimates of cash flow and other factors, rather than relying on sales prices in largely inactive markets. But observers such as Larsen note that the latest guidelines only confirm what careful readers of the FASB's fair value rules have known all along, that fire sales aren't meant to be the main determinant of value.
Thus, if the banks have been following the rules as intended all along, there could be little effect on the earnings. (emphasis added)
The FASB, which sets the guidelines under the aegis of the Securities and Exchange Commission, on Thursday also tweaked the rules for how banks may account for securities such as bonds that aren't expected to be repaid in full, but whose market value has been depressed as markets have grown less liquid.
Under the new rules, these so-called "other-than-temporary" impairments will be divided into two buckets, one that reflects the expected credit losses tied to a security and another that accounts for other declines in value, which may be tied to market uncertainty.
Inequality - from transactions of mutual benefit
Reply #318 on:
June 03, 2014, 02:58:39 PM »
The Little Miracle Spurring Inequality
Extreme leaps in innovation, like the invention of the microprocessor, bring with them staggering fortunes.
By JOHN STEELE GORDON WSJ
Updated June 2, 2014 7:35 p.m. ET
Judging by the Forbes 400 list, the richest people in America have been getting richer very quickly. In 1982, the first year of the list, there were only 13 billionaires on it. A net worth of $75 million was enough to earn a spot. The 2013 list has nothing but billionaires, with $1.3 billion as the cutoff. Sixty-one American billionaires aren't rich enough to make the list.
Many regard this as a serious problem, seeing the development of a plutocracy dominating the American economy through the sheer power of its wealth. The French economist Thomas Piketty, in his new book "Capital in the 21st Century," calls for an 80% tax on incomes over $250,000 and a 2% annual tax on net worth in order to prevent an excessive concentration of wealth.
That is a monumentally bad idea.
The great growth of fortunes in recent decades is not a sinister development. Instead it is simply the inevitable result of an extraordinary technological innovation, the microprocessor, which Intel brought to market in 1971. Seven of the 10 largest fortunes in America today were built on this technology, as have been countless smaller ones. These new fortunes unavoidably result in wealth being more concentrated at the top.
But no one is poorer because Bill Gates, Larry Ellison, et al., are so much richer. These new fortunes came into existence only because the public wanted the products and services—and lower prices—that the microprocessor made possible. Anyone who has found his way home thanks to a GPS device or has contacted a child thanks to a cellphone appreciates the awesome power of the microprocessor. All of our lives have been enhanced and enriched by the technology.
This sort of social transformation has happened many times before. Whenever a new technology comes along that greatly reduces the cost of a fundamental input to the economy, or makes possible what had previously been impossible, there has always been a flowering of great new fortunes—often far larger than those that came before. The technology opens up many new economic niches, and entrepreneurs rush to take advantage of the new opportunities.
The full-rigged ship that Europeans developed in the 15th century, for instance, was capable of reaching the far corners of the globe. Soon gold and silver were pouring into Europe from the New World, and a brisk trade with India and the East Indies sprang up. The Dutch exploited the new trade so successfully that the historian Simon Schama entitled his 1987 book on this period of Dutch history "The Embarrassment of Riches."
Or consider work-doing energy. Before James Watt's rotary steam engine, patented in 1781, only human and animal muscles, water mills and windmills could supply power. But with Watt's engine it was suddenly possible to input vast amounts of very-low-cost energy into the economy. Combined with the factory system of production, the steam engine sparked the Industrial Revolution, causing growth—and thus wealth as well as job creation—to sharply accelerate.
By the 1820s so many new fortunes were piling up that the English social critic John Sterling was writing, "Wealth! Wealth! Wealth! Praise to the God of the 19th century! The Golden Idol! The mighty Mammon!" In 1826 the young Benjamin Disraeli coined the word millionaire to denote the holders of these new industrial fortunes.
Transportation is another fundamental input. But before the railroad, moving goods overland was extremely, and often prohibitively, expensive. The railroad made it cheap. Such fortunes as those of the railroad-owning Vanderbilts, Goulds and Harrimans became legendary for their size.
The railroad also made possible many great fortunes that had nothing, directly, to do with railroads at all. The railroads made national markets possible and thus huge economies of scale—to the benefit of everyone at every income level. Many merchandising fortunes, such as F.W. Woolworth's five-and-dime, could not have happened without the cheap and quick transportation of goods.
Many of the new fortunes in America's Gilded Age in the late 19th century were based on petroleum, by then inexpensive and abundant thanks to Edwin Drake's drilling technique. Steel, suddenly made cheap thanks to the Bessemer converter, could now have a thousand new uses. Oil and steel, taken together, made the automobile possible. That produced still more great fortunes, not only in car manufacturing, but also in rubber, glass, highway construction and such ancillary industries.
Today the microprocessor, the most fundamental new technology since the steam engine, is transforming the world before our astonished eyes and inevitably creating huge new fortunes in the process.
To see how fundamental the microprocessor—a dirt-cheap computer on a chip—is, do a thought experiment. Imagine it's 1970 and someone pushes a button causing every computer in the world to stop working. The average man on the street won't have noticed anything amiss until his bank statement failed to come in at the end of the month. Push that button today and civilization collapses in seconds. Cars don't run, phones don't work, the lights go out, planes can't land or take off. That is all because the microprocessor is now found in nearly everything more complex than a pencil.
The number of new economic niches created by cheap computing power is nearly limitless. Opportunities in software and hardware over the past 30 years have produced many billionaires—but they're not all in Silicon Valley. The Walton family collectively is worth, according to Forbes, $144.7 billion, thanks to the world's largest retail business. But Wal-Mart couldn't exist without the precise inventory controls that the microprocessor makes possible.
The "income disparity" between the Waltons and the patrons of their stores is as pronounced as critics complain, but then again the lives of countless millions of Wal-Mart shoppers have been materially enriched by the stores' staggering array of affordable goods.
Just as the railroad, the most important secondary technology of the steam engine, produced many new fortunes, the Internet is producing enormous numbers of them, from the likes of Amazon, Facebook and Twitter. When Twitter went public last November, it created about 1,600 newly minted millionaires.
Any attempt to tax away new fortunes in the name of preventing inequality is certain to have adverse effects on further technology creation and niche exploitation by entrepreneurs—and harm job creation as a result. The reason is one of the laws of economics: Potential reward must equal the risk or the risk won't be taken.
And the risks in any new technology are very real in the highly competitive game that is capitalism. In 1903, 57 automobile companies opened for business in this country, hoping to exploit the new technology. Only the Ford Motor Co. survived the Darwinian struggle to succeed. As Henry Ford's fortune grew to dazzling levels, some might have decried it, but they also should have rejoiced as he made the automobile affordable for everyman.
Mr. Gordon is the author of "An Empire of Wealth: The Epic History of American Economic Power" (HarperCollins, 2004).
Returns on capital and labor
Reply #319 on:
June 15, 2014, 02:43:02 PM »
New Report Predicts Strong Bullish Move
by Mitch Zacks, Senior Portfolio Manager
For some time I have been calling for a market correction. This is nothing to fear. Corrections entail sell-offs of 10% or more in the S&P 500 over a couple of months, and are necessary to prevent asset bubbles.
In previous commentaries, I have expressed my concern that the market cap of the publicly traded companies in the U.S. relative to GDP is too high given historical levels of the ratio. I am still bothered that the majority of corporate earnings growth has materialized from cost savings due to margin expansion, and that this may not be sustainable without organic corporate revenue growth.
Additionally, the majority of gains in the S&P 500 over the past year materialized from P/E expansion rather than earnings growth and the P/E multiple of the market can only go so high.
At the same time, I have been indicating that bull markets rarely end at average P/E levels and the level of speculative fervor you find near the tail end of a bull market simply is not yet present.
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There remains a wall-of-worry for the market to climb based on the low growth economic recovery. Additionally, interest rates are incredibly low which is pumping up market valuations, and the European central bank is becoming more accommodative with its monetary policy.
The Bull Case for This Market
None other than Larry Summers, the former Secretary of the Treasury, advanced the Bull Case for the stock market to defy those calling for a correction. He predicts it will continue to head substantially higher. Summers' bull-market case is fascinating.
His thesis is that the economy has structurally changed. This change is basically that capital and labor are no longer complementary.
In the past, to produce goods you needed people, and people needed machines to produce goods. If you were running an automobile factory in the 1950's, you needed assembly line workers plus the machines or capital that were used by the people.
What Larry Summers is proposing is that, starting in the late 90's, capital began to be not a complement but a substitute for labor. Essentially, the automobile factory no longer needs the same ratio of people to machines. Effectively, the people making the cars can be replaced with technology.
An Accelerating Trend
More and more, technology is serving as a substitute for labor. Think of all the travel agents that were replaced by the Internet. What about the book store clerks whose jobs were destroyed by Amazon, or the newspaper delivery boys being put out of business by iPhones?
The argument goes that because technology is substituting for labor, an increase in labor productivity will not cause an increase in wages. In the past, greater capital meant higher productivity which leads to more jobs and higher wages. What Larry Summers is saying is that increased demand for technology is actually lowering demand for labor.
Where Is the Money Going?
This is causing the aggregate share of labor income to decline and the share of capital to rise. From a common sense perspective, if capital is a substitute for labor the economic pie is going to go more and more to those that own the capital and less to those that own the labor. This is the explanation for the growing amount of income inequality in the world. People are being replaced by technology and the capitalists are taking greater and greater gains from economic growth.
The result is that the jobs in most demand are ( 1 ) very low-wage jobs like barbers that are not easily replaced by technology, or ( 2 ) very high-wage positions that require extensive analytical abilities that are also hard to replace with machines. Retail clerks, assembly line workers, travel agents, and even low-level legal workers are all being replaced by technology. Meanwhile, high-level corporate managers who direct complex operations are seeing their wages increase.
Big Advantage for the Stock Market
This disruption is extremely positive for publicly traded corporations. We would expect to see higher profit margins in aggregate as a result of low wage growth and this is exactly what we are witnessing.
Twenty years ago, the largest publicly traded companies in the U.S. employed far more people. Google, Microsoft, and Facebook simply do not need the same number of workers as US Steel and General Motors required. In fact, the size of corporations in terms of employees has been declining over time. Even manufacturing and energy companies are employing fewer people and more and more technology.
If this shift from capital being a complement to labor to becoming a replacement for labor is truly here, the effect will be twofold:
First and foremost, interest rates will remain much lower for a longer time than anyone is currently anticipating. With capital replacing labor, wages remain under pressure. As I have said many times, there has never been a period of price inflation that has not been accompanied by a period of wage inflation.
Second, and most important to investors, the stock market should go much higher than what people, including me are anticipating. If technological advances are causing capital to get a greater percentage of the economic pie than it used to, the best course of action is to own the capital. In other words, invest in the stock market.
Then when you combine the structural shift in the economy with the way globalization is increasing the labor supply, and factor in the decline of labor unions, we are looking at a prolonged period of stagnant wage growth.
Our current outlook for the market might actually be somewhat conservative if the trend of wages not increasing continues to persist. Click here for free Zacks' June Outlook.
What Do I Think of This?
Well, an old saw of wisdom is that when people start saying that "This time it is different," they are usually mistaken. The theory that capital and technology are becoming substitutes for labor is a well thought out, if not brilliant argument. It explains why interest rates are globally low, profit margins are high, wages are stagnant, inflation is benign, inequality is rising, and yet the market keeps heading higher and the P/E multiple keeps expanding. The theory explains the data, but brilliant theories usually do.
However, I tend to feel that the more things change the more they stay the same especially with regard to the equity market. This time around nothing is different.
Wages will eventually go up, inflation will return, interest rates will rise and the market will appreciate not at an accelerated rate but at its historical rate of 6% above the risk-free interest rates.
Summers' argument is very powerful, but it is simply a brilliant way of saying "This time things are different."
So What Should You Do?
A market correction, unfortunately, is not out of the cards. Corrections will materialize and the best course of action, as always, will be to continue to hold equities even when interest rates begin to rise.
If you want the Zacks point of view on what is going to happen with the market moving forward, you are welcome to download our June Market Outlook.
This intelligence has been reserved for our private clients but today I am opening it up to you for free. Now you can see our latest, detailed predictions on GDP growth, inflation's next trend, where the market's headed through 2014 and 2015, and more.
Click to download Zacks' June Market Outlook Free
About Mitch Zacks
Mitch is a Senior Portfolio Manager at Zacks Investment Management. He wrote a weekly column for the Chicago Sun-Times and has published two books on quantitative investment strategies. He has a B.A. in Economics from Yale University and an M.B.A. in Analytic Finance from the University of Chicago.
Mitch also is a Portfolio Manager for the Zacks Small Cap Core Fund ( ZSCCX ).
And a response:
Reply #320 on:
June 15, 2014, 02:52:10 PM »
As usual, Larry Summers is talking like an economically illiterate person. "... capital and labor are no longer complementary ..."??
Ignorant people have been talking like this for a very long time -- every time that some capital investment has displaced labor. It's certainly true that digital technology has ramped up these effects, but it is still the same issue.
Meanwhile, almost all of this gibberish is just plain wrong. Money is not capital. A society's stock of capital is the physical and intellectual "goods" that enable the production of consumer goods. Nobody wants capital goods for their own sake; all production is for the purpose of producing more consumer goods, less expensively. Capital has value only to the extent that some entrepreneur thinks it has value. And an entrepreneur won't buy or produce capital goods unless he believes those goods can be employed to produce something that consumers (or entrepreneurs closer to the consumer) will buy for more than his costs.
Now it's true that capital goods allow the production of consumer goods with less labor than before, but capital and labor will always be complementary. At a minimum there must be an entrepreneur who visualizes how the available (or newly created) capital goods can be combined to produce valued consumer goods -- and it is pretty ridiculous to think that we are going to have successful firms with only one person working to apply the capital goods to the problem at hand. Those firms that do hold employment to very low numbers are invariably "outsourcing" a lot of work -- and people are always a necessary ingredient.
But you are correct when you say
"It could be argued that without the deficit spending - and redistribution of 'borrowed' funds to consumers over the past several years - many of today's great businesses would be broke."
Yes indeed, many government activities have distorted the market economy in ways that have caused entrepreneurs to launch capital goods projects that would not currently be profitable on unfettered markets. The Austrian School economists call this "malinvestment." Bad investments can be caused by central bank policies and various other government actions. Tesla, for example, could never produce a profit if it were not for the various "green" energy subsidies -- and without zero interest rate policies. In general, it's safe to say that much of the extreme applications of labor saving technology has been driven by cheap money and regulations in minimum wage, medical insurance, and others that make labor too expensive.
As for all of this being an argument in favor of higher nominal stock prices ... I don't see it. Capital goods have value only to the extent that they increase the production of valuable consumer goods and services. But as the stock of consumer goods rises, nominal prices for units of goods will normally fall -- unless there is monetary inflation. Furthermore, this environment of rampant technological advances produces more and more firms. How can all of their stock prices be rising? The total value of capital cannot exceed the value of consumer goods production, and that value is dictated by the prices consumers can and do pay for the consumer goods.
The author of the posted article, Zacks, says that
"I have expressed my concern that the market cap of the publicly traded companies in the U.S. relative to GDP is too high given historical levels of the ratio."
To this I would say "no kidding!" Below is a chart produced by that pariah John Hussman.
In this chart Hussman correlates Market cap/GDP to subsequent ten year nominal S&P 500 returns -- and includes the actual ten year returns (in red) for comparison. You might notice that the projected return for previous market highs turned out to be a bit optimistic. When people talk about current valuations being less extreme than they were in 2000, you have to consider that the ten year result from 2000 was a negative S&P 500 return. Is that the Wall Street goal once again?
Reply #321 on:
June 16, 2014, 08:41:12 AM »
Yes the Larry Summers view certainly is misguided, if accurately quoted and portrayed. And the response posted is right on the money and worth reading more than once.
If not Summers, it could be said about almost any leftist politician, they think the laws and forces of economics and human spirit don't apply to their failed ideas.
I have said often, capital employs labor. And a greater investment in capital makes labor more productive resulting in higher pay. The responder says money is not capital and is right, but when money becomes capital, it employs labor.
Without capital, no one gets employed. Poor people don't employ anyone. Poor economies with anti-business, anti-employment, anti-economic freedom rules and customs employ no one at a good wage. Wealthy people who have had it with business and investment and keep their money on the sidelines employ almost no one compared with the when they were risking their capital and building their businesses.
Capital is a substitute for Labor? What bunk!
Let's take a simple example. Our business digs ditches or moves earth for building foundations. Our capital is in shovels and we employ a few laborers. Over time, our business or at least the industry if invested with capital now owns giant diesel powered powered products from Cummins and Caterpillar and we now can dig with one person in one machine what used to take a thousand people to do. By Summers math, or Obama, etc. that productivity gain just put 999 workers out of work. Same as the Obama argument that the ATM (which hit the market in the 1970s) is costing us jobs. That argument is wrong in so many ways. Innovation improves and grows jobs. If yo9u can't see that intuitively, you can easily see it empirically.
We could analyze the math and see that jobs grew at the machinery companies and supply chains etc. and trace and calculate all of that. The biggest advancement though is that much larger jobs are now possible. A guy holding a shovel is displaced, but if he also responds to the changes in a dynamic world, he moves quickly from that to bettering himself. When we remove all incentives, responsibilities and consequences, likely he doesn't.
More simple is to understand that the dynamic economy that fosters innovation will grow and prosper and an economy burdened with rules slowing and stopping change does not. Economic success includes monetary prosperity but also is tied to things like health, education, environment and longevity.
Economies that innovate, prosper. Nothing unleashes human innovation like a private, freedom based risk capital system. Look around the world. Look through human history. Compare the Heritage Freedom indices with the results the leading countries are attaining. Yet we keep hearing every argument in politics that pulls in the opposite direction. Capital is no longer tied to jobs, good grief!
If leftist lived by the rules they impose on the private sector, they would be forced to disclose the harm they inflict with their policies and get sued for the damages.
Economics, Jonah Goldberg: Mr. Piketty's Big Book of Marxiness
Reply #322 on:
June 27, 2014, 10:09:43 AM »
A long, thoughtful takedown and deconstruction of Piketty's twisted book aagainst capital, by Jonah Goldberg in Commentary Magazine, June 2014:
With the quick slide in sales of Hillary's travel notes, maybe we can get back to real issues! Excerpted here, read it all at the link.
One: Piketty’s Charge
...It remains to be seen what history will make of Thomas Piketty’s Capital in the Twenty-First Century, which was released in America in April. But it was so perfectly timed that it joined the ranks of those lightning-in-a-bottle books even before its publication. Piketty purports to offer a “general theory of capitalism,” in the words of the economist Tyler Cowen. His theory is that capitalism inherently leads to ever-widening income inequality that can be addressed only through heavy taxes on accumulated wealth. In December 2013, President Obama prepared the intellectual battlefield for Piketty by declaring that income inequality was now “the defining challenge of our time.” As the enormous and dense tome finally settled in at the top of the charts, Hillary Clinton previewed a presidential campaign stump speech of sorts, which largely focused on Piketty’s core theme: inequality. Even the pope got in on the act. Adding a religious dimension to Piketty’s theories on Twitter, he declared in late April that “inequality is the root of social evil” and called for “the legitimate redistribution of economic benefits by the State.”
According to Boris Kachka of New York magazine, “One hundred and eighty years after Alexis de Tocqueville came back to France with the news that he’d found true égalité in America, his countryman has arrived on our shores to deliver the opposite news.”
Taken literally, the comparison between the two writers is ridiculous.
...Capital in the Twenty-First Century is the artillery shell his supporters have long been waiting for to begin the war against “economic inequality.”
Two: Piketty’s Claim
Piketty’s overarching argument is that Karl Marx was essentially correct when he identified what might be called the original sin of capitalism: the problem of “infinite accumulation.” This is the idea that the rich get richer and the poor get poorer. According to Piketty, it’s what happened when capitalism was left to its own devices at the end of the 19th century, and it’s what is about to happen in the United States and Europe in the 21st. There was, he says, a brief flattening-out of inequality in the middle of the 20th century, thanks to the devastation of two world wars, which destroyed enormous amounts of wealth and fueled huge spikes in taxation. But otherwise the story has remained the same.
Do the dynamics of private capital accumulation inevitably lead to the concentration of wealth in ever fewer hands, as Karl Marx believed in the nineteenth century? Or do the balancing forces of growth, competition, and technological progress lead in later stages of development to reduced inequality and greater harmony among the classes…?
Given this either/or, Piketty essentially sides with Marx. I say “essentially” because there is much bickering about whether it is fair or right to call Piketty a Marxist. Paul Krugman, for instance, finds the idea ridiculous, despite the fact that the very title of the book is an homage to Marx’s Das Kapital and that Piketty says Marx asked the right questions even if some of his answers had “limitations.” Piketty himself rejects the Marxist label, presents his arguments in neoclassical terms, and describes himself as a social democrat.
Others have called Piketty’s approach “soft Marxism.” But with apologies to Stephen Colbert, I’d call it “Marxiness.” Piketty attempts to avoid Marx’s scientistic messianism by proffering caveats like “one should be wary of economic determinism.” Yes, one should. But Piketty has a grating habit of offering seemingly deflating qualifiers and “to be sures” only to proceed—à la an unreconstructed Marxist—to argue as if science and objective truth are unquestionably on his side.
He concludes that the problem with capitalism is that “there is no natural, spontaneous process to prevent destabilizing, inegalitarian forces from prevailing permanently.” Rather, capitalism is structurally (or objectively, as the old Marxists might say) inegalitarian. It is a rigged casino where the winners not only keep winning but don’t deserve their chips in the first place.
His proof comes in the form of r > g, already the most famous mathematical formula since E=MC2. R is the rate of return on capital (investments, interest on savings, rent from land). G is the growth rate of the broader economy. The problem, according to Piketty, is that the rate of return on capital is greater than the growth of the broader economy. He postulates that if capital grows faster than national income, specifically income earned through wages, over time the capitalists will come to own everything unless something stops that from happening.
Piketty dismisses the claim that the free market self-corrects. He essentially rejects the belief that the law of diminishing returns applies to capital. Most economists hold that if there’s too much capital chasing too few opportunities for investment, the return on capital will inevitably drop. Such corrections, in his view, are fleeting shifts in the current of an ever-rising tide of inequality. And even when they occur, they don’t amount to much:
Never mind that such adjustments might be unpleasant or complicated; they might also take decades, during which landlords and oil well owners might accumulate claims on the rest of the population so extensive that they could easily own everything that can be owned, including rural real estate and bicycles, once and for all. As always, the worst is never certain to arrive. It is much too soon to warn readers that by 2050 they may be paying rent to the emir of Qatar.
Piketty asserts that the return on capital (the r in r > g) holds steady at about 5 percent over time. This means that once you’re rich, you keep getting richer thanks to the miracle of compound interest. Inherited wealth, or old money, expands forever—or, as Piketty puts it in a memorable line, “the past devours the future.”
Piketty’s occasional concessions to uncertainty about his most dire predictions illustrate one reason he shouldn’t be considered an orthodox Marxist. He has no grand Hegelian theory of the ineluctable progression of History with a capital H. But who needs dialectical materialism when you have algebra?
Indeed, his primary claim to originality comes from a statistical tendency he discerns through masses of data, according to which the free market yields a society in which the rich not only get richer but get richer faster than everyone else and ultimately leave the poor behind. This is, he says, the “central contradiction of capitalism.” He goes on:
Once constituted, capital reproduces itself faster than output increases. The past devours the future. The consequences for the long-term dynamics of the wealth distribution are potentially terrifying, especially when one adds that the divergence in wealth distribution is occurring on a global scale.
According to Piketty, we are not only returning to levels of income inequality not seen since the 19th century. We are also looking at a potentially eternal future where the overclass rules at the expense of the ever-growing underclasses. It’s economic Morlocks versus Eloi all the way down.
Matters would appear to be hopeless. But not to worry. Piketty has hope. What gives him hope, and what excites so many of his fans, is that this central contradiction of capitalism can be overpowered by the state.
His key proposal is what he calls a “global wealth tax” of 5 to 10 percent off the top for billionaires, 2 percent for people worth 5 million euros or more, and 1 percent for millionaires below that. He also advocates a top marginal tax rate of 80 percent. And that ain’t the half of it—literally. It’s more like less than a quarter of it. “If one follows Piketty in assuming a normal return on capital of 4 percent for the 21st century,” Stefan Homburg of the University of Leibnitz has written, “a 10 percent tax on wealth is equivalent to a 250 percent tax on the resulting capital income. Combined with the 80 percent income tax, taxpayers would face effective tax rates of up to 330 percent.”
How and by whom this money would be collected is kept rather vague, in part because even Piketty concedes that this proposal is “utopian.” More interesting, he is not especially concerned about what to do with these revenues. Leveling the gap between the rich and the rest of us is a much larger priority for him than lifting up the poor. “Confiscatory tax rates on incomes deemed to be indecent” are worthwhile in their own right, he says. Such rates, which reached 90 percent in the United States at one point, were an “impressive U.S. innovation of the interwar years.” He says this even though he concedes that a high marginal tax rate on extremely high incomes actually “brings in almost nothing” (because the rich would simply stop taking proceeds in taxable form). He does concede in a wonderful understatement at the end of the book that “before we can learn to efficiently organize public financing equivalent to two-thirds to three-quarters of national income”—what his desired tax rates would amount to—“it would be good to improve the organization and operation of the existing public sector.” There’s a useful insight.
His comfort with punitive taxation is reminiscent of Barack Obama’s response in 2008 when asked if he would support a higher tax on capital gains even if he knew it would bring in less revenue. Obama answered that he would still favor raising such taxes for “purposes of fairness.” In short, some people don’t deserve the money they have, and the government should take it from them.
Three: Piketty’s Data
The general consensus even from very critical economists—and there are many—is that Piketty and his colleagues (chiefly his frequent writing partner, Berkeley economist Emmanuel Saez) have masterfully collected an amazing amount of data that describe some very interesting trends over the past 300 years. They have made massive databases with information culled from tax returns, estate records, and virtually every other source they could find. They plausibly argue that such records are more valuable and accurate than conventional surveys because the sample size of responses from the wealthiest individuals are simply too small to give a clear picture of inequality. Capital in the Twenty-First Century is largely a repackaging of that work. But for Piketty and his fans, it amounts to nothing less than the spread of the Big Data revolution to economic history. Maybe so. But his analysis of those data is far more controversial.
One reason for the controversy is that Piketty oversimplifies the concept of capital. He depicts it “as a growing, homogeneous blob which, at least under peaceful conditions, ends up overshadowing other economic variables,” in the words of economist Tyler Cowen. But different kinds of capital have different rates of return. Right now Treasury bills yield barely better than a 1 percent return, while equities historically have a return of about 7 percent. As Cowen notes in an essay for Foreign Affairs, this alone reveals a certain blind spot in Piketty’s analysis: the hugely significant role of risk-taking in a free-market economy.
The most common and strongest complaint is that Piketty’s arrangement of the data paints a false picture of rising inequality in the United States. Harvard’s Martin Feldstein noted in the Wall Street Journal that Piketty fails to take into account important—albeit arcane—changes in the tax code that have caused business income to be counted on personal tax returns. “This transformation occurred gradually over many years as taxpayers changed their behavior and their accounting practices to reflect the new rules,” Feldstein writes. As an example, “the business income of Subchapter S corporations alone rose from $500 billion in 1986 to $1.8 trillion by 1992.” This leads Feldstein to conclude that Piketty “creates the false impression of a sharp rise in the incomes of high-income taxpayers even though there was only a change in the legal form of that income.”
Feldstein and Scott Winship, of the Manhattan Institute, identify another methodological problem. By focusing on tax returns (instead of household surveys and the like), Piketty fails to take into account the already sizable redistributive elements of our tax code. One in three Americans receives some means-tested government aid today. And that percentage will only grow as people live longer in retirement than ever before. In other words, social security, housing assistance, food aid, etc. don’t show up in Piketty’s portrait of inequality. Winship also notes that his method lumps together many young workers who might live at home and spouses who work only part time. Perhaps more significant, in Piketty’s data, capital gains are registered as a one-time windfall. In other words, if you buy shares in a mutual fund and you hold onto that asset for 25 years, the gains you realize when you sell are counted as income in a single year. But in fact, they’ve been earned over a quarter century. And by “excluding non-taxable capital gains,” Winship wrote in National Review,“most wealth accruing to the middle and working class, which comes in the form of home sales or 401(k) and IRA investments, is invisible in Piketty’s data.”
Then there is Piketty’s use, or abuse, of r > g. “Pretty much every economics textbook will tell you that r > g,” writes American Enterprise Institute economist Andrew Biggs. “But none of the textbook models take from this that the capital stock will rise endlessly relative to the economy. Most of them hold that it stays pretty constant, and the historical evidence supports that view.”
Indeed, as Homburg notes, historical evidence shows that the divide between wealth and income doesn’t eternally widen simply because r is greater than g. The evidence for this can be found in Piketty’s own book, which shows that for the last two centuries, the wealth-to-income ratio in the United States and Canada has remained fairly stable. This North American exception is important because, unlike Europe and Japan, we were not subjected to the physical devastation of the world wars (a topic I will return to later).
Homburg, the American Enterprise Institute’s Kevin Hassett, and a team at the Sciences Po in Paris, moreover, argue that the recent widening of the wealth-to-income gap in the United States that Piketty reports is largely a function of a housing boom in the past 30 years. This fact complicates the story. The housing boom has benefited rich people, to be sure, but it has also been fueled by a massive expansion of home ownership among not only the wealthy but also the middle and lower classes (though not in proportion to gains by the wealthy). “The largest single component of capital in the United States is owner-occupied housing,” notes the liberal economist Lawrence Summers in his review of the book for Democracy. “Its return comes in the form of the services enjoyed by the owners—what economists call ‘imputed rent’—which are all consumed rather than reinvested since they do not take a financial form.”
Also, housing booms cannot go on forever. If you exclude housing from other forms of wealth or capital (Piketty explicitly uses the terms interchangeably), these economists argue, the return on capital is less robust. “In the U.S.,” the Sciences Po economists write, “the net capital income ratio of housing capital was the same in 1770 as it was in 2010 and there is neither a long run trend nor a recent increase of this ratio.” They add: “This type of situation, where a small share of the population owns most of the housing capital, appears to be far from the current situation of developed countries, where the homeownership rate varies between 40 percent and 70 percent. The diffusion of homeownership is likely to slow or even reverse the rise of inequality regardless of trends in housing prices.” Ultimately, the Sciences Po economists found that their conclusions about inequality in recent years “are exactly opposite to those found by Thomas Piketty.”
Other critics raise a different objection. According to Saez, the largest portion of rising wealth has been in the growth of pension savings, which is a very good thing by most accounts. This is important for two reasons. First, pensions, while disproportionately held by the wealthy, are nonetheless very widely held (by teachers, policemen, autoworkers, et al.). Second, as Forbes’s Tim Worstall notes, pension wealth is generally not inheritable. Indeed, by design, it is intended to be spent.
But in order for Piketty’s invincible confidence that “the past will devour the future” to hold, wealthy people can’t spend down their money, because then it would circulate through the broader economy, raise the fortunes of others, and reduce their own net wealth. But one needs only to look outside the window to see that they do. The wealthy spend their money on cars, houses, boats, and, of course, their own children. Doing so depletes their own wealth holdings and increases the incomes of the less wealthy who provide these goods. They also spend it on museum wings, hospitals, charities of all kinds (even this magazine, a 501(c)3 to which you should be donating if you’re not already), and even progressive reform efforts of the kind Piketty surely endorses. Whatever the motive, they spend down their capital stock relentlessly—a major reason, in the United States and Canada especially, the wealth-to-income ratio has stayed relatively constant. As Feldstein notes, Piketty’s assumption about the rich might be true if every individual rich person lived forever.
...one must conclude that what its supporters have hailed as an irrefutable mathematical prophecy might have to be downgraded by everyone else into the well-informed hunch from a left-leaning French economist—a significant drop in confidence level, as the statisticians might say.
And this is hugely inconvenient for those holding aloft Capital in the Twenty-First Century as though it were the Statistical Abstract of the United States—because that would mean all of Piketty’s policy proposals and dire predictions for the future are based on a guess about the future, a guess he has falsely portrayed as an immutable law.
Four: Piketty’s Faith
Appeals to scientific fact are powerful only if the science holds up. The problem is that Piketty’s whole case sits on what could be called a one-legged stool: Remove that leg and there’s nothing left to hold it up but faith. Marxism suffered from a similar weakness. So long as its “scientific” claims remained uncontested and unexamined, Marxism had a huge advantage. Once it became clear that the science in “scientific socialism” was nothing more than clever branding, all that was left was faith.
The radical philosopher Georges Sorel (1847–1922) recognized that Marx’s Das Kapital was next to useless as a work of scientific analysis. That’s why he preferred to look at it as an “apocalyptic text… as a product of the spirit, as an image created for the purpose of molding consciousness.” And for generations of revolutionaries, intellectuals, artists, and activists, it served that purpose well. Marxism lent to its acolytes a certainty they could call “scientific”—an indispensable label amidst a scientific revolution—but, as Sorel understood, that was a kind of psychological marketing, a Platonic “vital lie” or what Sorel called a useful “myth.” Indeed, Lenin’s most significant contribution to Marxism lay in using Sorel’s concept of the myth to galvanize a successful revolutionary political movement.
Marx tapped into the language and concepts of Darwinian evolution and the Industrial Revolution to give his idea of dialectical materialism a plausibility it didn’t deserve. Similarly, Croly drew from the turn-of-the-century vogue for (heavily German-influenced) social science and the cult of the expert (in Croly’s day “social engineer” wasn’t a pejorative term, but an exciting career). In much the same way, Piketty’s argument taps into the current cultural and intellectual fad for “big data.” The idea that all the answers to all our problems can be solved with enough data is deeply seductive and wildly popular among journalists and intellectuals. (Just consider the popularity of the Freakonomics franchise or the cult-like popularity of the self-taught statistician Nate Silver.) Indeed, Piketty himself insists that what sets his work apart from that of Marx, Ricardo, Keynes, and others is that he has the data to settle questions previous generations of economists could only guess at. Data is the Way and the Light to the eternal verities long entombed in cant ideology and darkness. (This reminds me of the philosopher Eric Voegelin’s quip that, under Marxism, “Christ the Redeemer is replaced by the steam engine as the promise of the realm to come.”)
For the lay reader of Capital, this might seem ironic, given Piketty’s own criticisms of the economics profession. He mocks his colleagues’ “childish passion for mathematics and for purely theoretical and often highly ideological speculation” and “their absurd claim to greater scientific legitimacy, despite the fact that they know almost nothing about anything.” He decries the “scientistic illusion” that emerges from statistical lightshows. “The new methods often lead to a neglect of history and of the fact that historical experience remains our principle source of knowledge,” he writes. It is true that the economists he’s talking about don’t deal with real-world data but with abstract mathematical models masquerading as economic theory. Nonetheless, he would be well advised to consider that towering trees of data can blind you to the more complex nature of the forest.
With almost the sole exception of left-wing Salon columnist Thomas Frank, virtually none of his reviewers—positive and critical alike—have commented on the fact that Piketty has a remarkably thumbless grasp of historical context. “Piketty’s command of American political history is, quite simply, abysmal,” Frank correctly declares. ...
...Piketty sees the super rich as an undifferentiated agglomeration—a single static class bent on protecting its own collective self-interests. But the rich are not a static class, any more than capital can be reduced to a homogenous blob. Fewer than 1 in 10 of the 400 wealthiest Americans on the Forbes list in 1982 were still there in 2012. (Lawrence Summers notes that if Piketty was right about the stable return on capital, they should have all stayed on the list.) Of the 20 biggest fortunes on the Forbes list in 2013, 17 (85 percent) were self-made. Of the three remaining entries, only one—the Mars candy family—goes back three generations. The Koch brothers inherited the business their father created, but they also greatly expanded it through their own entrepreneurial zeal. The Waltons of Walmart fame inherited the family business from Sam Walton, a self-made billionaire from quite humble origins.
Nor are the poor and the middle class static. As a statistical artifice, there will always be a bottom 1 percent, just as there will always be a top 1 percent. But that doesn’t mean that if you are born in the bottom 1 percent, you will stay there. Some of Piketty’s fans seem confused about this, appearing to believe that economic inequality is synonymous with low economic mobility. There may indeed be a link between inequality and low economic mobility. After all, rich people by definition have advantages poor people do not. But there is no iron law that says any individual person must stay in his narrow economic bracket for life; the Morlocks can become Eloi. Indeed, there remains an enormous amount of churn in our economy; 61 percent of households will find themselves in the top quintile of income for at least two years, according to data compiled by economists Mark Rank and Thomas Hirschl. Just under 40 percent will reach the top 10 percent, and 5 percent will be one-percenters, at least for a while.
Piketty himself offers an extensive analysis of the Forbes list of the wealthiest people in the world in an attempt to prove that today’s richest people are much richer than they were in 1987 and that the “largest fortunes grew much more rapidly than average wealth.” He says the data show that wealth grew by an inflation-adjusted 7 percent, even higher than the normal 4-to-5 percent return implicit in r > g. In what seems a generous nod, Piketty even concedes that if you jigger the timespan—starting from, say, 1990 instead of 1987—the rate of return might drop a bit. But one problem remains: Piketty leaves out that the people on the list are almost all different people.3 The economist Stan Veuger, writing for U.S. News & World Report, looked at the same list and found that the top 10 individuals collectively earned about 0.5 percent on their capital during the period Piketty says “the rich” got richer. And, Vueger notes: “If it weren’t for Walmart, the wealthiest people in the world would actually have lost about half of their wealth in the last 25 years.”
Five: Piketty’s Warning
Piketty’s insistence that “historical experience remains our principal source of knowledge” and that economists need to get out of their abstract cocoons becomes all the more tone-deaf when we get to the question he barely addresses at all: Why should we care? So there’s income inequality. So what? For his part, Martin Wolf of the Financial Times raved about Capital, but conceded that the work has “clear weaknesses. The most important is that it does not deal with why soaring inequality…matters. Essentially, Piketty simply assumes that it does.”
The Economist’s Ryan Avent objected to Wolf’s criticism noting that Piketty finds income inequality “unsustainable” because it will either lead to a few (or even a single person) owning everything or to bloody revolution. Piketty does suggest as much—but he makes nothing resembling a sustained philosophical, historical, or ethical case to support his views. Rather, he breezily and unpersuasively assumes and asserts such conclusions as if they are the sorts of things everybody knows. ...
Six: Piketty’s Threat
Piketty is convinced that income inequality “inevitably instigates…violent political conflict.” Is that actually true? And if it is, is such violence justified? Skepticism is warranted on both counts, as history suggests.
For example, the French Revolution was about inequality, but not first and foremost economic inequality. Inherited titles, the power of the Church, the unjust rule of what Edmund Burke called “arbitrary power,” and other tangible examples of legal or formal inequality played enormous and mutually reinforcing roles. The American Revolution, likewise, was about political inequality, as were later fights in this country over abolition and civil rights. Economic inequality was a symptom, not the disease—at least according to countless revolutionaries, abolitionists, and civil-rights leaders.
The postwar history of the West actually makes a hash of Piketty’s sweeping presumption. He argues that the years 1950 to 1970 were a “golden age” of economic equality. If so, why did the greatest period of social unrest in Europe and the United States in the 20th century come at the height of this golden age in the 1960s? That unrest spilled over into the 1970s, but the domestic terrorists who roiled Germany and Italy and the crime wave that devastated the United States had an extremely tangential relationship to income inequality at best. Then, pollsters tell us, in the 1980s—when the West took a wrong turn, according to Piketty, thanks to the policies of Margaret Thatcher and Ronald Reagan—social contentment started to rise and continued to rise, with the usual dips, all the way into the 1990s. One small example: In 1979, 84 percent of Americans told Gallup they were dissatisfied with the direction of the country. In 1986, 69 percent were satisfied.
So, just looking at the historical record, the notion that greater income equality by itself yields social peace seems insane.
Seven: Piketty’s Capitalism
“The consequences for the long-term dynamics of the wealth distribution are potentially terrifying,” Piketty writes. For instance, Piketty fears that whenever the return on capital really starts to outstrip national growth, “capitalism automatically generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based.” That is open to debate, to put it mildly. Bill Gates, Sam Walton, Larry Ellison, Mark Zuckerberg, Sergey Brin, Fred Smith, and others became billionaires because they created goods and services of real value to consumers; there was nothing “arbitrary” about it. In fact, most of them didn’t achieve their wealth, strictly speaking, from “capital” in the Pikettyesque sense at all. They mostly earned it from technological innovation. Piketty seems to believe, without marshaling much if any evidence, that such accretions of wealth undermine meritocratic values—when in fact, in a very real sense, the wealth creation over the past 30 years collectively constitutes the most extreme example of meritocratic advancement the world has ever seen.
Do the masses resent their wealth? It doesn’t appear so, or if they do, it is not a major concern. As inequality has risen over the last 30 years, the share of the public who think that that the “rich are getting richer and the poor are getting poorer” has stayed fairly constant (80 percent told Harris pollsters they agree with that statement in 2013 compared with 82 percent in 1990). The number dipped a bit in the 1990s when inequality was increasing but wages were rising. But, in May, when Gallup asked voters what they saw as “the most important problem facing this country today,” a mere 3 percent volunteered the gap between rich and poor (which gives you a sense of how out of touch with the concerns of Americans some of Piketty’s biggest fans are and why, for instance, they wildly overestimated the significance of Occupy Wall Street at the time, and even in retrospect). Polls consistently find that Americans are much more concerned about creating jobs and making the economy grow than fighting income inequality or redistributing wealth. A poll in January conducted by McLaughlin & Associates (for the YG Network) found that Americans by a margin of 2:1 (64 percent to 33 percent) prefer expanding economic growth to narrowing the gap between rich and poor. In 1990, Gallup asked Americans whether the country benefits from having a class of rich people. Sixty-two percent said yes. In 2012, 63 percent said yes.
It seems that most Americans simply want a fair shake. They don’t really begrudge the success of others, and to the extent they do, they don’t want to do much about it. It’s hard to see how any of this amounts to an inequality-driven powder keg of social unrest waiting to explode.
A third claim—one can’t call them arguments because they don’t rise to that level—is that the super rich will rig democracy to their advantage. This, too, has a faint Marxist echo, featuring as it does the assumption that capitalist overlords form a homogenous political class bent on exploitation. One must only read the newspaper to know that this is nonsense on stilts. At this very moment, George Soros, Tom Steyer, and other liberal billionaires are in a hammer-and-tongs political battle with Sheldon Adelson, Charles and David Koch, and other conservative or libertarian billionaires. And the evidence that either side has the power to buy elections is discredited almost every November. This is not to say that our democracy couldn’t be healthier or that wealthy special interests do not cause real problems, but America is hardly being run today by characters out of a Thomas Nast cartoon. It’s being run, instead, by the son of a teenage single mother from Hawaii, the son of a barkeep from Ohio who became speaker of the House, and a miner’s son from Nevada who grew up in a shack with no running water before becoming majority leader of the Senate—none of them born into wealth, to put it mildly.
Eight: Piketty’s Choice
Piketty is shockingly unconcerned with the fact (which he acknowledges) that one of the driving forces of U.S. income inequality is rising global equality. The world’s poor are getting much richer, in large part because they are doing a lot of the sometimes backbreaking and manual labor that poor and middle-class people in rich countries once did. This clearly creates significant political and economic challenges for wealthy countries eager to maintain high domestic-living standards, but from the vantage point of someone who believes in universal economic rights, that is a small price to pay, no?
Thanks to capitalism, we have seen the single largest alleviation of poverty in human history. In 1981, 52 percent of humanity lived in “extreme poverty.” They could not provide for themselves and for their families such basic needs as housing and food. According to a recent study by Yale and the Brookings Institution, by the end of 2011, that number had fallen to 15 percent. They credit globalization, capitalism, and better economic governance (i.e., the abandonment of Marxism and similar ideologies). Even for economic nationalists, how is that not a staggering triumph for the ethical superiority of capitalism?
That is also the story of the West in the 19th and 20th centuries. Piketty might be right that whenever capitalism runs amok, the rich get richer faster than the poor get richer. Even so, the poor still get richer. The economic historian Deirdre McCloskey beautifully chronicles how for nearly all of history (and prehistory), the average human lived on the equivalent of $3 per day. What she calls the “great fact” of human advancement is that, thanks to the rise of democratic capitalism, that small figure no longer holds wherever democratic capitalism has been permitted to work its magic.
Even more troubling, Piketty places enormous emphasis on the role of the world wars as a great leveler of inequality and the primary driver of the postwar “golden age.” But ask yourself a question: If you were a remotely sane human in 1900 and you were given the choice of
(a) getting richer, though at a slower rate than the very wealthiest, so that in 1950 there was a lot of economic inequality but you and your kids were still much better off; or
(b) facing two horrendous and cataclysmic global wars in which whole societies were razed and a hundred million people died violently and you (along with the rich) were made poorer for it, and would die at a younger age,
What would you have chosen? It appears Piketty finds Option B awfully tempting. And that is madness.
Nine: Piketty’s Justice
In little more than a few throwaway sentences, Piketty asserts that confiscatory taxes on wealth are morally required as a matter of social justice. That an economist who has ensconced himself in the Parisian velvet of the social-democratic left for nearly all of his adult life believes such things is hardly surprising, particularly given his confidence that extreme wealth is essentially the arbitrary product of an “ideological construct.”
But this does not absolve him of the responsibility of making a case.
Piketty begins Capital in the Twenty-First Century with a quotation from the Declaration of the Rights of Man, the operating document of the French Revolution: “Social distinctions can be based only on common utility.” He concedes elsewhere in the book that the “social distinctions” to which it refers had to do with the hereditary “orders of privileges of the Ancien Regime” and not with economic inequality. Even so, he insists, we must breathe new life into the concept of “common utility”:
One can interpret the phrase more broadly, however. One reasonable interpretation is that social inequalities are acceptable only if they are in the interest of all and in particular of the most disadvantaged social groups. Hence basic rights and material advantages must be extended insofar as possible to everyone, as long as it is in the interest of those who have the fewest rights and opportunities to do so.
The notion that wealth—or, to put it another way, private property—is an arbitrary social distinction that can be erased for the betterment of the have-nots is incredibly radical. One might even call it Marxist (or at least “Marxy”). Given that, an argument on its behalf should be extended and defended. But aside from a perfunctory reference to the philosopher John Rawls’s “difference principle,” which says that justice should be weighted toward the least advantaged people in society, he does not do so. He is more than comfortable letting it sit as largely self-evident.
Where he breaks with Marxism is the means by which he would reward the have-nots: not the seizure of all property but the mere soaking of the rich in order to seize the returns on the means of production. Piketty’s obsession with tax hikes as a cure-all is almost a perfect mirror of how liberals see the supply-side obsessions with tax cuts. It is this idée fixe that allows him to summarily dismiss other proposals that might get us to his preferred destination without confiscating the ill-gotten gains of the well-to-do. For instance, Tyler Cowen and National Review’s Kevin D. Williamson point out that if Piketty’s assumptions about the long-term returns on capital are correct, then we would be crazy not to transform social security into a system of privately held investment accounts. Boldly expanding the Earned Income Tax Credit—which would necessarily increase the tax burden of the wealthy—might also do more to solve the problem, assuming it is a problem. An aggressive tax on consumption instead of income would, according to many economists, boost growth and have the added benefit of taxing the Gilded Age lifestyles of billionaires instead of merely taxing billionaires for the alleged crime of existing. But none of these has the satisfying bang of that 80 percent marginal tax rate—or, even more thrilling, the 10 percent “global tax” on billionaires’ filthy lucre.
And then, of course, there are the countless reforms that lie outside the realm of tax tables. The data are clear that marriage delivers roughly as much bang for the buck as going to college. Raising children in a stable two-parent home is a better guarantor of lifetime economic success than crude interventions by the state. But while Piketty is happy to opine at great length about the Gilded Age matrimonial lifestyles of the rich and famous, drawing deeply on Jane Austen and other sources to paint a vivid picture, he is uninterested in the same issues down the socioeconomic ladder.
Ten: Piketty’s Class
Why does Piketty reject the more romantic path of the classic Marxist? You know—“Let the ruling classes tremble at a Communistic revolution. The proletarians have nothing to lose but their chains. They have a world to win”—that kind of thing?
One answer to this question explains not only Piketty’s thinking but the response to his work as well: Piketty is a member of the ruling class. Piketty’s way puts Piketty and his friends in charge of everything. A one-time adviser to the Socialist politician Ségolène Royal, a star academic and a columnist for Libération, Piketty is a quintessential member of what the economist Joseph Schumpeter identified as the “new class.” Schumpeter’s prediction of capitalism’s demise hinged on his brilliant insight that capitalism breeds anti-capitalist intellectuals. Educators, bureaucrats, lawyers, technocrats, journalists, and artists, often the children of successful capitalists, always raised in the material affluence of capitalism, would organize to form a class whose collective interest lay in seizing economic decisions from the free market. As Deirdre McCloskey writes: “Schumpeter believed that capitalism was raising up its own grave diggers—not in the proletariat, as Marx had expected, but in the sons of daughters of the bourgeoisie itself. Lenin’s father, after all, was a high-ranking educational official, and Lenin himself a lawyer. It wasn’t the children of auto workers who pulled up the paving stones on the Left Bank in 1968.” No, it was actually people like Piketty’s own parents.
There is a reason the most passionate foes of income inequality tend to be very affluent but not super rich, intellectuals like Paul Krugman and other journalists eager to set the threshold for confiscatory tax rates just beyond their own income levels. But this sort of class war—the chattering classes versus the upper classes—is only part of the equation. Power plays a huge part as well. A full-throated endorsement of classic leftist radicalism would set a torch to Piketty’s own tower of privilege. The State, guided by experts, informed by data, must be empowered to decide how the Rawlsian difference principle is applied to society. Piketty’s assurance that inequality “inevitably” leads to violence amounts to an implied threat: “Let us distribute resources as we think best, or the masses will bring the fire next time.” Once again the vanguard of the proletariat takes the most surprising form: bureaucrats (the true “rentiers” of the 21st century!). A revealing sub-argument running throughout Capital is that we need to tax rich people in ever more, new, and creative ways just so we can get better data about rich people! To borrow a phrase from James Scott, author of Seeing Like a State, Piketty is obsessed with making society more “legible.” The first step in empowering technocrats is giving them the information they need to do their job.
This is what places the Piketty phenomenon squarely in the tradition of Croly and, yes, Marx himself. Piketty’s argument, with its scientific veneer and authoritative streams of numbers, is a warrant to empower those who think they are smarter than the market—and who feel superior to those most richly rewarded by it.
Stiglitz: Inequality is not Inevitable
Reply #323 on:
June 30, 2014, 01:47:21 PM »
Inequality Is Not Inevitable
By JOSEPH E. STIGLITZ (didn't he win a Nobel at one point? Not sure , , ,)
June 27, 2014 6:16 pm
The Great Divide
AN insidious trend has developed over this past third of a century. A country that experienced shared growth after World War II began to tear apart, so much so that when the Great Recession hit in late 2007, one could no longer ignore the fissures that had come to define the American economic landscape. How did this “shining city on a hill” become the advanced country with the greatest level of inequality?
One stream of the extraordinary discussion set in motion by Thomas Piketty’s timely, important book, “Capital in the Twenty-First Century,” has settled on the idea that violent extremes of wealth and income are inherent to capitalism. In this scheme, we should view the decades after World War II — a period of rapidly falling inequality — as an aberration.
This is actually a superficial reading of Mr. Piketty’s work, which provides an institutional context for understanding the deepening of inequality over time. Unfortunately, that part of his analysis received somewhat less attention than the more fatalistic-seeming aspects.
Over the past year and a half, The Great Divide, a series in The New York Times for which I have served as moderator, has also presented a wide range of examples that undermine the notion that there are any truly fundamental laws of capitalism. The dynamics of the imperial capitalism of the 19th century needn’t apply in the democracies of the 21st. We don’t need to have this much inequality in America.
Our current brand of capitalism is an ersatz capitalism. For proof of this go back to our response to the Great Recession, where we socialized losses, even as we privatized gains. Perfect competition should drive profits to zero, at least theoretically, but we have monopolies and oligopolies making persistently high profits. C.E.O.s enjoy incomes that are on average 295 times that of the typical worker, a much higher ratio than in the past, without any evidence of a proportionate increase in productivity.
If it is not the inexorable laws of economics that have led to America’s great divide, what is it? The straightforward answer: our policies and our politics. People get tired of hearing about Scandinavian success stories, but the fact of the matter is that Sweden, Finland and Norway have all succeeded in having about as much or faster growth in per capita incomes than the United States and with far greater equality.
So why has America chosen these inequality-enhancing policies? Part of the answer is that as World War II faded into memory, so too did the solidarity it had engendered. As America triumphed in the Cold War, there didn’t seem to be a viable competitor to our economic model. Without this international competition, we no longer had to show that our system could deliver for most of our citizens.
Ideology and interests combined nefariously. Some drew the wrong lesson from the collapse of the Soviet system. The pendulum swung from much too much government there to much too little here. Corporate interests argued for getting rid of regulations, even when those regulations had done so much to protect and improve our environment, our safety, our health and the economy itself.
But this ideology was hypocritical. The bankers, among the strongest advocates of laissez-faire economics, were only too willing to accept hundreds of billions of dollars from the government in the bailouts that have been a recurring feature of the global economy since the beginning of the Thatcher-Reagan era of “free” markets and deregulation.
The American political system is overrun by money. Economic inequality translates into political inequality, and political inequality yields increasing economic inequality. In fact, as he recognizes, Mr. Piketty’s argument rests on the ability of wealth-holders to keep their after-tax rate of return high relative to economic growth. How do they do this? By designing the rules of the game to ensure this outcome; that is, through politics.
So corporate welfare increases as we curtail welfare for the poor. Congress maintains subsidies for rich farmers as we cut back on nutritional support for the needy. Drug companies have been given hundreds of billions of dollars as we limit Medicaid benefits. The banks that brought on the global financial crisis got billions while a pittance went to the homeowners and victims of the same banks’ predatory lending practices. This last decision was particularly foolish. There were alternatives to throwing money at the banks and hoping it would circulate through increased lending. We could have helped underwater homeowners and the victims of predatory behavior directly. This would not only have helped the economy, it would have put us on the path to robust recovery.
OUR divisions are deep. Economic and geographic segregation have immunized those at the top from the problems of those down below. Like the kings of yore, they have come to perceive their privileged positions essentially as a natural right. How else to explain the recent comments of the venture capitalist Tom Perkins, who suggested that criticism of the 1 percent was akin to Nazi fascism, or those coming from the private equity titan Stephen A. Schwarzman, who compared asking financiers to pay taxes at the same rate as those who work for a living to Hitler’s invasion of Poland.
Our economy, our democracy and our society have paid for these gross inequities. The true test of an economy is not how much wealth its princes can accumulate in tax havens, but how well off the typical citizen is — even more so in America where our self-image is rooted in our claim to be the great middle-class society. But median incomes are lower than they were a quarter-century ago. Growth has gone to the very, very top, whose share has almost quadrupled since 1980. Money that was meant to have trickled down has instead evaporated in the balmy climate of the Cayman Islands.
With almost a quarter of American children younger than 5 living in poverty, and with America doing so little for its poor, the deprivations of one generation are being visited upon the next. Of course, no country has ever come close to providing complete equality of opportunity. But why is America one of the advanced countries where the life prospects of the young are most sharply determined by the income and education of their parents?
Among the most poignant stories in The Great Divide were those that portrayed the frustrations of the young, who yearn to enter our shrinking middle class. Soaring tuitions and declining incomes have resulted in larger debt burdens. Those with only a high school diploma have seen their incomes decline by 13 percent over the past 35 years.
Where justice is concerned, there is also a yawning divide. In the eyes of the rest of the world and a significant part of its own population, mass incarceration has come to define America — a country, it bears repeating, with about 5 percent of the world’s population but around a fourth of the world’s prisoners.
Justice has become a commodity, affordable to only a few. While Wall Street executives used their high-retainer lawyers to ensure that their ranks were not held accountable for the misdeeds that the crisis in 2008 so graphically revealed, the banks abused our legal system to foreclose on mortgages and evict people, some of whom did not even owe money.
More than a half-century ago, America led the way in advocating for the Universal Declaration of Human Rights, adopted by the United Nations in 1948. Today, access to health care is among the most universally accepted rights, at least in the advanced countries. America, despite the implementation of the Affordable Care Act, is the exception. It has become a country with great divides in access to health care, life expectancy and health status.
In the relief that many felt when the Supreme Court did not overturn the Affordable Care Act, the implications of the decision for Medicaid were not fully appreciated. Obamacare’s objective — to ensure that all Americans have access to health care — has been stymied: 24 states have not implemented the expanded Medicaid program, which was the means by which Obamacare was supposed to deliver on its promise to some of the poorest.
We need not just a new war on poverty but a war to protect the middle class. Solutions to these problems do not have to be newfangled. Far from it. Making markets act like markets would be a good place to start. We must end the rent-seeking society we have gravitated toward, in which the wealthy obtain profits by manipulating the system.
The problem of inequality is not so much a matter of technical economics. It’s really a problem of practical politics. Ensuring that those at the top pay their fair share of taxes — ending the special privileges of speculators, corporations and the rich — is both pragmatic and fair. We are not embracing a politics of envy if we reverse a politics of greed. Inequality is not just about the top marginal tax rate but also about our children’s access to food and the right to justice for all. If we spent more on education, health and infrastructure, we would strengthen our economy, now and in the future. Just because you’ve heard it before doesn’t mean we shouldn’t try it again.
We have located the underlying source of the problem: political inequities and policies that have commodified and corrupted our democracy. It is only engaged citizens who can fight to restore a fairer America, and they can do so only if they understand the depths and dimensions of the challenge. It is not too late to restore our position in the world and recapture our sense of who we are as a nation. Widening and deepening inequality is not driven by immutable economic laws, but by laws we have written ourselves.
This is the last article in The Great Divide.
Krugman: Conservative delusions about inflation
Reply #324 on:
July 07, 2014, 12:46:05 PM »
Many of us here predicted massive inflation by now , , ,
Re: Krugman: Conservative delusions about inflation
Reply #325 on:
July 07, 2014, 01:15:58 PM »
Quote from: Crafty_Dog on July 07, 2014, 12:46:05 PM
Many of us here predicted massive inflation by now , , ,
Re: Krugman and price levels at minimum velocity
Reply #326 on:
July 07, 2014, 06:12:24 PM »
Quote from: G M on July 07, 2014, 01:15:58 PM
Quote from: Crafty_Dog on July 07, 2014, 12:46:05 PM
Many of us here predicted massive inflation by now , , ,
(Broken record here but...) There is a difference between inflation and price level increases even though we conflate the terms. Mr. Krugman, Nobel award winner, no one ever said M = P, they said MV = PQ. Price increases are a consequence of excessive money supply increases, but not a big threat when the economy is running nowhere near peak velocity. The question is, how big will be the price level increases AFTER normal velocity returns?
Crafty wrote: "Many of us here predicted massive inflation
, , ," (emphasis added)
Krugman writes as if the final score is in, but the damages are not all known by now and posted. We have seen but the tip of the iceberg of the consequences of these wrongheaded policies.
Surprising (not really) that any professional who was off on economic growth by -200% last quarter (Wesbury, Krugman, etc.) would be smug about how right or wrong amateurs are at (straw argument) forecasting.
Average GDP growth the last 7 years was 0.4T/yr.
QE has been averaging 3/4 Trillion per year (in press reports), so the money supply is growing at nearly twice the rate of real output, by my count. To say that will have no consequence seems insincere, to put it nicely. Krugman is setting up is to blame the aftermath of these policies on Obama's successor, while still blaming Obama's predecessor for his current failures. The technical term for that level of analysis is ... partisan hack.
Reply #327 on:
July 08, 2014, 02:34:26 AM »
Scott Grannis has been cautioning us on our take of things and he is no partisan hack.
Reply #328 on:
July 08, 2014, 07:30:51 AM »
Quote from: Crafty_Dog on July 08, 2014, 02:34:26 AM
Scott Grannis has been cautioning us on our take of things and he is no partisan hack.
Agree, Scott Grannis gives honest analysis. It was Krugman's choice to go from respected academic to partisan hack and it is a long accumulated, well earned characterization of his columns, even if poorly documented by me in that short post.
I doubt if Grannis believes the combination of fiscal and monetary excesses caused no damage just because large price increases do not show up yet, nor does he use the sluggish Obama economy to slam the conservative viewpoint.
For one thing, Scott Grannis acknowledges that the Fed's strategy has destroyed the incentive to save in this country. What are the long term consequences of that? Nothing?
Re: Economy under-performing by 10%
Reply #329 on:
July 08, 2014, 07:56:15 AM »
"We are very likely still in a recovery, but the problem—as illustrated in the chart above—is that the economy is more than 10% below where it could or should be if long-term growth trends are extrapolated. This is without doubt and by far the weakest recovery in history. I think the reasons for this weak growth are a huge increase in regulatory burdens (e.g., Obamacare), a significant increase in top marginal tax rates, a hugely burdensome, complicated, and distorting tax code, and the developed world's highest corporate tax rates." - Scott Grannis June 25, 2014
It means we have given up over $11 TRILLION in economic activity over this period of wrongheaded economic policies. That is the difference between young people getting a good start and not getting a good start. That is not very different from my view.
Impact on the millennials
Reply #330 on:
July 08, 2014, 11:58:41 AM »
At Krugman's mansion, they probably don't notice
Reply #331 on:
July 09, 2014, 06:21:54 AM »
Reply #332 on:
July 09, 2014, 11:06:57 AM »
I mentioned Grannis in this moment in the context of our being wrong here about inflation. No argument from me on the rest of it. Terrible recovery, terrible consequences, debt out of control etc etc etc
Beneath the glossy veneer of the jobs report
Reply #333 on:
July 10, 2014, 07:28:27 AM »
Everything a boom or a bubble?
Reply #334 on:
July 10, 2014, 07:58:58 AM »
Reynolds: Piketty data is worthless
Reply #335 on:
July 10, 2014, 09:23:23 AM »
Alan Reynolds is a very good supply side economist.
Why Piketty's Wealth Data Are Worthless
Private retirement plans rose to $12.4 trillion in 2012 from $875 billion in 1984. None of it is reported on tax returns.
By Alan Reynolds
July 9, 2014 6:39 p.m. ET
No book on economics in recent times has received such a glowing initial reception as Thomas Piketty's "Capital in the Twenty-First Century." He remains a hero on the left, but the honeymoon may be drawing to a sour close as evidence mounts that his numbers don't add up.
Mr. Piketty's headline claim is that capitalism must result in wealth becoming increasingly concentrated in fewer hands to a "potentially terrifying" degree, on the grounds that the rate of return to capital exceeds the rate of economic growth. Is there any empirical evidence to back up this sweeping assertion? The data in his book—purporting to show a growing inequality of wealth in France, the U.K., Sweden and particularly the United States—have been challenged. And that's where the story gets interesting.
In late May, Financial Times economics editor Chris Giles published anessay that found numerous errors in Mr. Piketty's data. Mr. Piketty's online "Response to FT" was mostly about Europe, where the errors Mr. Giles caught seem minor. But what about the U.S.?
Mr. Piketty makes a startling statement: The data in his book should now be disregarded in favor of a March 2014 Power Point presentation, available online, by Mr. Piketty's protégé, Gabriel Zucman (at the London School of Economics) and his frequent co-author Emmanuel Saez (of the University of California, Berkeley). The Zucman-Saez estimates, Mr. Piketty says, are "much more systematic" and "more reliable" than the estimates in his book and therefore "should be used as reference series for wealth inequality in the United States. . . (rather than the series reported in my book)."
Zucman-Saez concludes that there was a "large increase in the top 0.1% wealth share" since the 1986 Tax Reform, but "no increase below the top 0.1%." In other words, all of the increase in the wealth share of the top 1% is attributed to the top one-tenth of 1%—those with estimated wealth above $20 million. This is quite different from the graph in Mr. Piketty's book, which showed the wealth share of the top 1% (which begins at about $8 million, according to the Federal Reserve's Survey of Consumer Finances) in the U.S. falling from 31.4% in 1960 to 28.2% in 1970, then rising to about 33% since 1990.
In any event, the Zucman-Saez data are so misleading as to be worthless. They attempt to estimate top U.S. wealth shares on the basis of that portion of capital income reported on individual income tax returns—interest, dividends, rent and capital gains.
This won't work because federal tax laws in 1981, 1986, 1997 and 2003 momentously changed (1) the rules about which sorts of capital income have to be reported, (2) the tax incentives to report business income on individual rather than corporate tax forms, and (3) the tax incentives for high-income taxpayers to respond to lower tax rates on capital gains and dividends by realizing more capital gains and holding more dividend-paying stocks. Let's consider each of these issues:
• Tax reporting. Tax laws were changed from 1981 to 1997 to require that more capital income of high-income taxpayers be reported on individual returns, while excluding most capital income of middle-income savers and homeowners. This skews any purported increase in the inequality of wealth.
For example, interest income from tax-exempt municipal bonds was unreported before 1987—so the subsequent reporting of income created an illusory increase in top incomes and wealth. Since 1997, by contrast, most capital gains on home sales have disappeared from the tax returns of middle-income couples, thanks to a $500,000 tax exemption. And since the mid-1980s, most capital income and capital gains of middle-income savers began to vanish from tax returns by migrating into IRAs, 401(k)s and other retirement and college savings plans.
Balances in private retirement plans rose to $12.4 trillion in 2012 from $875 billion in 1984. Much of that hidden savings will gradually begin to show up on tax returns as baby boomers draw them down to live on, but they will then be reported as ordinary income, not capital income.
Tax law changes, in summary, have increased capital income reported at the top and shifted business income from corporate to individual tax returns, while sheltering most capital income of middle-income savers and homeowners. Using reported capital income to estimate changing wealth patterns is hopeless.
• Switching from corporate to individual tax returns. When individual tax rates dropped from 70% in 1980 to 28% in 1988, this provoked a massive shift: from retaining private business income inside C-corporations to letting earnings pass through to the owners' individual tax returns via partnerships, LLCs and Subchapter S corporations. From 1980 to 2007, reports the Congressional Budget Office, "the share of receipts generated by pass-through entities more than doubled over the period—from 14 percent to 38 percent." Moving capital income from one tax form to another did not mean the wealth of the top 1% increased. It simply moved.
• Tax rates and capital gains. There were huge, sustained increases in reported capital gains among the top 1% after the capital-gains tax was reduced to 20% from 28% in 1997, and when it was further reduced to 15% in 2003. Although more frequent asset sales showed up as an increase in capital income, realized gains are no more valuable than unrealized gains so realization of gains tells us almost nothing about wealth. Similarly, a portfolio shift from municipal bonds, coins or cash into dividend-paying stocks after the tax on dividends fell to 15% in 2003 might look like more capital income when it was merely swapping an untaxed asset for a taxable one.
In his book, Mr. Piketty constructed estimates of top wealth shares, decade by decade, melding and massaging different kinds of data (estate tax records, the Federal Reserve's Survey of Consumer Finances). These estimates are suspect in their own right; but as we now learn from Mr. Piketty's response to Mr. Giles, we can ignore them.
Yet Mr. Piketty's preferred alternative, the Zucman-Saez slide show, is also irreparably flawed as a guide to wealth concentration. Mr. Piketty's premonition of soaring U.S. wealth shares for the top 1% finds no credible support in his book or elsewhere.
Mr. Reynolds, a senior fellow with the Cato Institute, is author of a 2012 Cato Institute paper, "The Misuse of Top 1 Percent Income Shares as a Measure of Inequality."
WSJ: How to spark another great moderation
Reply #336 on:
July 16, 2014, 08:43:13 AM »
How to Spark Another 'Great Moderation'
A new House bill would encourage the Fed to abide by monetary policy rules.
John B. Taylor
July 15, 2014 8:07 p.m. ET
Sound money and free markets go hand in hand. In 1776, Adam Smith wrote of the importance of rules for "a well-regulated paper-money" in "The Wealth of Nations." In 1962, Milton Friedman made the chapter "Control of Money," with its rationale for monetary rules, a centerpiece of "Capitalism and Freedom." In the 1980s, British Prime Minister Margaret Thatcher and President Ronald Reagan made sound money principles a key part of their market-based reform platforms.
The reason is clear: Economic crises and slow economic growth, as in the Great Depression of the 1930s and the Great Inflation of the 1970s, could be traced to deviations from sound rules-based monetary policy. That common- sense finding still holds.
When monetary policy became more rules-based during the 1980s, 1990s and until recently, the economy improved and we got what economists call the Great Moderation of strong economic growth with declining unemployment and inflation during those same years. When policy became more ad hoc, interventionist and discretionary during the past decade, the economy deteriorated and we got a financial crisis, a Great Recession, and a not-so-great recovery.
So as Americans begin to diagnose the poor economic performance of recent years and look for remedies that rely more on markets, they are again looking to monetary reform. A welcome example is the Federal Reserve Accountability and Transparency Act, just introduced in the House.
Federal Reserve Chair Janet Yellen in her Senate testimony on Tuesday. Getty Images
Its first main section "Requirements for Policy Rules for the Fed" would require that the Federal Reserve submit to Congress and the American people a rule or strategy for how the Fed's policy instrument, such as the federal-funds rate, would change in a systematic way in response to changes in inflation, real GDP or other inputs. The bill was the subject of a hearing on Capitol Hill last week, and Fed Chair Janet Yellen was asked about its requirements Tuesday during her testimony to the Senate Banking Committee. It ought to be the main subject when she testifies Wednesday before the House Financial Services Committee.
According to the legislation, the Fed, not Congress, would choose the rule and how to describe it. But if the Fed deviated from its rule, then the chair of the Fed would have to "testify before the appropriate congressional committees as to why the [rule] is not in compliance." The rule would have to be consistent with the setting of the actual federal-funds rate at the time of the submission. The legislation also creates a transparent process for accountability: The U.S. comptroller general would be responsible for determining whether or not the "Directive Policy Rule" was in compliance with the law and report its finding to Congress.
The legislation provides flexibility. It does not require that the Fed hold any instrument of policy fixed, but rather that it make adjustments in a systematic and predictable way. It allows the Fed to serve as lender of last resort or take appropriate actions to provide liquidity in a crisis. Moreover, the legislation even allows for the Fed to change its rule or deviate from it if the Fed policy makers decide that is necessary. As stated in the act: "Nothing in this Act shall be construed to require that the plans with respect to the systematic quantitative adjustment of the Policy Instrument Target be implemented if the Federal Open Market Committee determines that such plans cannot or should not be achieved due to changing market conditions." But "Upon determining that plans . . . cannot or should not be achieved, the Federal Open Market Committee shall submit an explanation for that determination and an updated version of the Directive Policy Rule."
In the interests of clarity, the legislation also specifies a "Reference Policy Rule," to which the Fed must compare its policy rule. The reference policy rule, to quote from the legislation, "means a calculation of the nominal Federal funds rate as equal to the sum of the following: (A) The rate of inflation over the previous four quarters. (B) One-half of the percentage deviation of the real GDP from an estimate of potential GDP. (C) One-half of the difference between the rate of inflation over the previous four quarters and two [percent]. (D) Two [percent]."
In monetary and financial circles this rule is known as the Taylor Rule, due to a proposal I made in 1992, and researchers routinely compare any policy rule they are considering to this rule. It is thus a straightforward task for the Fed. Many at the Fed already make such comparisons, including Fed Chair Janet Yellen.
Some will object to the legislation, including some at the Fed. But there is nothing partisan about rules-based monetary policy, and there is a clear precedent for congressional oversight. The Federal Reserve Act previously required that the Fed report the ranges for the future growth of the money supply, but these requirements were removed from the law in 2000. The proposed legislation fills that void.
Some will say that the legislation would destroy central-bank independence. But since the Fed chooses its own rule, its independence is maintained. The purpose of the act is to prevent the damaging departures from rules-based policy, which central-bank independence obviously has not prevented.
Based on writings, speeches and publicly released transcripts of meetings, we know that many at the Fed favor a more rules-based policy. Constructive comments from the Fed would undoubtedly improve the legislation, but if it were passed into law as is, economic performance would improve greatly.
The Federal Reserve Accountability and Transparency Act limits discretion and excessive intervention by our independent central bank, as its name implies, in a transparent and accountable way. It thereby meets Milton Friedman's goal of "legislating rules for the conduct of monetary policy that will have the effect of enabling the public to exercise control over monetary policy through its political authorities, while at the same time . . . prevent[ing] monetary policy from being subject to the day-by-day whim of political authorities."
Mr. Taylor, a professor of economics at Stanford University and a senior fellow at the Hoover Institution, served as Treasury undersecretary for international affairs from 2001 to 2005.
Re: Economics, How inherited wealth helps the economy
Reply #337 on:
July 16, 2014, 07:06:56 PM »
Greg Mankiw is head of the Harvard Economics Dept.
How Inherited Wealth Helps the Economy
JUNE 21, 2014
By N. GREGORY MANKIW
Is inherited wealth making a comeback?
Yes, says Thomas Piketty, author of the best seller “Capital in the Twenty-First Century.” Inherited wealth has always been with us, of course, but Mr. Piketty believes that its importance is increasing. He sees a future that combines slow economic growth with high returns to capital. He reasons that if capital owners save much of their income, their wealth will accumulate and be passed on to their heirs. He concludes that individuals’ living standards will be determined less by their skill and effort and more by bequests they receive.
To be sure, one can poke holes in Mr. Piketty’s story. Since the book came out, numerous economists have been doing exactly that in book reviews, blog posts and academic analyses.
Moreover, given economists’ abysmal track record in forecasting, especially over long time horizons, any such prognostication should be taken with a shaker or two of salt. The Piketty scenario is best viewed not as a solid prediction but as a provocative speculation.
An undated photograph shows John D. Rockefeller, wearing a bow tie, and family members. Credit Rockefeller Archive Center
But it raises the question: So what? What’s wrong with inherited wealth?
First, let’s consider why parents leave bequests to their children. I believe that this decision is based on three principles:
INTERGENERATIONAL ALTRUISM This starts with the prosaic premise that parents care about their children. Economists simplify this phenomenon with the concept of “utility,” a measure of lifetime satisfaction or happiness. Intergenerational altruism within the family is modeled by assuming that the utility of Generation One depends on the utility of Generation Two.
And it doesn’t stop there, because future generations will also care about their children. Generation Two’s utility depends on Generation Three’s utility, which depends on Generation Four’s utility, and so on. As a result, each person’s utility depends not only on what happens during his own lifetime but also on the circumstances he expects for his infinite stream of descendants, most of whom he will never meet.
CONSUMPTION SMOOTHING People get utility from consuming goods and services, but they also exhibit “diminishing marginal utility”: The more you are already consuming, the less benefit you get from the next increase in consumption. Your utility increases if you move from a one- to a two-bathroom home. It rises less if you move from a four- to a five-bathroom home.
Because of diminishing marginal utility, people typically prefer a smooth path of consumption to one that jumps around. Consuming $50,000 of goods and services in each of two years is generally better than consuming $80,000 one year and $20,000 the next. People smooth consumption by saving in good times and drawing down assets when conditions are lean.
REGRESSION TOWARD THE MEAN This is the tendency of many variables to return to normal levels over time. Consider height. If you are much, much taller than average, your children will most likely be taller than average as well, but they will also most likely be shorter than you are.
The same is true for income. According to a recent study, if your income is at the 98th percentile of the income distribution — that is, you earn more than 98 percent of the population — the best guess is that your children, when they are adults, will be in the 65th percentile. They will enjoy higher income than average, but much closer to that of the typical earner. (This regression to the mean over generations, of course, has nothing to say about a nation’s overall income inequality, which is an entirely separate issue.)
This phenomenon is clearest for the most extreme cases. In their own times, John D. Rockefeller and Steve Jobs each created one of the world’s most valuable companies and made a ton of money along the way. They must have known it was unlikely that their children would accomplish the same feat.
Together, these ideas explain why top earners often leave sizable bequests to their families. Because of intergenerational altruism, they make their consumption and saving decisions based not only on their own needs but also on those of their descendants. Because of regression toward the mean, they expect their descendants to be less financially successful than they are. Hence, to smooth consumption across generations, they need to save some of their income so future generations can consume out of inherited wealth.
This logic also explains why many people aren’t inclined to reduce their current spending so they will have money saved for bequests. For those in the bottom half of the income distribution, regression toward the mean is good news: Their descendants will very likely rank higher than they do. Even those near the middle can expect their children and grandchildren to earn higher incomes as technological progress pushes productivity and incomes higher. Only for those with top incomes does the combination of intergenerational altruism, consumption smoothing and regression toward the mean lead to a significant role for inherited wealth.
From a policy perspective, we need to consider not only the direct effects on the family but also the indirect effects on the broader economy. Rising income inequality over the past several decades has meant meager growth in living standards for those near the bottom of the economic ladder, and one might worry that inherited wealth makes things worse. Yet standard economic analysis suggests otherwise.
When a family saves for future generations, it provides resources to finance capital investments, like the start-up of new businesses and the expansion of old ones. Greater capital, in turn, affects the earnings of both existing capital and workers.
Because capital is subject to diminishing returns, an increase in its supply causes each unit of capital to earn less. And because increased capital raises labor productivity, workers enjoy higher wages. In other words, by saving rather than spending, those who leave an estate to their heirs induce an unintended redistribution of income from other owners of capital toward workers.
The bottom line is that inherited wealth is not an economic threat. Those who have earned extraordinary incomes naturally want to share their good fortune with their descendants. Those of us not lucky enough to be born into one of these families benefit as well, as their accumulation of capital raises our productivity, wages and living standards.
N. Gregory Mankiw is a professor of economics at Harvard.
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