Friday, May 9, 2014

Piketty: Capital/income Ratio in the Long Run

In his comparison of Europe and North America Thomas Picketty showed that there were differences between the Old World and the New World in the pricing of capital.  For one thing, the capital/income ratio has tended to be lower in the United States and Canada.  That's because North America has seen a huge increase in population over the modern era and people don't show up at Ellis Island with lots of capital.

But why has the capital/income ratio returned to its 19th century level in Europe after a collapse in the wars and turmoil of the early-to-mid 20th century, and why should the ratio in the United States always be lower?

To answer the question, Piketty introduces a "Second Fundamental Law of Capitalism."  It is this:
Capital/income ratio = (savings rate) / (growth rate)
What does that mean, exactly?  Here is Piketty's explanation:
[I]f a country saves 12 percent of its national income every year, and the rate of growth of its national income is 2 percent per year, then in the long run the capital/income ratio will be equal to 600 percent[.] 
Just to be clear, the "First Fundamental Law of Capitalism" introduced in the chapter on Income and Output was that:
Capital/income ratio = (share of income from capital) / (rate of return on capital)
I've shuffled the equation around a bit, but here is Piketty's explanation of his First Law:
[I]f national wealth represents the equivalent of six years of national income, and if the rate of return on capital is 5 percent per year, then capital's share in national income is 30 percent.
So my first question is: where does this "savings rate" come from?  How can you even measure such a thing.  The closest I can come to an explanation is on page 28 of the Technical Appendix (pdf), where Piketty writes that the Second Law "stems directly from the basic mathematical equation describing wealth accumulation."
In a model without price effect, and where wealth entirely comes from accumulation (no natural resources), wealth in year t+1 Wt+1 simply equals the sum of wealth in year t Wt and savings [in year t] St[.]
Oy!  Deirdre McCloskey says: capitalism is not about "accumulation"; it is about innovation.  George Gilder says that capitalism is "surprise."  For instance Apple Computer.  At the end of 2008 AAPL stock price was about $85 per share.  At the end of 2009 AAPL was about $211.  Assuming about 900 million shares, that's an increase in wealth from $76 billion to $190 billion.  You call that savings? Give me a break.  Instead, what we see is the capitalization of an unanticipated future income stream from an amazing innovation, a Steve Jobs surprise, called the iPhone.

Anyway, Piketty goes off into a long riff about what happens if a nation starts with zero and "saves 12 percent of its national income for a year.  It will take 50 years to "save the equivalent of six years of income" and then, of course, the national income will be bigger.  Accumulation takes time.

No!  Here's how the world works.  Carnegie creates cheap steel and bingo, the economy rockets into the stratosphere as steel rails allow much heavier railroad trains. Ditto Rockefeller and oil; Ford and autos.  That's not accumulation; that's a quantum leap.

Anyway, Piketty explains the increase in the capital/income ratio since World War II by his accumulation theory.  The return of a high capital/income ratio means "the emergence of a new patrimonial capitalism."  What we are seeing is low growth and high savings, he says. (Yes, but how exactly is he computing "savings"?)

But what about the future?  Using his Second Law, Piketty estimates that the world capital/income ratio will slowly rise to about 6 to 7 times national income by the end of the 21st century, "approximately the level observed in Europe from the eighteenth century to the Belle Époque.  And we know what that means.


Piketty gives us the accumulationist narrative.  Here's the Austrian/innovation/surprise narrative.  After a big war, when lots of things and people have been destroyed, only the most urgent production and capital projects make sense.  The future is heavily discounted; what matters is to work and rebuild now; you get the French Trente Glorieuses.  Interest rates are high and therefore capital is priced low.  But as the emergency passes the national wealth increases; interest rates go down and people get more relaxed about the future.  Capital values go up and less urgent projects start to make sense.  Meanwhile, all the time, crazy kids keep turning up with crazy ideas that turn into Texas Instruments, Microsofts, Qualcomms, Apples, Facebooks: literally creating huge wealth out of nothing.


Part One: Income and Capital

Income and Output


Part Two: The Dynamics of the Capital/Income Ratio

Changes in Capital

New World Capital and Slavery

Capital/income Ratio in the Long Run

Capital's Share of Income

Part Three: The Structure of Inequality

Inequality and Its Concentration

Two Worlds: France and the US

Inequality of Labor Income

Inequality of Capital Ownership

Merit and Inheritance in the Long Run

Global Inequality of Wealth in the 21st Century

Part Four: Regulating Capital in the Twenty-First Century

A Social State for the 21st Century

Rethinking the Progressive Income Tax

A Global Tax on Capital

The Question of the Public Debt


1 comment:

  1. I don't think you understand economics very well. Pikkety doesn't need to redefine the concept of "savings rate"--its a pretty standard concept that you could pick up in any introductory macroeconomics book, or even on apparently. Here, try reading this: