Saturday, May 10, 2014

Piketty: Capital's Share of Income

We now return to Thomas Piketty's First Fundamental Law of Capitalism.  It is the equation that Piketty introduced in his chapter on Income and Output.
(Share of national income from capital) = (rate of return on capital) x (capital/income ratio)
The idea is to tease out the share of capital and labor in the national income.  The question is: how do you compute the rate of return on capital?

But first, Piketty wants us to look at the history of capital's share of national income in Britain since 1770 and France since 1820.  His chart of capital income in Britain shows a capital share of about 34% in 1800 that rises to a peak of 43% in 1850.  Then it declines to about 33 percent in 1890, before collapsing after World War I to 22%.  Since then capital income has jogged along between 20% and 30% of national income with a nadir in 1970 at 20% and highs in 1940 and 2000 at 27%.

In France, capital's share of national income starts at 30% in 1820, rises to a peak of 43% in 1850-60, and declines sharply to 26% in 1890 and bouncing to 34% in 1910.  Capital share declines to 29% after World War I and collapses to 13% in 1940.  Since then it has jogged along between 20% and 30% of national income with a nadir in 1980 at 20% and a high of 26% in 2010.

Piketty doesn't discuss it, but I find myself fascinated by the peak in capital income in the mid 19th century.  What was really going on then?  Was it railroads?  Here's my thought.  Railroads meant that small-scale farmers went to the wall.  Before railroads, when grain was transported by horse and cart, the cost of the grain would double with a single day's travel.  After railroads, midwestern US grain could compete with farmers everywhere, as Zola showed in La Terre.  So the farmers migrated off the land to the mines and the factories, and all they could earn was the Marxian subsistence wage --  until the migration eased and wages started to climb in the later 19th century.

But Piketty's calculation of capital's "share" of national income depends on a calculation of a national rate of return on capital.  He computed it by
adding various amounts of income from capital included in national accounts regardless of legal classification (rents, profits, dividends, interest, royalties, etc., excluding interest on public debt and before taxes) and then dividing this total by... the national capital stock (which gives the average rate of return on capital, denoted r).
In Britain the average rate of return on capital starts at about 5% in 1800, rises to a peak of 6.3% by 1860 and declines to 5% by 1890.  After World War I the rate of return climbed erratically up to a peak of 11% in 1950 before declining to about 5-6% after 1980.

France shows a similar pattern only more abrupt.  Rate of return on capital starts at 6% in 1820 and rises to 7.5% in 1850, declining abruptly after 1870 to a little over 4%.  Rate of return peaks at 10% in 1920, troughs at 6.4% in 1940, peaks again at nearly 11% in 1950 before declining to under 5% by 2010.

Piketty thinks that his numbers are pretty solid: he refers back to Jane Austen and Balzac.  Back then the rentier class more or less assumed a 5% return on land or on government debt.  But I am not so sure.

A middling sort of capitalist like me does not compute rate of return from income and dividends.  He computes it from comparing net worth last year with this year.  In Piketty's terms, this means combining income from capital with savings.  In my terms it means combining interest and dividends with the capital gain from a stock rising in price.  Why does a stock rise in price?  Because, e.g., Apple just came out with a new iPhone that every consumer wants to buy and does buy.  On this basis, I suspect, the share of income from capital appreciation over the last 200 years would dwarf the income from interest and dividends.

Picketty now embarks on a discussion of the marginal productivity of capital, "defined by the value of the additional production due to one additional unit of capital."  Of course, when capital becomes abundant the "marginal productivity of capital decreases as the stock of capital increases."  The question is by how much, and "everything depends on the vagaries of technology" and the ability to substitute capital for labor and vice versa.  But this leaves out the basic fact of every decision to change production.  Every decision is a bet on the future which might, or might not work out.

Economists have been arguing over the question of the capital income share since World War II.  In mid century economists thought that the capital share would remain about constant, but in the last 40 years it has been going up.  That, according to Piketty is because the substitution of capital from labor tends to increase capital's share of income, a trend that also reflects capital's "increase in bargaining power vis-à-vis labor".

But what about "human capital", the notion that knowledge and skills represent a growing share of wealth creation that has crowded out capital? For Piketty this represents "mindless optimism: capital... is still useful"!

And what about Marx's prediction that the bourgeoisie would "dig its own grave" as capital accumulated and the rate of profit fell, according to Marx's analysis?  Piketty applies his two Fundamental Laws of Capitalism and finds a logical contradiction, with a positive savings rate accumulating more and more capital.  If growth is zero then the capital/income ratio tends towards infinity. But this is rubbish, and shows the weakness of using the "savings" notion.  If growth is zero it means that the increase in wealth is zero and therefore the savings, the increase in wealth from year to year is zero, and that capital investments don't add to wealth.  Is is possible that Piketty's Second Fundamental Law of Capitalism is meaningless?

But economists have been arguing over this.  In Britain economists argued that growth was "entirely determined by the savings rate" while in the US economists argued that the savings rate and the capital/income ratio could adjust to each other.  But if you reject the accumulationist theory and argue that growth comes from innovation and surprise then the argument is all about counting angels on the head of a pin.  And you say that savings is a result of an increase in wealth.

Piketty wants us to think that a return to low growth, economic and/or demographic, means a "return of capital."  For, "in stagnant societies, wealth accumulated in the past naturally takes on considerable importance."

Or maybe in a stagnant society the upper crust keep spending and mortgaging themselves until the whole thing collapses.  As often happens in 19th century novels.

One last point at the end of the chapter. One should not think that technology will save us.
If one truly wishes to found a more just and rational social order based on common utility, is not not enough to count on the caprices of technology.
But the problem is that the lefty answer to that is to count instead on the caprices of political power -- in the right hands, of course.


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


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