Pikettymania has gotten out of control. Thomas Piketty, of course, is the French economist whose book, Capital in the Twenty First Century, has become an international sensation. The American left is treating it like gospel, accepting it uncritically. The American right is treating it like a joke, now that a writer from the Financial Times has pointed out some apparent errors in the work.
Both views are overblown. Piketty has made an important, maybe even historic contribution to our understanding of economics. But he may also be wrong about a few things. As it happens, some of the smartest criticism has come from liberal thinkers obviously sympathetic to Piketty's world view. These thinkers including one former and one present member of the Obama Administration, as well as one very well-known columnist for the New York Times. They’re not rejecting Piketty's arguments outright. They are questioning some of the nuances.
Before discussing why, let’s review what Piketty really says in his book. To simplify just a bit, Piketty argues that there are forces in capitalism that will tend to make wealth inequality worse—specifically, that the gap between the very rich and everybody else will get bigger over time, unless governments act to keep that from happening. Note that this is not the same thing as arguing that rising inequality is inevitable.
Piketty thinks that capitalism widens the wealth gap through two separate mechanisms—what Matt Bruening, of Demos, has dubbed the “Capital Share Effect” and the “Capital Concentration Effect.” The Capital Share Effect is the idea that, with each new year, more of the economic pie will go the people who provide capital and less will go to the people who provide labor. To put that in English, relatively more income will go to the people who own the factories, arrange the financing of businesses, and come up with new software ideas—while relatively less income will go to the people who assemble the cars, answer phones at the bank, and actually write the code. Why? Piketty says that overall economic growth is bound to subside, thanks to demographics; when it does, Piketty argues, the return on investment for capital (r) will fall less than the drop in growth of national incomes (g). That leads directly to an increase in share of total income accruing to owners of capital.
The Capital Concentration Effect means that, absent government action, possession of capital is likely to be distributed less and less evenly over time—with the wealthiest people gaining possession over more and more of it. In other words, we can expect that ownership of those factories, stocks and bonds, and trademarked software ideas will increasingly belong to a group of extremely wealthy people. In econospeak, that means r will reliably be greater than g and the rich will save a sufficient percentage of their income. This is distinct from the Capital Share Effect. Piketty believes both forces are present, but it’s possible that one or the other could exist without the other.
So what’s the issue? A basis for both arguments is Piketty’s belief that r (the return on capital) will fall less quickly than g (the growth in income). Larry Summers, the former Treasury Secretary who reviewed Piketty’s book for the journal Democracy, isn’t so sure about that. After calling Piketty’s collection of data a “Nobel Prize-worthy contribution,” Summers writes, “[The theory] presumes, first, that the return to capital diminishes slowly, if at all, as wealth is accumulated...Economists universally believe in the law of diminishing returns. As capital accumulates, the incremental return on an additional unit of capital declines.” In other words, Summers is saying, r will decrease more quickly than Piketty’s argument allows.
And Summers is not the only one making a version of this argument. Paul Krugman wrote a laudatory review of Capital for the New York Review of Books. But, Krugman notes, “Piketty asserts that r will fall less than g. This doesn’t have to be true.” Jason Furman, chairman of the Council of Economic Advisors for President Obama, made a similar case in a speech in Dublin three weeks ago:
Moreover, economic theory is unclear about whether slowing growth would in fact result in a rise in r – g. In general when growth rates fall, the ratio of capital to income rises, and the increased prevalence of capital drives down the rate of return on capital. Whether the return on capital falls more or less than the growth rate depends on how substitutable capital and labor are, with less substitutability meaning that the extra capital will be less useful thus driving its return down more. Unfortunately, the degree of this substitutability has not been clearly established, although Piketty's assumption that it is sufficient to prevent a large fall in the rate of return on capital is a plausible reading of the aggregate data.
The three economists aren’t saying precisely the same thing. Summers more or less rejects Piketty’s assertion about the rate of return on capital. Furman and Krugman are merely raising questions about it. If Summers is right, that calls into question much of Piketty’s economic theory, including the premise that r will fall less than g. Wealth inequality may still increase, but it would not happen through the channels that Piketty hypothesizes.
The new critique that has conservatives so excited—the discovery of possible mistakes in Piketty’s work—is similarly nuanced. Chris Giles, the economics editor at the FT, discovered a number of errors and unexplained adjustments that significantly change some of his findings. Breitbart’s James Delingpole declared that Capital is now “just another worthless leftist screed in the dustbin of history.” At Hot Air, the errors were “more likely to make Capital in the 21st Century an expensive, unread table book.”
While the mistakes are real and Piketty needs to respond to them, the FT investigation has overblown their significance. As I wrote on Friday, Giles’s work does not significantly alter Piketty’s wealth inequality findings for Sweden, France or the United States. In addition, we have other sources of data that have shown rising wealth inequality in the U.S., corroborating Piketty’s findings. The best data comes from a PowerPoint (and soon-to-be-published paper) from Emmanuel Saez and Gabriel Zucman, who used a new statistical method and found significant increase in wealth inequality in the United States over the past 30 years:
Most important, Giles’s findings do not undermine Piketty’s theory. In fact, they only impact one part of his theory: the Capital Concentration Effect. Giles’ critique, like the ones from Summers, Krugman, and Furman, show that Pikettymania has gone too far. They don’t suggest we should dismiss him completely—not even close. Instead, we need a much more nuanced understanding of his theory and less schaudenfraude from both sides.