Deirdre McCloskey has written an excellent essay reviewing Thomas Piketty’s Capital in the Twenty-First Century.
As an economic historian and historian of economic ideas, McCloskey can place the arguments into the framework of centuries-old ideas (and fallacies) as few others can. She has read philosophy and "social ethics." She can even knowledgeably review the literary references.
Her central point: "trade-based betterment," (she wisely avoids "capitalism" to emphasize that the focus on "capital" is about a hundred years out of date) has raised living standards by factors of 30 or more -- much more if you think about health, freedom, lifespan, tavel, etc. unavailable at any price in 1800; it has led to much greater equality in many things that count, such as consumption, health and so on; and stands to do so again if we do not kill the goose that laid these golden eggs. From late in the review,
Redistribution, although assuaging bourgeois guilt, has not been the chief sustenance of the poor....If all profits in the American economy were forthwith handed over to the workers, the workers ... would be 20 percent or so better off, right now....
But such
one-time redistributions are two orders of magnitude smaller in helping the poor than the 2,900 percent Enrichment from greater productivity since 1800. Historically speaking 25 percent is to be compared with a rise in real wages 1800 to the present by a factor of 10 or 30, which is to say 900 or 2,900 percent.
As a too-long post on a far-too-long review of a enormously-too-long book, I'll pass on some particularly good bits with comment.
On the long history of fashionable worrying:
.. Piketty’s worry about the rich getting richer is indeed merely “the latest” of a long series back to Malthus and Ricardo and Marx. Since those founding geniuses of Classical economics, a trade-tested betterment (a locution to be preferred to “capitalism,” with its erroneous implication that capital accumulation, not innovation, is what made us better off) has enormously enriched large parts of a humanity..., and bids fair in the next fifty years or so to enrich everyone on the planet. ...And yet the left in its worrying routinely forgets this most important secular event since the invention of agriculture—the Great Enrichment of the last two centuries—and goes on worrying and worrying,... in a new version every half generation or so.
Here is a partial list of the worrying pessimisms, which each has had its day of fashion...: greed, alienation, racial impurity, workers’ lack of bargaining strength, women working, workers’ bad taste in consumption, immigration of lesser breeds, monopoly unemployment, business cycles, increasing returns, externalities, under-consumption, monopolistic competition, separation of ownership from control, lack of planning, post-War stagnation, investment spillovers, unbalanced growth, dual labor markets, capital insufficiency ..., peasant irrationality, capital-market imperfections, public choice, missing markets, informational asymmetry, third-world exploitation, advertising, regulatory capture, free riding, low-level traps, middle-level traps, path dependency, lack of competitiveness, consumerism, consumption externalities, irrationality, hyperbolic discounting, too big to fail, environmental degradation, underpaying of care, overpayment of CEOs, slower growth, and more.
"Secular stagnation," "global imbalances," "deflationary vortices," "hysterisis"... Long lists are fun and a good rhetorical device. She might have added, though, that if you want to stay up at night, read Bob Gordon on the end of innovation. The central mechanism of "trade-based betterment" can come to an end either naturally or if we let the Pikettys of the world kill it. Neither she nor I think it will, but that makes for a much more coherent worry.
On how to get famous in economics:
... [I] can reveal their formula: first, discover or rediscover a necessary condition for perfect competition or a perfect world (in Piketty’s case, for example, a more perfect equality of income). ... conclude with a flourish that “capitalism” is doomed unless experts intervene with a sweet use of the monopoly of violence in government to implement anti-trust against malefactors of great wealth or subsidies to diminishing-returns industries or foreign aid to perfectly honest governments or money for obviously infant industries or the nudging of sadly childlike consumers or, Piketty says, a tax on inequality-causing capital worldwide.
On r > g, self-perpetuating wealth, and the long history of disdain for the returns to capital:
.. In 2014 he [Piketty] declared to the BBC’s Evan Davis in an interview that “Money tends to reproduce itself,” a complaint about money and its interest rate repeatedly made in the West since Aristotle. As the Philosopher said of some men, “the whole idea of their lives is that they ought either to increase their money without limit, or at any rate not to lose it. . . . The most hated sort [of increasing their money], . . . is usury, which makes a gain out of money itself.”
... The [r > g].. argument ... is conclusive, so long as its factual assumptions are true: namely, only rich people have capital; human capital doesn’t exist; the rich reinvest their return; they never lose it to sloth or someone else’s creative destruction; inheritance is the main mechanism, not a creativity that raises g for the rest of us just when it results in an r shared by us all; and we care ethically only about the Gini coefficient, not the condition of the working class.
She left out two important conditions: The wealthy do not consume, and they leave estates intact to one child. With characteristic self-contradiction, the Pikettys of the world bemoan the excessive and garish consumption of the rich, but then claim wealth grows as if it is not consumed, if not directly then by spendthrift heirs. The correct equation is r - c - n > g, where c is the ratio of consumption to wealth and n is the growth rate of heirs.
On the facts:
... The focus on relative wealth or income or consumption is one serious problem in the book. Piketty’s vision of a “Ricardian Apocalypse,” as he calls it, leaves room for the rest of us to do very well indeed, ... as in fact since 1800 we have. What is worrying Piketty is that the rich might possibly get richer, even though the poor get richer, too. His worry,..is... about a vague feeling of envy raised to a theoretical and ethical proposition.
Finish with a nice epigram.
On the obvious problem -- if wealth accumulation inevitably leads to more inequality, why are the heirs of Astors, Rothschilds, Medici--heck, Julius Caesar--not on top of the heap rather than these upstarts Gates, Walton, and so on?
Yet in fact his own... research, as he candidly admits ... suggest that only in Canada, the U.S., and the U.K. has the inequality of income increased much, and only recently. “In continental Europe and Japan, income inequality today remains far lower than it was at the beginning of the twentieth century and in fact has not changed much since 1945” (p. 321, and Figure 9.6)...
Piketty’s fears were not confirmed anywhere 1910 to 1980, nor anywhere in the long run at any time before 1800, nor anywhere in Continental Europe and Japan since World War II, and only recently, a little, in the United States, the United Kingdom, and Canada ... That is a very great puzzle if money tends to reproduce itself, always, evermore, as a general law... Yet inequality in fact goes up and down in great waves, for which we have evidence from many centuries ago down to the present, which also doesn’t figure in such a tale..
At one point Piketty says just that: “r > g will again become the norm in the twenty-first century, as it had been throughout history until the eve of World War I (p. 572, italics supplied); ... Why then did the share of the rich not rise anciently to 100 percent? At the least, how could the share be stable at, say, the 50 percent that in medieval times typified unproductive economies with land and landlords dominant? Sometimes Piketty describes his machinery as a “potentially explosive process” (p. 444), at other times he admits that random shocks to a family fortune means that “it is unlikely that inequality of wealth will grow indefinitely, . . rather, the wealth distribution will converge toward a certain equilibrium” (p. 451). On the basis of the Forbes lists of the very rich, Piketty notes, for example, “several hundred new fortunes appear in [the $1 billion to $10 billion] range somewhere in the world almost every year” (p. 441). Which is it, Professor Piketty? Apocalypse or (what is in fact observed, roughly, with minor ups and downs) a steady share of rich people constantly dropping out of riches or coming into them, in evolutionary fashion? His machinery seems to explains nothing alarming, and at the same time too much alarming.
The cure can be worse than the disease -- and sometimes is the disease:
Let us therefore bring in the sweet and blameless and omni-competent government—or, even less plausibly, a world government, or the Galactic Empire—to implement “a progressive global tax on capital” (p. 27) to tax the rich.....
The science writer Matt Ridley has offered a persuasive reason for the (slight) rise in inequality recently in Britain. “Knock me down with a feather,” Ridley writes,
You mean to say that during three decades when the government encouraged asset bubbles in house prices; gave tax breaks to pensions; lightly taxed wealthy non-doms [that is, “non-domiciled,” the citizens of other countries such as Russia and Saudi Arabia living in the U.K.]; poured money into farm subsidies [owned by landlords mainly rich]; and severely restricted the supply of land for housing, pushing up the premium earned by planning permission for development, the wealthy owners of capital saw their relative wealth increase slightly? Well, I’ll be damned. . . . [Seriously, now] a good part of any increase in wealth concentration since 1980 has been driven by government policy, which has systematically redirected earning opportunities to the rich rather than the poor.
In the United States, with its pervasive welfare payments and tax breaks for our good friends the very rich... one can make a similar case that the government, which Piketty expects to solve the alleged problem, is the cause.
On creative destruction among entrepreneurs, a great leveling force in the 1%
Piketty does not acknowledge that each wave of inventors, of entrepreneurs, and even of routine capitalists find their rewards taken from them by entry, which is an economic concept he does not appear to grasp. Look at the history of fortunes in department stores...
...William Nordhaus has calculated that the inventors and entrepreneurs nowadays earn in profit only 2 percent of the social value of their inventions. If you are Sam Walton the 2 percent gives you personally a great deal of money from introducing bar codes into stocking of supermarket shelves. But 98 percent at the cost of 2 percent is nonetheless a pretty good deal for the rest of us. The gain from macadamized roads or vulcanized rubber, then modern universities, structural concrete, and the airplane, has enriched even the poorest among us.
Piketty... focuses instead on the great evil of very rich people having seven Rolex watches by mere inheritance. Lillian Bettancourt, heiress to the L’Oréal fortune (p. 440), the third richest woman in the world, who “has never worked a day in her life, saw her fortune grow exactly as fast as that of [the admittedly bettering] Bill Gates.” Ugh, Piketty says, which is his ethical philosophy in full.
Again, close with a nice epigram. Later,
...And in some important ways even French-style equality is improved by an ethic of trade-tested bettermemt. Free entry erodes monopolies that in traditional societies keep one tribe rich and the other poor...
On human capital, education, and more cure vs. disease:
The technical flaws in the argument are pervasive...
For example—a big flaw, this one—Piketty’s definition of wealth does not include human capital, owned by the workers, which has grown in rich countries to be the main source of income, when it is combined with the immense accumulation since 1800 of capital in knowledge and social habits, owned by everyone with access to them. ...
... The only reason in the book to exclude human capital from capital appears to be to force the conclusion Piketty wants to achieve, that inequality has increased, or will, or might, or is to be feared. ..
If human capital is included—the ordinary factory worker’s literacy, the nurse’s educated skill, the professional manager’s command of complex systems, the economist’s understanding of supply responses [!]—the workers themselves now in the correct accounting own most of the nation’s capital, and Piketty’s drama from 1848 falls to the ground.
The neglect of human capital on the Problems side of the book is doubly strange because on the Solutions side Piketty recommends education and other investment in human capital. Yet in his focus on raising the marginal product of workers unemployed by government program, rather than helping them by correcting the governmental distortions that created the unemployment in the first place, he joins most of the left, especially those with university jobs. Thus in South Africa the left proposes to carry on with high minimum wages and oppressive regulation, solving the unemployment problem generated governmentally by improving through the same government the education of unemployed South Africans. No one, left or right or libertarian, would want to complain about better education, especially if it falls from the sky at no opportunity cost—though we bleeding heart libertarians would suggest achieving it by some other means than by pouring more money into a badly functioning nationalized industry providing elementary education or into a higher education system grossly favoring the rich over the poor, as it does strikingly in France, by giving the rich student, better prepared, a tuition-free ride into the ruling class. In any case the sweet-sounding “we-love-education” ploy exempts the left from facing the obvious cause of unemployment in South Africa, namely, a sclerotic system of labor-market and other regulations in aid of the Congress of South African Trade Unions, rigged against the wretchedly poor black South African sitting jobless with a small income subsidy in a hut in the back country of KwaZulu-Natal.
Supply and demand:
The fundamental technical problem in the book, however, is that Piketty the economist does not understand supply responses. In keeping with his position as a man of the left, he has a vague and confused idea about how markets work, and especially about how supply responds to higher prices. If he wants to offer pessimistic conclusions concerning “a market economy based on private property, if left to itself” (p. 571), he had better know what elementary economics, agreed to by all who have studied it enough to understand what it is saying, does in fact say how a market economy based on private property behaves when left to itself.
... Startling evidence of Piketty’s miseducation occurs as early as page 6.... "If the supply of any good is insufficient, and its price is too high, then demand for that good should decrease, which would lead to a decline in its price.” The (English) words I italicize clearly mix up movement along a demand curve with movement of the entire curve, a first-term error at university. The correct analysis ...is that if the price is “too high” it is not the whole demand curve that “restores equilibrium” ... but an eventually outward-moving supply curve. ... entry is induced by the smell of super-normal profits.... New oil deposits are discovered, new refineries are built, new suburbs are settled, new high-rises saving urban land are constructed, as has in fact happened massively since, say, 1973, unless government has restricted oil exploitation (usually on environmental grounds) or the building of high-rises (usually on corrupt grounds).
Supply, demand, and a simplistic view of government:
..[to Piketty,] supply responses do not figure in the story of supply and demand, which anyway is unpleasant and complicated—so much less so than, say, the state taking a radically larger share of national income in taxes, with its attendant inefficiencies, or the state encouraging the spurning of capitalist ownership in favor of “new forms of governance and shared ownership intermediate between public and private” (p. 573), with its attendant corruptions and lack of skin in the game.
On to larger pursuits:
...the fundamental ethical problem in the book, is that Piketty has not reflected on why inequality by itself would be bad. The Liberal Lady Glencora Palliser (née M'Cluskie) in Anthony Trollope’s political novel Phineas Finn (1867-1868) declares...
Either ethical or economic, that is the gaping open question. Other than envy, why is the object of policy not simply the betterment of people's lives? I left off the quote here, just to point out McCloskey going mano a mano with philosophical, ethical, and even literary arguments.
You can't dismiss McCloskey with the usual calumnies that "oh, you just don't care." The erudite preamble:
This is not to say that no one in rich countries such as the United States is unskilled, addicted, badly parented, discriminated against, or simply horribly unlucky. George Packer’s recent The Unwinding: An Inner History of the New America (2013) and Barbara Ehrenreich’s earlier Nickel and Dimed: On (Not) Getting By in America (2001) carry on a long and distinguished tradition telling the bourgeoisie about the poor, back to James Agee and Walker Evans, Let Us Now Praise Famous Men (1944), George Orwell, The Road to Wigan Pier (1937), Jack London, The People of the Abyss (1903), Jacob Riis, How the Other Half Lives: Studies among the Tenements of New York (1890), and the fount, Friedrich Engels, The Condition of the Working Class in England (1845). They are not making it up. Anyone who reads such books is wrenched out of a comfortable ignorance about the other half. In fictional form one is wrenched by Steinbeck’s The Grapes of Wrath (1939) or Farrell’s Studs Lonigan (1932-1935) or Wright’s Native Son (1940), or in Europe, among many observers of the Two Nations, Zola’s Germinal (1885), which made many of us into socialists. The wrenching is salutary. It is said that Winston Churchill, scion of the aristocracy, believed that most English poor people lived in rose-covered cottages. He couldn’t imagine back-to-backs in Salford, with the outhouse at the end of the row. Wake up, Winston.
I suspect that unlike many pundits, McCloskey has actually read these books.
The eternal conceit of the left that taking counterproductive actions with good intentions makes one worthy:
But waking up does not imply despairing, or introducing faux policies that do not actually help the poor, or proposing the overthrow of the System, if the System is in fact enriching the poor over the long run, or at any rate is enriching the poor better than those other systems that have been tried from time to time. Righteous, if inexpensive, indignation inspired by survivor’s guilt about alleged “victims” of something called “capitalism,” and envious anger at the silly consumption by the rich, do not invariably yield betterment for the poor. Remarks such as “there are still poor people” or “some people have more power than others,” though claiming the moral high-ground for the speaker, are not deep or clever. Repeating them, or nodding wisely at their repetition, or buying Piketty’s book to display on your coffee table, does not make you a good person. You are a good person if you actually help the poor. Open a business. Arrange mortgages that poor people can afford. Invent a new battery. Vote for better schools. Adopt a Pakistani orphan. Volunteer to feed people at Grace Church on Saturday mornings. Argue for a minimum income and against a minimum wage. The offering of faux, counterproductive policies that in their actual effects reduce opportunities for employment, or the making of indignant declarations to your husband after finishing the Sunday New York Times Magazine, does not actually help the poor.
... That even over the long run there remain some poor people does not mean the system is not working for the poor, so long as their condition is continuing to improve, as it is, contrary to the newspaper stories and the pessimistic books, and so long as the percentage of the desperately poor is heading towards zero, as it is. That people still sometimes die in hospitals does not mean that medicine is to be replaced by witch doctors, so long as death rates are falling and so long as the death rate would not fall (as economically speaking in Mao’s China or Stalin’s Russia, they did not), under the care of the witch doctors.
Inequality vs. prosperity, especially of the poor, and substantial mobility
.. Robert Reich argues that we must nonetheless be alarmed by inequality, Gini-coefficient style, rather than devoting all our energies to raising the absolute condition of the poor. “Widening inequality,” declares, “challenges the nation’s core ideal of equal opportunity.” “Widening inequality still hampers upward mobility....”
Reich is mistaken. Horwitz summarizes the results of a study by Julia Isaacs on individual mobility 1969-2005: “82% of children of the bottom 20% in 1969 had [real] incomes in 2000 that were higher than what their parents had in 1969. The median [real] income of those children of the poor of 1969 was double that of their parents.”...
There is no doubt that the children and grandchildren of the English coal miners of 1937, whom Orwell describes “traveling” underground, bent over double a mile or more to get to the coal face, at which point they started to get paid, are much better off than their fathers or grandfathers. There is no doubt that the children and grandchildren of the Dust Bowl refugees in California are. Steinbeck chronicled in The Grapes of Wrath their worst and terrible times. A few years later many of the Okies got jobs in the war industries, and many of their children later went to university. Some went on to become university professors who think that the poor are getting poorer.
Equality vs. prosperity:
Much of the research on the economics of inequality stumbles on this simple ethical point, focusing on measures of relative inequality such as the Gini coefficient or the share of the top 1 percent rather than on measures of the absolute welfare of the poor, focusing on inequality rather than poverty, having elided the two. ... Piketty himself barely gets around to caring about “the least well off” (p. 577, the last phrase in the last sentence of the book, though he does occasionally mention the issue in the body of the book, as on p. 480).
Dworkin and Piketty and too often much of the left, in other words, miss the ethical point, which is the liberal, Joshua-Monk one of lifting up the poor. By redistribution? By equality in diamond bracelets? No: by the dramatic increase in the size of the pie, which has historically brought the poor to 90 or 95 percent of “enough,” as against the 10 or 5 percent attainable by redistribution without enlarging the pie.
Capital in the 19th century, vs. ideas in the 21st:
The most fundamental problem in Piketty’s book, then, is that the main event of the past two centuries was not the second moment, the distribution of income on which he focuses, but its first moment, the Great Enrichment of the average individual on the planet by a factor of 10 and in rich countries by a factor of 30 or more. The greatly enriched world cannot be explained by the accumulation of capital—as to the contrary economists have argued from Adam Smith through Karl Marx to Thomas Piketty, and as the very name “capitalism” implies. Our riches were not made by piling brick upon brick, bachelor’s degree upon bachelor’s degree, bank balance upon bank balance, but by piling idea upon idea.
The consequence of redistributionary taxation, and prices are always first and foremost signals:
..what about subsequent “distribution” of the fruits? Why shouldn’t we— one might ask, who “we”?—seize the high incomes of the professor and the airline pilot and the heiress to the L’Oréal fortune and distribute them to dustmen and cleaners? ... If medical doctors make ten times more than cleaners, the rest of the society, which pays voluntarily for the doctors and cleaners is saying, “If cleaners could become doctors, viewing the matter in the long run, shift more of them into doctoring.” If we reduce the Great Society to a family by taxing the rich to the limit we destroy the signaling. People wander between cleaning and doctoring without such signals about the value people put on the next hour of the services. Neither doctoring nor cleaning gets done well. ...
Bottom line:
On the next to last page of his book Piketty writes, “It is possible, and even indispensable, to have an approach that is at once economic and political, social and cultural, and concerned with wages and wealth.” One can only agree. But he has not achieved it. His gestures to cultural matters consist chiefly of a few naively used references to novels he has read superficially—for which on the left he has been embarrassingly praised. His social theme is a narrow ethic of envy. His politics assumes that governments can do anything they propose to do. And his economics is flawed from start to finish.
It is a brave book. But it is mistaken.
* * *
A few minor criticisms -- in addition to the obvious that it needs to be cut in half by reorganizing and eliminating repetition. (Like another advocate of good writing I know, do as she says not as she does!)
That last sentence. No, it is not a brave book. And more importantly, "brave" is a false summary of McCloskey's devastating review. It is not "brave" to write five hundred pages that is simply wrong as simple microeconomics (supply and demand) and growth economics (r > g); that fails, in McCloskey's view, basic ethics; whose evidence is contrary to its thesis; and that advocates policies -- confiscatory taxation by a centralized world government -- that would turn back the trade-based betterment that has saved billions from grinding poverty.
It is not "brave" to write a book so calculated, in McCloskey's analysis, to play the game of academic fame, to guarantee one star status at trendy Parisian cocktail parties and fat speaking fees from bien-pensant "nonprofits." It is not "brave" to write a book full of, as McCloskey points out, old fallacies, fallacies put to the test and failed miserably a hundred times over, and demanding in the end immense power for the author and his fellow travelers. (No, of course, Stalin, Mao, Castro, East Germany and North Korea just implemented it wrong. With us at the helm, the truly smart and caring, it will all work out fine.)
The Road to Serfdom was a brave book. Capitalism and Freedom was a brave book. McCloskey has written bravely. Brave means signing up for all the Proper People in the New York Times savaging you and calling you names, not cheering you on.
I suspect McCloskey, a midwesterner like myself, was brought up always to say something nice. Sometimes, there isn't anything nice to say.
McCkoskey praises Piketty's numeracy, along with many snarky comments about theory and regression-running. But her critique barely mentions the facts, and instead savage's Piketty's misunderstanding of basic...theory. High prices lead to supply curves that shift out, capital includes human capital, growth comes from ideas, and so on. Let us admit then that theory matters. Pure empiricism for a thousand years did not figure out that washing hands stops infections, until we understood the theory. Quantitative theory. Numbers without equations are as useless as equations without numbers. And, as misleading as regressions can be, simply staring at data does not sort out cause from effect, the central challenge of economics and other non-experimental social sciences, and the central criticism that McCloskey has of Piketty.
McCloskey goes slightly awry, as we all do, when she writes about things she hasn't kept up with.
He does not get entangled as so many economists do in the sole empirical tool they are taught, namely, regression analysis on someone else’s “data” ... Therefore he does not commit one of the two sins of modern economics, the use of meaningless “tests” of statistical significance ... Piketty constructs or uses statistics of aggregate capital and of inequality and then plots them out for inspection, which is what physicists, for example, also do in dealing with their experiments and observations. Nor does he commit the other sin, which is to waste scientific time on existence theorems. Physicists, again, don’t...Piketty stays close to the facts, and does not, say, wander into the pointless worlds of non-cooperative game theory, long demolished by experimental economics. He also does not have recourse to non-computable general equilibrium, which never was of use for quantitative economic science, being a branch of philosophy, and a futile one at that. On both points, bravissimo.
This sort of thing is just out of date. Empirical economics has become very fact-oriented in the last 20 years, and nobody really writes anything about "statistical significance" without establishing economic significance, or clear patterns in the data. The stars in their 30s are scraping data off the internet. Existence theorems? Non-cooperative game theory? Non-computable general equilibrium? These are straw people from the 1970s.
But as she had to close with something nice, I have to close with something to whine about. A great read, and I recommend the whole thing.