Gwen Ifill and PBS’s NewsHour hosted a brief debate last night on Thomas Piketty’s Capital in the Twenty-First Century. The participants in the debate were Heather Boushey of from the Washington Center for Equitable Growth and Kevin Hassett of the American Enterprise Institute. In the course of the debate, Hassett made an important representation about Piketty’s argument that Boushey effectively let pass. That’s a shame, because Hassett has misinterpreted Piketty in a rather serious way, and the error shouldn’t be allowed to stand.
At one point in the discussion, Hassett says this:
And if you look at what’s been going on in his data, then the share of income going to capital in the United States has gone up over time. And what he [Piketty] does is, he gives a theory for why that’s going to continue, and eventually capital is going to have everything, unless we have 80 percent tax rates and so on.
But the problem that he has is that his story for why that could happen, why capital will ultimately get all the income, is that we’re going to substitute capital for workers, and so we’re going to have robots making hamburgers and so on, which is a story — it could be true that that’s something that we need to think about.
So according to Hassett, Piketty has argued that eventually capital is going to “have everything” and “get all of income.” And the reason for this is that our economy can indefinitely substitute capital equipment for labor, so that all returns will eventually accrue to the owners of that capital.
But Piketty makes no such argument.
Piketty says first that the capital/income ratio β – the ratio of total accumulated wealth to annual national income – tends toward s/g over the long run, where s is the nation’s savings rate and g is its growth rate. And the total capital share of national income is always rβ, where r is the rate of return on capital. So if the total accumulated wealth of some nation is 5 times its annual national income, and the annual rate of return on capital is 5%, then the total capital share of income will be 25%. Suppose also the savings rate is 9% and the growth rate is 1.5%, and that these rates are stable over an extended period of time. Then s/g is 6, and that initial 25% capital share will move in the direction of 30%, and stabilize there.
So, then, one important question we can ask about the long run evolution of the capital share depends on the long run evolution of r. Piketty considers various possibilities for the future dynamics of r, but explicitly repudiates the notion that capital can be substituted for labor indefinitely, and defends the idea that in many observable historical circumstances “too much capital kills the return on capital.” One issue, then, is whether the decrease in the rate of return on capital during this phase is greater or less than the increase in the capital share; and if it is less for some time, for how long will it be less. In this connection, Piketty argues:
… it is likely that the return on capital, r, will decrease as β increases. But on the basis of historical experience, the most likely outcome is that the volume effect will outweigh the price effect, which means that the accumulation effect will outweigh the decrease in the return on capital. (p. 221)
But eventually, the capital share stops increasing. In the end, Piketty says, rβ could reach “30 or 40 percent.” If growth rates are much lower, or if the return on capital decreases even more slowly, the capital share “might rise even higher”. (p. 233)
So Piketty never predicts the capital share could reach 100%, or that it is trending toward such an astronomical level, contrary to what Hassett seems to take as an element of Piketty’s argument. Piketty also says that “it is possible that technological changes over the very long run will slightly favor human labor over capital, thus lowering the return on capital and the capital share.” Indeed, he had earlier accepted the probability of “the long-run decrease in capital’s share of national income from 35-40 percent to 25-30 percent.” (p. 224)
But, Piketty claims, such a long-run decrease does not represent “a change in civilization”. And here is the fundamental point: Piketty’s central arguments in Capital in the Twenty-First Century concern the actions of those forces of wealth and income divergence that are driving a growth in inequality. The circumstances favoring this growing inequality – forces which can produce an “inheritance society” dominated by patrimonial wealth and by high concentrations of wealth persisting from generation to generation – do not depend on a continually increasing capital share of income. A steady capital share of 30% is quite enough to allow for the dominance of the forces of divergence over the forces of convergence, and for a continuing rise in inequality. There are also other forces for divergence attributable to large inequalities in the labor share of income itself, quite apart from inequalities that are being driven by the size of the capital share. Piketty devotes a whole chapter to these latter forces and their effects, which appear to be especially strong in the English-speaking countries.
Explaining the dynamics of all of these phenomena, examining the structure of inequality, and analyzing the forces driving the observable contemporary increases in inequality, are the subjects of most of Part Three of Piketty’s Capital in the Twenty-First Century, a span of discussion covering six chapters and 240 pages which very few people appear to be reading closely. I have briefly discussed some of these issues before in a previous post, and will take them up again in the future.