What to Do about Thomas Piketty?

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Last week’s blog featuring Michael Jensen’s powerful model of factor income distribution sets the stage for this week’s examination of Thomas Piketty’s more celebrated, but decidedly less good, treatment of the same subject. Worldwide attention paid to the French economist and his Capital in the Twenty-First Century (2013) is a wake-up call to macroeconomists.

There is no doubting Piketty’s significant contribution in the compilation, largely from income and estate tax records, of a huge international data base on the distribution of earnings and wealth over extended time periods. His agenda, however, is much more ambitious. He is attempting to return economics to its early methodologies and concerns, in particular the division of national income between labor and capital. He uses his interpretation of how the surplus created when people engage in cooperative activities is apportioned as a call to action, concluding that across a broad swath of countries the concentration of income and wealth is inexorably rising, unchecked by market forces, and is increasingly eroding economic opportunity and social stability. Piketty asserts that the welfare damage caused by inequality today is sufficient to justify openly confiscatory income and estate taxes on the rich. The recent French flirtation with a 75% marginal income tax rate comes to mind.

Two characteristics of the “Piketty craze” are especially troubling. First, his analysis is proudly rooted in casual empiricism, a methodology that supports little more than guessing about the fundamental processes generating the evidence. He makes no attempt to construct an economic model, rooted in objective functions, plausible assumptions/constraints, and specified trading arrangements, that is relevant to the distribution process itself or the consequences of the policies he recommends. Capital has no convincing means of assessing the countless alternative hypotheses that purport to explain the observed macrodynamics of wealth/income concentrations and is reduced to 600 pages of (too much) information on what Thomas Piketty believes.

Rejecting behavioral models, Piketty relies on two identities to squeeze meaning out of his pile of evidence. In Capital (p.33), his analytic tools are “α=r x β (which says that the share of capital in national income is equal to the product of the return on capital and the capital/income ratio), or β=s/g (which says that the capital/income ratio is equal in the long run to the savings rate divided by the growth rate). I ask readers not well versed in mathematics to be patient and not immediately close the book: these are elementary equations, which can be explained in a simple, intuitive way and can be understood without any specialized technical knowledge. Above all, I try to show that this minimal theoretical framework is sufficient to give a clear account of what everyone will recognize as important historical developments.”

Second, and even more discouraging, in the today’s academy important income/wealth concentration questions have been largely abandoned to Capital’s casual empiricism. Mainstream macro theorists have no coherent capacity to adequately model distribution in highly specialized economies or the associated policy issues. Their models cannot coherently accommodate the existence of market rents (labor and capital) that are at the heart of the distributional macrodynamics apparent in Piketty’s data base. Macroeconomists, if they are to play by the rules set down in the consensus New Neoclassical Synthesis, have little useful to say about increasing income/wealth concentration. Why does it occurs? What does it mean? What should be done about it? None of those questions can be adequately addressed, let alone answered, in coherent market-centric DSGE modeling, leading some mainstream theorists to conclude that Capital’s questions are uninteresting. Such arrogance allows Piketty’s cavalier analysis to remain largely unchallenged.

By contrast, the generalized-exchange modeling featured in the GEM Project coherently accommodates labor and capital market rents, fundamentally reworking textbook modeling of production, labor and capital supply, and factor-income distribution. (Chapters 2 and 3) The powerful analysis supports careful investigation of the grand dynamics that drive the accumulation and distribution of capital. The generalization of exchange usefully provides a superior platform from which to analyze Piketty’s policy recommendations.  In the TVGE model class, confiscatory income taxation is easily demonstrated to be an inherently flawed policy, net harmful to any nation that attempts it. Surely Piketty is familiar with the range of alternative policies that more effectively address the problems of equal opportunity and social instability than does the wasteful, blunt instrument of confiscation. More generally, interested readers are invited to contrast the two narratives describing the linked great disruptions of the 20th century, one produced by Piketty in Capital and the other produced in the GEM Project. The latter is serious economic analysis; the former is not. (Chapters 4 and 5)

I am not one of Capital’s admirers. My central problem is not his support for confiscatory taxation. Piketty’s polemic beliefs will be thrashed out in political debate. My rejection is instead rooted in his misguided attempt to reestablish casual empiricism as the proper approach for economists in their interpretation of evidence and derivation of policy implications. Capital reduces its central analysis of the β timepath to little more than a Rorschach exercise uncovering the author’s presumptions about the way economies work. At the very least, he should acknowledge the existence of many competing narratives, producing quite different policy implications, that fit the behavior of the wealth-income ratio as well as, or better than, his story. His assertion that evidence is best interpreted absent behavioral modeling is more than wrong. It is irresponsible and dangerous.

Blog Type: Policy/Topical Saint Joseph, Michigan

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