Monday, November 24, 2014

A devastating critique of Piketty

Last April I wrote a post about the problems with Piketty's book, Capital in the Twenty-First Century. Over the weekend I read Deirdre McCloskey's 55-page tour de force review of the book. It's far more than just a critique or a review of the book, it's an education in economics and a dazzling collection of references and observations on politics, society, and economic history. It's densely written, however, so it will require several hours of effort, but I think you'll find it worthwhile.

In one passage, McCloskey the professor gives Piketty a failing grade in basic economics:

Startling evidence of Piketty’s miseducation occurs as early as page 6. He begins by seeming to concede to his neoclassical opponents (he is I repeat a proud Classicist, Ricardo plus Marx). “To be sure, there exists in principle a quite simple economic mechanism that should restore equilibrium to the process [in this case the process of rising prices of oil or urban land leading to a Ricardian Apocalypse]: the mechanism of supply and demand. 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 (we tell our first-year, first-term students at about week four) is that if the price is “too high” it is not the whole demand curve that “restores equilibrium” (though the high price in the short run does give people a reason to conserve on oil or urban land with smaller cars and smaller apartments, moving as they in fact do up along their otherwise stationary demand curves), but an eventually outward-moving supply curve. The supply curve moves out because entry is induced by the smell of super-normal profits ...



Benjamin Cole said...

I do not know what is the appeal of Piketty's book. Even accepting its main premise---that wealth becomes concentrated---one must admit only if the wealthy reinvest.
Even so, I think beating the market is hard.

randy said...

It is one thing to argue that Piketty's assertions are based on faulty economics. My simple mind could never quite understand how it's possible for R to be greater than G for an extended period of time. It's another thing to ignore that wealth has become more concentrated, and to recognize that in the long run, it's unhealthy - and yes unfair - when those gains aren't from some tangible production, but rather financial engineering. I don't blame the wealthy. To a large extent it is a result of artificially low interest rates for too long, and globalization / tech driven productivity. It's easy to complicate the debate but IMO that's pretty much what it comes down to. There are things that can be done to improve the outcome - but simply taxing the wealthy and transferring that to others for consumption is not going to help.

William said...

Jack Ma's, the founder of Alibaba, had an interesting take on the issues Randy's raises. Before the IPO, he clearly stated that he didn't think that shareholders and shareholders value were the number one goal in managing a company. Here is the quote from the Financial Post 20 OCT 14:

“Putting the shareholders first is capitalism’s biggest mistake,” Mr. Ma said in a 2013 interview. “Shareholders do not have a long-term vision for the company.”

Rather, Mr. Ma’s business model, as articulated in a letter accompanying the prospectus for what would become Alibaba’s record-setting IPO, is: “customers first, employees second and shareholders third.”.

CurmudgeonlyTroll said...

It's all about the elasticity of substitution between capital and labor.

If capital and labor are not very substitutable, i.e. you always need one worker and one unit of capital, and if you have more capital it stands idle, then labor does well. The more capital you have, the more labor you need.

If it's easy to substitute labor for capital, for example you could cheaply make robots that do everything humans can do, then you could get a situation where you get massive accumulation in capital, while the labor share declines.

Piketty thinks the elasticity is > 1, and the recent drop in labor share is an iron law of technology and capitalism, while when labor did well it was temporary effect of war, policies that hurt capital...others think the drop in labor share is a temporary effect of globalization and over time the marginal return on capital will decline.

CurmudgeonlyTroll said...

meant to link to Summers, here are the links again, apologies for not previewing before posting

Noah Smith
Robert Solow
Larry Summers

Joseph Constable said...

Lack of redistribution did not cause inequality.

Brad Napper said...