Thomas Piketty’s CapitalA Critical Review

Professor Hannes H. GissurarsonEuropean Students for Liberty, Bergen

18 October 2014: 14–14.45

Piketty Replacing Rawls as Prophet

Rawls, and the Poor

• Main proposition: Income distribution just if poor are as well off as they can be: maximum of minimum (maximin)

• Let us look at Index of economic freedom, with data from long time and many places

Which Country Better, A or B?

A

B

0 100 200 300 400 500 600 700 800

Income of PoorIncome of Rich

Four Worlds of Freedom

Free

Semi-Free

Semi-Unfree

Unfree

$0 $10,000 $20,000 $30,000 $40,000

Average GDP/capita 2010

Lowest Incomes in Four Worlds

Free

Semi-Unfree

Semi-Free

Unfree

$.000

$2000.000

$4000.000

$6000.000

$8000.000

$10000.000

$12000.000

Average Income of Bottom 10% in 2010

Productive Power of Capitalism

5 135 265 395 525 655 785 915 104511751305143515651695182519550

1,000

2,000

3,000

4,000

5,000

6,000

7,000

World Average GDP per capita 1–2003 AD in $1990

Much Less Violence than in Past

1350 1450 1550 1650 1750 1850 19500

5

10

15

20

25

30

35

40

45

Homicide Rate in Europe per 100,000

Clean Water: Saving Lives

19121916

19201924

19281932

19361940

19441948

19521956

19601964

19681972

19761980

19841988

19921996

020406080

100120140160180200

US Deaths per Million, Water-related Diseases 1912–98

Malaria Typhoid and paratyphoid fever

The Green Revolution

19611964

19671970

19731976

19791982

19851988

19911994

19972000

20032006

20092012

010000002000000300000040000005000000600000070000008000000

World Production of Cereals

Area (Acres) Production (Tonnes)

Escaping the Malthus Trap

1950-1955

1955-1960

1960-1965

1965-1970

1970-1975

1975-1980

1980-1985

1985-1990

1990-1995

1995-2000

2000-2005

2005-2010

0

5.0

10.0

15.0

20.0

25.0

Rate of Natural Increase of Population per 1,000

Similar Countries, Different Paths

• Four Chinese economies: mainland China, Hong Kong, Taiwan, Singapore

• Australia and Argentina, similar natural resources, European immigrants

• Singapore and Jamaica, small tropical islands under British rule

Four Chinese Economies 2011

Singapore

Hong Kong

US

Taiwan

EU

China

0 10000 20000 30000 40000 50000 60000 70000

GDP/capita $

Parting Ways: Australia and Argentina

19301935

19401945

19501955

19601965

19701975

19801985

19901995

20002005

20100

5,000

10,000

15,000

20,000

25,000

30,000

GDP/capita $1990

AustraliaArgentina

Parting Ways: Jamaica and Singapore

19601963

19661969

19721975

19781981

19841987

19901993

19961999

20022005

20080

5,000

10,000

15,000

20,000

25,000

30,000

35,000

GDP/capita $1990

JamaicaSingapore

Seven Nordic economies 2010

Minnesota

South Dakota

Manitoba

Sweden

Iceland

Denmark

Finland

0 10000 20000 30000 40000 50000 60000

GDP/capita $

Swedes in Different Economies

Swedes in Sweden

Average US

Swedish-Americans

0 10000 20000 30000 40000 50000 60000

GDP/capita 2008 $

Gini Coefficient and Lorenz Curve

0 1 2 3 4 5 6 7 80

10

20

30

40

50

60

70

80

90

100

Equal DistributionFactual Distribution

Income Distribution in Four Countries

Iceland

Sweden

UK

US

0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45

Gini Coefficient 2011 Disposable Income

Country of Immigrants

• US subject to waves of immigrants, first from Europe and Asia, now from Mexico and Central America

• Brings down US averages, even if only temporarily

• Creates a statistical illusion

Problem with Gini Coefficient

• Compare two countries with same Gini C.• One then changes in two ways: more people get

educated and more people live longer• Both changes increase Gini Coefficient because

ranks of temporarily poor (students and pensioners) swell

• Does not reflect increased income inequality between groups, only between periods in individual lives

Resurrection of the Dead?

• Data should be critically evaluated• Example: World Bank accepted data on economic

growth from Ceausescu’s Romania which would have had Romanians below starvation level, if extrapolated backwards

• Example: ICP (International Comparison Program) 2005 data cut Chinese and Indian prices by 40%

• Same error, if extrapolated backwards: below existence minimum in 1950

Piketty, and the Rich

• Main proposition: poor do not gain from capitalism

• Capital accumulated by rich, because r > g

• Need for Confiscatory international taxes on wealth and top income

Piketty’s Income Share of 1% Top

19031910191719241931193819451952195919661973198019871994200120080

5

10

15

20

25

30

Sweden United Kingdom United StatesFrance Germany

Problems with Piketty’s Numbers

• Financial Times: Errors in calculations of wealth distribution in the UK

• French economists: inflated real estate prices cause overestimate of wealth

• Neither criticism very relevant to Piketty’s income distribution

• However: no correlation between the redistributive welfare state and income inequality

Problems with Piketty’s Method

• Underestimates bottom income: uses income before transfers

• Overestimates top income: ignores changes brought about by changed taxation, top income becoming more visible

• Method suffers from same problems as Gini coefficient: relative share of top increases if more people study longer or live longer

Impact of Globalisation

• Piketty possibly right that bottom income stagnant or even slightly decreasing

• Competition from China and India: Massive migration into middle class

• Global income distribution become more equal, while income distribution in West less equal

• West only 1 of 7 billion people on earth

Income Share of 90% Bottom, China

0

2000

4000

6000

8000

10000

12000

Average income in ¥2000

Do Data Reflect Reality?

• Data on bottom or average income in West show stagnation in equalised $

• But living conditions of bottom group (and all groups) much better than before

• Takes fewer hours to work for most goods, not only lightbulbs, vacuum cleaners and food, but also books

Why the Super-Rich?

• People with special, non-replicable skills (i.e. earning rent from abilities), innovators, entrepreneurs, entertainers, athletes

• By definition, supply (almost) fixed, while demand flexible

• Suddenly find demand, the market for their services, going from 300 million people to perhaps 3 billion, impact of globalisation

What’s Wrong With Inequality?

• Country with an income distribution D1

• Milton Friedman comes to give a lecture• 1,000 attend, each paying $50• Friedman $50,000 richer, 1,000 people each

$50 poorer: less equal distribution D2

• No problem: everybody is happy• Distribution by choice: from each as she

chooses, to each as she is chosen

More Problems with Piketty’s Ideas

• Rate of return of capital not always higher than economic growth

• Capital not immobile and unbreakable• Capital not in hands of rentiers, landowners and

bondholders, also innovators, entrepreneurs, investors, funds, third sector organisations

• Dispersed by children, divorces, risks, uncertainties

Challenge to Retain Wealth

Barbara Hutton Charles Koch

Reading Balzac

• Piketty quotes Balzac, Old Goriot

• Story of fragile wealth• Goriot penniless• Anastasie’s lover with

gambling debts• Delphine’s husband

failed speculations

Economic Growth

• Piketty’s confiscatory taxes would become a self-fulfilling prophecy

• Immense creative powers of capitalism• Almost unlimited possibilities of economic

growth• Capitalism needs innovators, entrepreneurs

and investors• Welfare state needs taxpayers

Sustaining the Welfare State

Lowest Quintile

Next-lowest Quintile

Mid-Quintile

Next-highest Quintile

Highest Quintile

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

Proportion of US Total Tax Payments in 2000

Laffer Curve for Switzerland and Sweden

0 10 20 30 40 50 60 70 80 90 1000

5000

10000

15000

20000

25000

30000

Tax Revenue per capita in $

Tax Rate % of GDP

SwitzerlandSweden

Rand’s Thought Experiment

• The rich contribute most of tax revenue

• What happens if they emigrate (as they sometimes do)?

• What happens if they choose to disappear: Theme of Rand’s Atlas Shrugged

Further Benefits of the Rich

• Pay for experimental process to turn luxuries into necessities

• Provide risk capital; 1,000 experiments instead of 10

• Have means to fight bureaucratic aggression and government oppression

The Challenge of the Red Queen

19921994

19961998

20002002

20042006

20082010

20122014

20160

5

10

15

20

25

30

Proportion of Gross International Product

EUUSChina and India