The Most Important Economics Book Ever Is All Wrong

It's hard to think of another book on economics published in the past several decades that's been praised as lavishly as Thomas Piketty's "Capital in the Twenty-First Century." The adulation tells you something, though not mainly about the book's qualities. Its defects, in my view, are greater than its strengths — but the rapturous reception proves that the book, one way or another, meets a need.

Martin Wolf of the Financial Times calls it "extraordinarily important." Paul Krugman, writing in the New York Review of Books, says it's "truly superb" and "awesome." Branko Milanovic, a noted authority on global income disparities, calls it "one of the watershed books in economic thinking." Even John Cassidy, in a relatively balanced appraisal for the New Yorker, says "Piketty has written a book that nobody interested in a defining issue of our era can afford to ignore."

That issue is inequality, and in confronting it Piketty should certainly be applauded for his ambition. The title invites comparison with Karl Marx's great work, and the author offers nothing less than a general theory of capitalism.

Better still, his theory makes arresting claims — "that a market economy," as Piketty puts it, "if left to itself, contains powerful forces of convergence [in the distribution of wealth]…; but it also contains powerful forces of divergence, which are potentially threatening to democratic societies and to the values of social justice on which they are based." And he argues that the divergent forces are likely to be more powerful in the 21st century than they were in the 20th.

When it comes to exploring historical data on incomes and wealth, Piketty is second to none in industry and ingenuity. It's how he made his name as a scholar, and the book, as you would expect, is packed with new information. (A companion website puts all the numbers and sources online.) In addition to intellectual ambition and tireless excavation of the historical record, Piketty brings a zeal for accessibility: He writes in non-technical language, with almost no mathematical apparatus to confound the interested non-specialist.

All of which is grand. So what's the problem?

Quite a few things, but this to start with: There's a persistent tension between the limits of the data he presents and the grandiosity of the conclusions he draws. At times this borders on schizophrenia. In introducing each set of data, he's all caution and modesty, as he should be, because measurement problems arise at every stage. Almost in the next paragraph, he states a conclusion that goes beyond what the data would support even if it were unimpeachable.

This tendency is apparent all through the book, but most marked at the end, when he sums up his findings about "the central contradiction of capitalism":

The inequality r>g [the rate of return on capital is greater than the rate of economic growth] implies that wealth accumulated in the past grows more rapidly than output and wages. This inequality expresses a fundamental logical contradiction. The entrepreneur inevitably tends to become a rentier, more and more dominant over those who own nothing but their labor. Once constituted, capital reproduces itself faster than output increases. The past devours the future. The consequences for the long-term dynamics of the wealth distribution are potentially terrifying …

Every claim in that dramatic summing up is either unsupported or contradicted by Piketty's own data and analysis. (I'm not counting the unintelligible. The past devours the future?)

As he explains elsewhere, r>g isn't enough by itself to trigger the dynamic he describes. If capital grows faster than the economy, inequality will indeed tend to increase because ownership of capital is concentrated — though much less so than in the past. But capital will outpace the economy only if owners of capital save a sufficiently large part of the income they derive from it. (Suppose they save none of it: Their wealth won't grow at all.)

You might say this misses the point. Wolf offers this clarification: Piketty "argues that the ratio of capital to income will rise without limit so long as the rate of return is significantly higher than the economy's rate of growth. This, he holds, has normally been the case." That's better: The gap between r and g has to be "significant." The bigger the gap, the more likely it is that saving will build capital faster than output rises — and Piketty does show that the gap usually has been big.

The trouble is, he also shows that capital-to-output ratios in Britain and France in the 18th and 19th centuries, when r exceeded g by very wide margins, were stable, not rising inexorably. The same was true of the share of national income paid to owners of capital. In Britain, the capitalists' share of income was about the same in 1910 as it had been in 1770, according to Piketty's numbers. In France, it was less in 1900 than it had been in 1820.

What about the 21st century? Perhaps the capitalists' share will rise inexorably in future — and that's what matters.

Perhaps it will, but Piketty advances reasons to doubt this too. He expects r to be a bit lower and g a bit higher than their respective historical averages. There are many other factors to consider, as he says, but on his own analysis the chances are good that the future gap between return on capital and growth will be smaller than the gap that failed to produce an inexorably rising capital share in the two centuries before 1914.

As I worked through the book, I became preoccupied with another gap: the one between the findings Piketty explains cautiously and statements such as, "The consequences for the long-term dynamics of the wealth distribution are potentially terrifying."

Piketty's terror at rising inequality is an important data point for the reader. It has perhaps influenced his judgment and his tendentious reading of his own evidence. It could also explain why the book has been greeted with such erotic intensity: It meets the need for a work of deep research and scholarly respectability which affirms that inequality, as Cassidy remarked, is "a defining issue of our era."

Maybe. But nobody should think it's the only issue. For Piketty, it is. Aside from its other flaws, "Capital in the 21st Century" invites readers to believe not just that inequality is important but that nothing else matters.

This book wants you to worry about low growth in the coming decades not because that would mean a slower rise in living standards, but because it might cause the ratio of capital to output to rise, which would worsen inequality. In the frame of this book, the two world wars struck blows for social justice because they interrupted the aggrandizement of capital. We can't expect to be so lucky again. The capitalist who squanders his fortune is a better friend to labor than the one who lives modestly and reinvests his surplus. In Piketty's view of the world, where inequality is all that counts, capital accumulation is almost a sin in its own right.

Over the course of history, capital accumulation has yielded growth in living standards that people in earlier centuries could not have imagined, let alone predicted — and it wasn't just the owners of capital who benefited. Future capital accumulation may or may not increase the capital share of output; it may or may not widen inequality. If it does, that's a bad thing, and governments should act. But even if it does, it won't matter as much as whether and how quickly wages and living standards rise.

That is, or ought to be, the defining issue of our era, and it's one on which "Capital in the 21st Century" has almost nothing to say.

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