AEI’s Kevin Hassett provided a pointed critique of Thomas Piketty’s new book, “Capitalism in the Twenty-First Century,” Tuesday, telling an audience at the Tax Policy Center that Piketty’s prediction of a “potentially terrifying” future, in which capitalism collapses under the weight of wealth concentration, is not grounded in economic reality. Hassett showed that Piketty’s analysis doesn’t factor in the actual relationship between capital and labor, existing taxes and transfers, the negative effects of a global wealth tax, and the global decline of income inequality resulting from capitalism.
Piketty, a professor at the Paris School of Economics, argues that when the rate of return on capital exceeds economic growth, there is increasing wealth concentration. This dynamic was held at bay during the 20th century by the world wars (which destroyed significant portions of capital stock) and population growth. However, such forces may not occur in the 21st century. If capital accumulation continues unchecked and growth remains slow, Piketty posits that the wealth-income disparity could reach or surpass 19th century oligarchic levels and result in political and social upheaval. He proposes a global wealth tax as the solution to rising inequality.
Hassett, appearing with Piketty, argued that Piketty’s argument rests on the assumption that the elasticity of substitution between capital and labor is greater than 1, which is to say that capital and labor can be easily substituted. This would mean that higher levels of capital accumulation by wealthy people would not reduce the return on capital very much, so that capital share of income would skyrocket.
However, Hassett points out that the elasticities in the economics literature are much lower than Piketty needs to support his story, and even these estimates are high because they exclude structures from the analysis, something Piketty includes. In plain English: if you cannot make a hamburger with a building, then capital and labor cannot easily be substituted for each other, and the collapse of capitalism that Piketty predicts does not occur.
A significant portion, and in some countries the entire amount of the observed increase in capital’s share of national income in Piketty’s data, is attributable to increases in housing. Indeed, if housing is excluded, the sharp increase in capital is almost eliminated, and the collapse of capitalism he projects disappears. This is especially important because housing cannot be substituted with labor (e.g. people holding umbrellas cannot substitute for houses), which again casts doubt on the idea that the elasticity of substitution of capital and labor is greater than 1. Moreover, Piketty’s entire framework to address the link between capital and growth is based on the idea that capital is like a robot or a machine. But his data are dominated by capital movements that cannot be modeled well by his approach.
In his policy proposals to combat the explosion of wealth that he predicts, Piketty dismisses the “serious efficiency costs” of a wealth tax and its impact on savings. This is especially problematic for him, since the redistributive income taxes he proposes are far more harmful to the economy when the elasticity of substitution between labor and capital is large. Generally, those who support high marginal tax rates do so because they believe that elasticities are small. Piketty’s evidence and policy position, then, are inconsistent with one another. (He also largely dismisses the consumption taxation literature for no clear reason.)
Piketty examines pretax, pretransfer incomes over the past several decades, a time during which the US has massively expanded its transfer programs. Indeed, transfers have increased relative to GDP more than the income share of the top, so ignoring them has a significant impact on the results. When assessing incomes in the US on a post-tax, post-transfer basis, income inequality is much less severe than the levels identified by Piketty. When assessing inequality on the basis of consumption, it is even less pronounced. However, Piketty does not examine consumption inequality. By focusing on only part of the overall story, capitalism appears to be unstable, whereas the political process has produced fairly stable consumption shares through expanded transfers.
Piketty’s view of inequality on a within-country basis fails to acknowledge that capitalism has led to a decline of income inequality globally and has helped lift millions of people out of abject poverty. If the world implements a global wealth tax, as he suggests, we could curb that progress in the developing world and perhaps increase global inequality.
Piketty argues that political power becomes as concentrated as wealth. For him, this is a key reason to aggressively redistribute income. Hassett points out, however, that transfer programs have increased dramatically while incomes have become more concentrated. If the wealthy and politically powerful were using their political might to increase their own welfare at the expense of others, one would expect to see the opposite pattern.
Piketty’s critiques of capitalism were predicted decades ago by Joseph Schumpeter. Schumpeter predicted that academics would have “a group interest in shaping a group attitude that will much more realistically account for hostility to the capitalist order than could the theory,” and that capitalism would sow the seeds of its own destruction by sending the children of capitalists to universities that bombard them with anti-capitalist propaganda. Hassett argues that this threat to capitalism seems at least as plausible as that mentioned by Piketty.
Hassett’s full powerpoint deck (and charts) can be found here.
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