Thomas Piketty and the Nobelists Why Nobel Laureate Economists Paul Krugman,

Joseph Stiglitz, and Robert Solow All Raved About Piketty's book, Capital In the 21st Century, and What That Tells Us About Capitalism in the

21st Century

Gene EpsteinJunto

August 7th 2014

Old Woody Allen Joke

• “I took a course in speed reading, learning to read straight down the middle of the page, and I was able to go through War and Peace in 20 minutes. It's about Russia."

“Most-unread book”

•“The contest isn't even close. Mr. Piketty's book is almost 700 pages long, and the last of the top five popular highlights appears on page 26. Stephen Hawking is off the hook; from now on, this measure should be known as the Piketty Index.”•--Wall Street Journal, July 3rd

What Piketty’s book is about

• 1. Capitalism leads to ever-widening inequality in income and wealth that…

• 2. …must be curbed by heavy taxes on those who are rich in income and wealth.

My two part presentation-1

• 1. Philosophy, laced with economics– drawing on work of another Nobel laureate economist, F. A. Hayek.

• Even if Piketty is right, why should we care?

1. Even if Piketty is right, why should we care?

• Answer: under free-market capitalism, we shouldn’t; only under crony capitalism should we care, but then heavy taxes on the rich are not the solution.

My two part presentation-2

•2. Economics, laced with sociology.

Is Piketty right?

2. Is Piketty right?

• Answer: No, unless we make unrealistic and ahistorical assumptions about human nature and free markets. And as Krugman noticed, even Piketty scraps his own grand thesis when applied to the U.S., engaging in what Krugman calls “a sort of intellectual sleight of hand.”

Epigraph to chapter in The Constitution of Liberty by F.A. Hayek

I have no respect for the passion for equality

• ,which seems to me merely

idealizing envy.

• Oliver Wendell Holmes, Jr.

Liberty vs. Equality

• "Not only has liberty nothing to do with any other sort of equality, but it is even bound to produce inequality in many respects. This is the necessary result and part of the justification of individual liberty: if the result of individual liberty did not demonstrate that some manners of living are more successful than others, much of the case for it would vanish." --From Constitution of Liberty

Market Order vs. Merit• “It has been argued persuasively that

people will tolerate major inequalities of the material positions only if they believe that the different individuals get what they deserve…. The market order, however, does not owe its origins to such beliefs, nor was it originally justified in this manner.”—Hayek’s Mirage of Social Justice

Market Order vs. Just Price and Wages

• “The [market] order could develop…when a thousand years of vain efforts to discover substantively just prices or wages were abandoned, and the late schoolmen…taught instead that the prices determined by just conduct of the parties in the market, i.e. the competitive prices arrived at without fraud, monopoly and violence, was all that justice required.”—Mirage of Social Justice

Tom Cruise, yes, Jack Welch, no

• “I have never known ordinary people grudge the very high earnings of the boxer…football idol or…cinema star—they seem often even to revel vicariously in the display of extreme luxury and waste of such figures compared with which those of industrial magnates or tycoons pale.”—Mirage of Social Justice

Inherited Wealth? • “Many people who agree that

the family is desirable as an instrument for the transmission of morals, tastes, and knowledge still question the desirability of the transmission of material property.”

From The Mirage of Social Justice

• “It is probably a misfortune that, especially in the USA, popular writers…have defended free enterprise on the ground that it regularly rewards the deserving…. It is therefore a real dilemma to what extent we ought to encourage in the young the belief that when they really try they will succeed, or should rather emphasize that some unworthy will succeed and some worthy fail.”

Piketty on “Merit”

• “Our democratic societies rest on a meritocratic worldview, or at any rate a meritocratic hope, by which I mean a belief in a society in which inequality is based on…merit and effort.”

• Capital in the 21st Century

“The Tenth Commandment Club”

• “We could…use tolerance for luck-based inequality: for the inheritor of a fortune, for the pretty-good CEO who gets an eight-figure bonus just because his company's product went viral… That’s why I propose the creation of the Tenth Commandment Club. The tenth commandment—’You shall not covet’—is a foundation of social peace.”

• --economist Garett Jones

“Needs satisfied”

“[Income] shares [in a free market] are the outcome of a process the effect of which on particular people was neither intended nor foreseen by anyone when the institutions first appeared—institutions which were then permitted to continue because it was found that they improve for all or most the prospect of having their needs satisfied.”

Bleeding-Heart Capitalism

• Free-market capitalism is essential to lifting the living standards of the broad masses of people.

Brookings Institution study

• "The number of people worldwide living in extreme poverty—defined as living on $1.25 a day or less—was cut in half between 1990 and 2010.”

• From two billion people to one billion.

Economic Freedom Index, average

• 102 countries •2010: 6.83

•2000: 6.71

•1990: 5.67

Even the poor have more than ever-1

• --”By 2011…average per capita housing space for people in poverty was higher than the U.S. average for 1980, and crowding (more than one person per room) was less common for the 2011 poor than for the nonpoor in 1970.”

• --Nick Eberstadt, author of The Poverty of “The Poverty Rate”

Even the poor have more than ever-2

• --” More than three-quarters of the 2011 poor had access to one or more motor vehicles, whereas nearly three-fifths were without an auto in 1972-73.”

• --Nick Eberstadt, author of the The Poverty of “The Poverty Rate”

58% of adults own a smart phone*• Age breakdown

• 18-29………..83%

• 30-49………...74%

• 50-64…………49%

• 65+…………….19%

• *Pew research, Jan. 2014

Smartphones eliminate need for…• --landline telephones• --watches• --alarm clocks• --cameras• --pocket calculators• --flash lights• --tape recorders• --compasses• --GPS navigators• --snail-mail letters• --CD players• --radiios

“The Piketty Panic”--Krugman

• “What’s really new about [Piketty’s] Capital is the way it demolishes that most cherished of conservative myths, the insistence that we’re living in a meritocracy in which great wealth is earned and deserved…. But how do you make that defense if the rich derive much of their income not from the work they do but from the assets they own? And what if great wealth comes increasingly not from enterprise but from inheritance?”

“not from work, not from enterprise” Krugman’s Job Offer from CUNY

• “As a distinguished professor in the Ph.D. program in economics, your nine-month salary will be $225,000. During year one (2015-2016), you will not be expected to teach or supervise students. Instead, you will be asked to contribute to our build-up of LIS [Luxembourg Income Study Center] and the inequality initiative and play a modest role in our public events.”

Two-thirds Upstarts

• On the 2013 Forbes list of 400 richest, 261, or nearly two-thirds, were not old-guard but upstarts, self-made billionaires such as Amazon.com's Jeff Bezos, Google's Sergey Brin and Larry Page, Facebook's Mark Zuckerberg, eBay's Pierre Omidyar, and entertainer Oprah Winfrey.

More Entrepreneurs over Time, Not Fewer

• “Entrepreneurs Have Become a Larger Part of the Forbes 400 While Those with Inherited Wealth Have Fallen off the List”

• --Tax Foundation study, July 2014

Joseph Stiglitz on “corporate welfare”

• One stream of the extraordinary discussion set in motion by Thomas Piketty's timely, important book, ‘’Capital in the Twenty-First Century,‘’ has settled on the idea that violent extremes of wealth and income are inherent to capitalism….

• This is actually a superficial reading of Mr. Piketty's work, which provides an institutional context for understanding the deepening of inequality over time.

Stiglitz on “corporate welfare”

• “Our current brand of capitalism is an ersatz capitalism. For proof of this go back to our response to the Great Recession, where we socialized losses, even as we privatized gains…. If it is not the inexorable laws of economics that have led to America’s great divide, what is it? The straightforward answer: our policies and our politics. So corporate welfare increases as we curtail welfare for the poor.”

Crapitalism* in the 21st Century-1

• *contraction for crony capitalism• Hayek: “competitive prices and wages arrived

at without fraud, monopoly, and violence”• Violence: “restrictive licensure” (hair cuts, taxi

cab rides)

Piketty: “spectacular increase in inequality”

Crapitalism* in the 21st Century-2

• .“And what caused and characterized these bubble eras? They were principally caused by the U.S. Federal Reserve and other central banks creating far too much new money and debt. They were characterized by an explosion of crony capitalism as some rich people exploited all the new money, both on Wall Street and through connections with the government in Washington.”

-- Hunter Lewis, author of Crony Capitalism in America

Robert Solow’s Choice

• “Would you rather live in a society in which the real wage was rising rapidly but the labor share was falling…or one in which the real wage was stagnating…so the labor share was unchanging? The first is surely better on narrowly economic grounds: you eat your wage, not your share of national income.”

Robert Solow on Piketty-2

“But there could be political and social advantages to the second option. If a small class of owners of wealth—and it is small—comes to collect a growing share of the national income, it is likely to dominate the society in other ways as well. This dichotomy need not arise, but it is good to be clear.”

Makes a case for limited government

• --Instead of taking money out of politics, take politics out of money.

• --Piketty’s solution to curbing domination by the rich—heavy taxation—will only enhance the power of government over money, and thus encourage the rule of elites and special interest groups, including rule by the majority.

Republic vs. Democracy

• “Historically, a republic was defined in opposition to a democracy, in particular a popular democracy, which to [the Framers] connoted demagogic rule by the masses, whose political power could easily trample on the very rights of liberty and property that government was sworn to preserve.”

• --Richard Epstein, The Classical Liberal Constitution

What This Tells Us About Capitalism in the 21st Century-I

• 1. Envy and covetousness are persistent human traits, creating a perennial welcome-mat for books about inequality.

What This Tells Us About Capitalism in the 21st Century-2

• 2. Advocates of the free market must accept material inequality, but should emphasize that free market capitalism bestows untold riches on everyone.

What This Tells Us About Capitalism in the 21st Century-3

• 3. Advocates of the free market should vigorously oppose Crapitalism (crony capitalism), which does lead to unjust inequality of income and wealth, since it arises from fraud, monopoly, and violence imposed by the state.

• 4. On balance, mainstream economics is part of the problem, not part of the solution.

My two part presentation-2

• 2. Economics, laced with sociology.Is Piketty right?

• (Answer: No, unless we make unrealistic and ahistorical assumptions about human nature and free markets. And as Krugman noticed, even Piketty scraps his own grand thesis when applied to the U.S., engaging in what Krugman calls “a sort of intellectual sleight of hand.”)

Robert Solow

This is Piketty’s main point, and his new and powerful contribution to an old

topic: as long as the rate of return [on capital] exceeds the rate of growth, the income and wealth of the rich will grow

faster than the typical income from work.

r > g

r = return on capitalg = rate of growth

“potentially terrifying”

• If r = 4% - 5%• g = 1%- 1.5%

That gap of a few percentage points, when compounded over many years, can render economic inequality “potentially terrifying.”

How Piketty’s Scenario Might Work for Actual People

• --Children and grandchildren of successful capitalists are equally brilliant as capitalists; generationally, there is no regression toward the mean.

• --People never die; wealth is never diluted over time when left to multiple heirs, or further diluted by estate taxes, philanthropy, or changes in market conditions.

Piketty Assumes no Change in Market Conditions

• On the company level, no firm company ever loses it’s place in the sun. There is no advance-and-retreat.

• --IBM never yields to Apple, Microsoft, or Google.

• --Sears Roebuck never yields to Walmart. • --GM never yields to Toyota.• --Borders books never goes bankrupt; Barnes &

Noble is never threatened by Amazon.

For Piketty capitalism is a system of profits, rather than of profit-and loss

“Capital is never quiet: it is always risk-oriented and entrepreneurial, at least at its inception, yet it always tends to transform itself into rents as it accumulates in large enough amounts—that is its vocation, its logical destination.”

• •“[W]hat could be more natural to ask of a capital

asset than that it produce a reliable and steady income: that is in fact the goal of a ‘perfect’ capital market as economists define it.”

But even Piketty acknowledges it’s not valid, as Krugman admits

• “And yet there is one thing that slightly detracts from the achievement—a sort of intellectual sleight of hand, albeit one that doesn’t actually involve any deception or malfeasance on Piketty’s part. Still, here it is: the main reason there has been a hankering for a book like this is the rise, not just of the one percent, but specifically of the American one percent. Yet that rise, it turns out, has happened for reasons that lie beyond the scope of Piketty’s grand thesis.”

Piketty on the “causes of rising inequality in the United States”

• “The increase was largely the result of an unprecedented increase in wage inequality, and in particular the emergence of extremely high remunerations at the summit of the wage hierarchy, particularly among top managers of large firms.”

• --Capital in the 21st Century

No longer “potentially terrifying”

• Median CEO tenure has been variously estimated at 6 to 10 years.

Piketty’s Explanation for Sky-High CEO Salaries--1

• Corruption at the top—the unholy alliance between executives and the paymasters.

“At the every highest levels salaries are set by the executives themselves or by corporate compensation committees whose members earn comparable salaries (such as senior executives at other large corporations).”

Piketty’s Explanation for Sky-High CEO Salaries--2

• Why didn’t this abuse occur prior to 1980?• Answer: high marginal tax rates• “The very large decrease in the top marginal

income tax rate in the English-speaking countries after 1980…seems to have totally transformed the way top executive pay is set, since top executives now had much stronger incentives than in the past to seek large raises.”

But private company boards are controlled by large shareholders….

• “Private company execs have done even better than public company execs since 1979, the time when pay at the top picked up.”—Steven Kaplan, author of “The Real Story Behind Executive Pay”

Best explanation for exploding CEO pay

• Same explanation for higher pay of Tom Cruise• --U.S. companies are operating in much larger

global market-place, in which stakes are much higher than ever before to find the “right” person.

• --”Free agency” and executive search firms also help.

Final howlers-1

• “Once a fortune is established, the capital grows according to a dynamic of its own, and it can continue to grow at a rapid pace for decades simply because of its size.”

Final howlers-2

• “Of course a US citizen at the median of the wealth distribution has only $100,000 to invest, so he must be his own money manager and probably has to rely on the advice of his brother-in-law. To be sure, financial advisors and money managers are not infallible (to say the least), but their ability to identify more profitable investments is the main reason why the largest [university] endowments obtain the highest returns.”

Focus solely on university endowments

• “For the 500 of 850 universities whose endowment was less than $100 million, the average return was 6.2 percent in 1980–2010 (and 5.1 percent in 1990–2010), which is already fairly high and significantly above the average return on all private wealth in these periods [endnote: 5% in the U.S. from 1980-2010].”

For the investor with “brother-in-law”; total returns from an index fund

•30-year real return ending 2010 was 7.21%.•20-year real return ending 2010 was 7.04%.

•vs. 5-6.2% for smaller endowments and private wealth holders

“The greater the endowment, the greater the return.”

• “For the 60 universities with endowments of more than $1 billion, the average return was 8.8 percent in 1980–2010 (and 7.8 percent in 1990–2010).”

Piketty ignores hedge funds

• Barclay Hedge Fund Index: (average net return of all hedge funds):

• --In 10 years from 2004-2013, the BHFI beat the total returns on the S&P 500 in just 3 years (2005, ‘07, and ‘08).

• --Total returns on S&P 500 exceed the BHFI by a yearly average of 4.9 percentage points.

•

Nobel Laureate Paul Samuelson on Keynes’ General Theory

“It is a badly written book, poorly organized; … It abounds in mares' nests and confusions. In it the Keynesian system stands out indistinctly, as if the author were hardly aware of its existence or cognizant of its properties… In short, it is a work of genius.”

What This Tells Us About Capitalism in the 21st Century-I

• 1. Envy and covetousness are persistent human traits, creating a perennial welcome-mat for books about inequality.

What This Tells Us About Capitalism in the 21st Century-2

• 2. Advocates of the free market must accept material inequality, but should emphasize that free market capitalism bestows untold riches on everyone.

What This Tells Us About Capitalism in the 21st Century-3

• 3. Advocates of the free market should vigorously oppose Crapitalism (crony capitalism), which does lead to unjust inequality of income and wealth, since it arises from fraud, monopoly, and violence imposed by the state.

• 4. On balance, mainstream economics is part of the problem, not part of the solution.

Other Legacies• “Among the…ways in which those who have

gained power and influence might provide for their children, the bequest of a fortune is socially bv far the cheapest. Without this outlet, these men would look for other ways of providing for their chil dren, such as placing them in positions which might bring them the income and the prestige that a fortune would have done…Those who dislike the inequalities caused by inheritance should therefore recognize that…it is the least of evils…”