There’s a new book by French economist Thomas Piketty, called “Capital in the Twenty-First Century,” that supposedly identifies the Achilles’ Heel of the market economy.
Piketty argues that the rate of return to capital is higher than the economy-wide growth rate and that this will lead to untenable inequality as the rich grab a larger and larger share of the pie.
The solution, he claims, is confiscatory tax rates.
Garett Jones of George Mason University has a very good review that casts doubt on Piketty’s hypothesis, but I also think Margaret Thatcher pre-debunked (if I’m allowed to make up a word) Piketty in this classic video from the House of Commons.
Simply stated, if you care about those with lower incomes, your goal should be faster growth.
If the economy is more prosperous, that means a rising tide that will lift all boats.
Piketty’s class-warfare prescription, by contrast, almost certainly will hurt the poor because of anemic growth, largely because higher tax rates will discourage productive behavior and exacerbate the tax code’s bias against saving and investment.
This means less capital and there should be no doubt about the strong link between the capital stock and worker compensation.
But I sometimes worry that this type of analysis sounds too theoretical for a lot of people and that perhaps it would be helpful to offer some tangible real-world evidence.
So it is quite fortuitous that I’m currently in Lithuania as part of the Free Market Road Show and that one of the participants is John Charalambakis, who teaches at the Patterson School of Diplomacy and International Commerce at the University of Kentucky.
In discussing the importance of economic growth, he explained that Singapore and Jamaica were economically similar in the early 1960s and then asked why they are so different today.
I have to admit that I was skeptical. I know Singapore is much richer today, but was it actually the case that it had the same level of per-capita GDP as Jamaica as recently as 50 years ago?
So I looked at the long-run data and John was exactly right. Take a look at this chart and you’ll understand why rapid growth caused by free markets is so vastly superior to the stagnation caused by statism.
I also included the world average for per-capita GDP so you can see that Singapore easily out-paced a lot of nations, not just Jamaica.
P.S. Keith Hennessey of the Hoover Institution writes that it makes more sense to think of the economy as a garden rather than a pie.
The pie metaphor for the economy is misleading and damaging, especially if you place a high priority on economic growth. …because dividing a pie is zero-sum, the flawed metaphor assumes that if one person’s slice grows larger, it comes at the expense of others. The inapt metaphor and its accompanying flawed logic lead one to conclude that when rich people have a larger share of a bigger economy, they do so “at the expense of” others lower on the income scale. …A flower garden is a better metaphor for looking at economic growth and income distribution. A flower’s growth depends on the individual characteristics of that type of flower and that particular seed. …the rapid growth of a sunflower at one end of the garden largely does not come at the expense of a struggling tulip at the other end. The sunflower may have advantages the tulip does not, even unfair ones, but the fast-growing sunflower is not “taking growth” from the slow-growing tulip. Flowers will grow at different rates for a variety of different reasons. Policymakers should focus their energies on absolute growth rates rather than relative ones.
Or, if he isn’t correct, it’s because the garden analogy doesn’t go far enough. If my neighbor is akin to a fast-growing sunflower, that presumably creates more wealth that will benefit me and the other tulips of the world.
In other words, I’m more likely to get richer if my neighbor gets richer.
But if you like the “pie” approach, then this pizza graphic is very appropriate because it gets across the message that the pie isn’t fixed in size.
P.P.S. For more on the inequality vs. growth issue, here’s my PBS debate.
P.P.P.S. The indispensable Tim Carney addresses the relationship between growth and inequality in this post.
P.P.P.P.S. Last but not least, here’s a post with some very sage analysis by George Will, Ronald Bailey, and Scott Winship.
In other words, Mr. Bishop, your solution is to slow down productivity gains? Bring improvement to a halt? If we improve too much, there won’t be any jobs available for all of the workers? Maybe we could do something to restrict the supply of workers – should we institute state controls on how many workers we are allowed to produce?
This brings to mind a story I heard about Milton Friedman visiting a construction project in India. He noticed very little heavy equipment in use, with most of the digging being done by men with shovels. So, he asked the construction supervisor about it, who responded that this was a “jobs” project and that if they used heavy equipment, many jobs would be lost. To that, Mr. Friedman replied that he should then take away the shovels and give all of the workers spoons to dig with.
I’m really hoping Mr. Dan will respond. I don’t have the economics background to provide a learned response, but there is something about your comment on productivity – that the ever-increasing productivity will result in “simply no longer require[ing] all currently available labor to remain at full productivity” – that just does not ring true to me. It seems to me that as productivity increases in one area, labor will naturally be diverted to other areas, with that process of resource reallocation repeating itself indefinitely. You seem to believe there is some sort of broad-scale productivity ceiling beyond which we cannot go. I’m not convinced that exists.
You are only looking at the numerator! There is obviously some benefit to everyone owing to economic growth resulting from increasing productivity and productive returns to capital. But your story, and moral, takes an enormous misstep in overlooking the ongoing structural transformation in the relationship of labor to capital. Capitalism has been astonishingly successful in fulfilling its (narrow) promise. The system has produced and distributed more goods and services of higher quality to more people at lower cost than anyone might have imagined. And therein lies the root of the problem. Increases in efficiency and productivity are driving the marginal cost of pretty much everything toward zero. With every new technological innovation we increase the productivity both of labor and of capital. We simply no longer require all currently available labor to remain at full productivity. The divergence between the size of the growing (potential) labor force, and the declining demand for labor relative to any measure of output will continue just as surely as innovation will continue. As we become more and more productive and efficient, we will consume less and less labor. This MAY be good if you are a capitalist, but it is clearly not good if you are a laborer.
You casually misconstrue income per worker as related to (or even the proxy for) wages (or mean/median wages). Income per worker will continue to rise as capital becomes increasingly efficient and productive, AND as the number of workers employed per unit of output declines. (The numerator goes up while the denominator goes down.) This may be very nice for general accounts, but is very bad both for people who work for a living, and for those who would like to be working. Over time, as has been observed by so many others, both aggregate and proportionate returns to capital will increase, while they will decrease for labor. Income disparities will grow not only not only between labor and capital, but between the laboring and the unemployed.
To combat this so as to maintain both society and the republic, we can either perpetually transfer wealth and income from the productive to the non-productive, and pay people not to work, much as we now pay people not to farm, and so on, or we must figure out how to put a great many people to work by consuming “something else.” (Preferably something that demands high labor inputs.) Since the innumerable successes of capital and “the market” have effectively satiated many of us in terms of private material goods, it seems likely that we may have to look to significant expansion of the public realm in which to create the markets needed to consume surplus labor.
I agree with Picketty that the fundamentals for further inequality rises are present in today’s globalized world. This is simply because the benefit offered by exceptional people in today’s world can reach billions in short order. In other words, the benefit that exceptional people provide in today’s ever globalizing world has greatly increased. Since the benefit offered by exceptional individuals is now greatly magnified, it only makes sense that their personal rewards be equally magnified, leading to greater inequalities.
The voter-lemming groups that leave this reality — and the steeper effort-reward curves it implies — unadulterated will prosper in an ever more unequal but ever more absolutely prosperous environment. Those electorates that try to go against this reality by flattening the effort-reward curve will develop along more modest growth trendlines and thus inevitably compound their nations into decline.
This will be the main mode in which successful societies will break away from the not so successful ones in the next few decades. Like in all evolution, most branches dead-end. Few will be spared and define the successful dominant surviving branch. For the last two centuries America has been that branch, the America that has now finally decided to culturally converge to the rest of the world. That is why Americans are in for a rude awakening, poised to experience decline, as their growth decelerates to a more European 1-2% trendline while the world as a whole continues its 4% ascent, drowning the once lucky Americans into mediocrity.
The American voter-lemmings who once left the effort-reward curves unadulterated by have now joined the rest of the world along a more socialist path, will see their prosperity ride along a lower growth trendline and eventually compound their once enviable standard of living into the rising worldwide average.
Can we copy the rest of the world? Can we decline? “Yes we can!” Of course! Not only you can, but it is the absolutely natural thing to do. The siren song of an easier, more distributed communal prosperity is always popular. How do you suppose so many other nations declined?
Yes, but we can redistribute that 17-20% trickle into our salaries…. and we will stop growing since nobody will have any motivation to do anything exceptional — not the least of, exceptional enough to outcompete most other companies worldwide. But a 17-20% immediate redistribution today is worth 5% compounding growth into perpetuity. Isn’t it? Is my arithmetic wrong?
“Trickle down” is an appropriate metaphor for capitalism, but it’s the capitalist that gets the trickle.
When starting a company it is the capitalist that temporarily loses money invested. It goes out to the new workers hired and his suppliers. In the pre-production phase, the capitalist loses seed capital while others win. There is no guarantee that he will ever get his money back.
If the company seems to be successful, profits are reinvested, while workers and suppliers continue to receive earned income.
When growth begins to level off, workers and suppliers still receive most of the revenues. In the normal company salaries are 4-5 times profits. Out of those profits only a minor percentage is paid in dividends.
Better in the Venezuelan 2nd from the top quintile than the Singaporean 2nd from the bottom quintile! It’s all relative. When you are surrounded exclusively by other poor people, you just FEEL better. Those who refuse to understand this fact must be made to understand it, or just live with it. After all, “Yes we can”, so what choice do they have?
The real Achilles heel is that the Fed treats wage growth as inflation. Their “dual mandate” has become a double standard. Ever since we broke the monetary system in 71, the definition of inflation changed from a decline in the value of the dollar (against commodities, gold) to an increase in an arbitrarily constructed lagging index. After getting the cause and effect of the 70’s backwards, then to “get ahead of the curve,” the academic economists at the Fed settle on wages as a “leading indicator” because labor is an input cost to everything.
As a result, income growth for the bottom 90% is flat…FOR FORTY YEARS!. This is the only true problem we face, everything else (spending, deficit, debt, obamacare, entitlement solvency, popularity of socialism among youngsters, etc) is a symptom.
I submit that we will never again see sustained across the board prosperity as long as we continue to allow the Fed to treat wage growth as inflation.