Piketty In A Coal Mine

Flooded Marina (Gas Pumps)" by Richard Misrach
“Flooded Marina (Gas Pumps)” by Richard Misrach

A new book by French economist Thomas Piketty has been causing quite a stir in academic circles over the past year. Now, with the translated publication of Capital in the Twenty-First Century, that fervor is about to spill out of the ivory towers and onto the streets. Piketty’s book ambitiously tackles the topic of economic inequality. His central thesis, in absolute simplest terms, is that the very rich are getting richer and the poor are staying put. Those who rely on wage income for their wealth (the middle class and the poor), Piketty argues, are not likely to see their lot improve in the near future. The very rich, who do not rely on wage income because they have capital in the form of real estate, financial assets, businesses, or patents, will continue to see their wealth skyrocket into the twenty-first century. Ultimately, if capital growth continues to exceed overall economic growth, Piketty worries that this striking imbalance will cause the breakdown of democratic institutions and the social fabric of society.

The Washington Post's "Wonkblog" considered this the graph of the year in 2013.
The Washington Post’s “Wonkblog” considered this the graph of the year in 2013.

Whether or not one agrees with his final premise, Piketty has done his fair share of research and is well respected within the economics field. While studying at the prestigious École Normale Supérieure and subsequently while teaching at MIT, Piketty began to collect historical data on income and wealth, something that economists at the time neglected to do. Although Capital in the Twenty-First Century was written for a global audience, Piketty has the data to back up his findings, though it has not gone without criticism. Most of Piketty’s harshest critics paint him as Marxist or Communist, when in reality he is merely challenging certain aspects of the current free market system – the part that contributes to a great deal of economic inequality. But any work that deals with inequality is bound to get political. And as Piketty notes in an interview with the New York Times, he is welcoming the debate.

Piketty’s ideas for solving this rising inequality are perhaps the weakest part of his argument. In his book he calls for a global tax on wealth that is at best impossible and at worst extremely out-of-touch with the political realities that frame any worthy discussion of policy prescriptions in developed countries. But we should not shrug off his work because of his ideas on policy. Piketty succeeds in collecting and presenting decades of historical data on an issue that has come to define the early twenty-first century. Working as an economic archaeologist, Piketty has made some fascinating discoveries. He has dug up a set of evidence that captures in a new light the increasing economic inequality today. His work is best read as a challenge to our current paradigm of economic inequality, not as a revolutionary tale of two cities.

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Growth Under the Haves, the Have-Nots, and the Have-Yachts

Ever since the financial crisis and recession hit in 2007, there has been an increased interest in inequality and it’s effects on economic growth. Most of these arguments have been founded on questions of morality, but also some on pragmatism. Emmanuel Saez at the University of California-Berkeley found that 95% of income gains in the two first two years of the recovery after the Great Recession have gone to the top 1% of income-earners in the United States, leaving the rest of society lagging. More globally, 85 of the richest families in the world control 1 trillion ($1.6 trillion), roughly the same as the bottom 3.5 billion people.

Joseph Stiglitz, Nobel Laureate and one of the leading opponents of global income inequality

The issue of inequality and its effects on growth have been debated for a while. One of the earliest hypotheses was put forward by Simon Kuznets back in the 1950s and 1960s, known as the Kuznets curve. This curve basically showed that, empirically, economic development results first in increasing inequality, reaches a peak, and then reduces inequality. The growth in countries like South Korea and Taiwan has largely debunked this hypothesis. An argument put forward by some academics and leaders is that inequality provides incentives for entrepreneurship due to the fact that they have so much to gain. In poor countries, Robert Barro has written that inequality can lead to growth by letting a few individuals get a good education and invest in businesses. Others, in particular Nobel laureate Joseph Stiglitz, have argued that global inequality distorts economic growth through political economic power that promotes rent-seeking and weak corporate governance over strengthening human capital and ideas of fairness.

Through this quagmire, the IMF recently waded into this global argument with a new paper written by Jonathan Ostry, Andrew Berg, and Charalambos Tsangarides about both the effects of inequality on growth and redistribution’s inequality on growth. In particular, they make a distinction between what they call “market inequality”, which is inequality before taxes and transfers, and “net inequality”, or inequality after taxes and transfers. One of the main conclusions from the study is that more unequal societies tend to redistribute more. This is mostly skewed from industrial states, especially in Europe, that have large amounts of redistribution, cutting down their net inequality.

Lower inequality leads to less sustained growth

The bulk of this study focuses on the findings that the higher the net inequality, the lower the real growth rate on GDP. It also finds no statistical significance on redistribution affecting GDP growth. An example given is that an increase in inequality from the level of the United States (ranked 37) to the level of Gabon (ranked 42) would shave 0.5% off of GDP. The last part of the study looked at the duration of the growth spells. Again, the results show that higher rates of inequality are correlated with a higher risk that the spell of growth will end. Turning to redistribution, if there is already a large amount of redistribution in society, such as in some of the developed countries, further redistribution hurts growth. However, for the lower 75% of countries in the world, redistribution has no discernible effect on the duration of growth.

There are a few caveats that need to be addressed with this study, though relatively minor ones. As with any statistical study, these are only correlations, and correlation should not be confused with causation. Data on redistribution is also light, with this study using a proxy of direct taxes and subsidies. Amazingly, they don’t include government provisions, such as health and education. Both of these factors have been proven in various studies to have positive impacts on growth, including studies from the World Health Organization showing adult survival rates improving GDP growth to studies by Eric Hanushek and Ludger Woessmann showing how years of schooling is correlated with higher GDP growth. As these factors are a little more difficult to quantify, it’s understandable that they were not included in the redistribution factors. However, the results of these studies, along with others, show a general trend that countries could improve education and health spending along with other measures to reduce inequality while having economic growth at the same time.

Inequality in the developing world

How We Define Inequality

"Saying Grace" by Norman Rockwell (1951)
“Saying Grace” by Norman Rockwell (1951)

During the 2008 Financial Crisis and into the Great Recession thereafter, journalists and policy makers alike turned their focus to the seemingly rising inequality in America. As protesters occupied Zoccotti Park in the financial district of Manhattan, their cheers and chants echoing down the side streets towards the New York Stock Exchange, we became a nation divided into 99 percenters and 1 percenters. Inequality has come to be the clarion call of the 2010s. Nearly every news program, town hall meeting, and op-ed these days brings up the topic in one way or another. Yet as Amartya Sen explains in his book Inequality Reexamined, a work that grapples with and expands upon John Rawls’ A Theory of Justice, “inequality” is a slippery term that carries with it many unconscious assumptions that greatly influence how we come to view society.

When speaking of equality, Sen argues, it would benefit us greatly to ask: “Why equality?” and “Equality of what?” Today, when a politician, journalist or blogger mentions inequality, more often than not they are referring to income inequality: the distribution of yearly income for a household or an individual. It is true that income inequality is easy to measure and easy for the majority of the population to understand, but to a large extent it ignores what Sen would call “the basic heterogeneity of human beings” and “the multiplicity of variables in terms of which equality can be judged.” After all, inequality is much more than one’s salary—it is also where you can afford to go to school, the type of groceries you can buy, the safety of your neighborhood, the hospital that you go to when you get sick, the opportunities for a job and much, much more. Understandably, these variables are difficult to measure. But they are just as (if not more) relevant in our nationwide discussion of inequality. Even if distribution were equal, Sen writes, “two persons holding the same bundle of primary goods can have very different freedoms to pursue their respective conceptions of the good.”

Some prominent writers on the subject of inequality turn to the Gini coefficient to measure inequality across nations. This number has dominated much of the conversation on the subject of world inequality. It is, as we will explain later, a useful but perhaps imperfect calculation of inequality. The Gini coefficient, usually expressed as a number between 0 and 1, measures income dispersion by calculating the ratio of the area between the line of perfect income equality and the Lorenz curve. Most commonly it is used to measure income after taxes and transfers (this is a major factor when comparing the US with the EU). An unequal nation will have a Gini coefficient closer to 1 while an equal nation will have a coefficient closer to 0. In recent years the United States has hovered around the .45 mark. Brazil was calculated at .519 in 2012. South Korea and Russia are slightly more equal according to the Gini coefficient, ranking at .419 and .417 respectively in 2011.

Yet as Lane Kenworthy points out in his work Jobs with Equality, the Gini coefficient and its effect on inequality can be misleading. Consider the four hypothetical nations in the box below which have been borrowed from Kenworthy’s book.

Table 1

In Society D, inequality is at its highest (if we look at the Gini coefficient), yet poor households are pulling in more money than any other Society. Rather than rising inequality, Kenworthy argues, what should really concern us is that poverty has not improved in America. We should be looking to increase income at the bottom of the spectrum by providing well-paying jobs. The distinction between poverty and inequality is a crucial one. Additionally, the debate over poverty and inequality changes drastically when one frames the argument in relative rather than absolute terms.

In the end we must consider inequality in all of its forms, quantifiable or not. It would help to examine our end goals as well. What type of equality do we hope to achieve? What, if any, is an acceptable level of inequality? To what extent should we allow people to fail? Additionally, the tools that we use to measure inequality in America are somewhat inadequate in measuring inequality worldwide. It is difficult to translate inequality statistics between nations because each country has unique advantages and disadvantages stemming from geography, political institutions, trade agreements and an array of other factors.  Oftentimes the cost of living in “dollars-per-day” is a better measure of poverty because the price of goods and services varies greatly across the globe. Even if we are  limited in our tools for measuring inequality, that should not discourage us from finding new tools and furthering the conversation.