Friday, June 6, 2014

Piketty's Introduction - Part I

This is a four part series going through Thomas Piketty's Capital in the 21st Century the parts can be found here:
Part I, Part II, Part III, Part IV

Piketty's introduction is the first problem with the book. He manages to get through paragraph one without serious problems but can't manage to extend that record to paragraph two.

Piketty claims
Modern economic growth and the diffusion of knowledge have made it possible to avoid the Marxist apocalypse but have not modified the deep structures of capital and inequality. 
But that's just not right. What is it about modern economic growth that makes it Marx bane as opposed to pre-modern economic growth? Piketty doesn't say up front. Perhaps later, but there doesn't seem to be much discussion of it uncovered by a Google search. The concept of a magical 'modern' economic growth doesn't make much sense. The diffusion of knowledge makes a very vague reference to the real issue of R > G but not in a particularly helpful way. Isn't the very existence of deep structures of capital and inequality the question that Piketty is putatively seeking to answer, ie whether Marx was right all along?

It's only the introduction but it's not looking good so far. Piketty has already revealed that he is assuming his conclusions.

It gets worse
When the rate of return on capital exceeds the rate of growth of output and income... capitalism automatically generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based. 
This is simply not true. You have to have an additional factor for an undermining effect to take place. You have to limit the conversion of individuals who live via labor to individuals who earn a living via capital. There are plenty of people who work to pull up the ladder that enables this conversion but they do not generally reside among the advocates of laissez faire. Piketty's advertised solution, a heavy wealth tax, pulls up the ladder quite effectively. This makes Piketty a decided villain by his own R > G standards.

An illustration should suffice. Take a room full of poor entrepreneurs. Add exactly one money bags investor. The economy will rely on the investor to supply virtually all the capital. Assume that out of 100 business proposals he funds 10 and being the only game in town he does so at quite advantageous terms to himself. 1 is a 100x investment success, 6 are variously successful averaging 4x return, and 3 go bust. The return to capital is clearly going to be greater than economic growth in this situation. But the 100x successful business yields enough money in the heretofore poor entrepreneurs hands that he can fund a venture all by himself and the 6 entrepreneurs can fund another 2 if they act together. The next funding round sees essentially 4 money bags and more businesses being funded. Each subsequent round will see less and less lopsided terms being granted the entrepreneurs. After all, they can play one investor off against another. More and more of the poor entrepreneurs will either propose or be part of a successful team. More and more deals will be self-financed. Eventually you get to a balance. This is the deep structure of capitalism and it is very different from what Piketty is assuming.

Now add Piketty's famous wealth tax and what happens. The money bags won't be investing in 10 businesses, but 7, the balance of his funds being absorbed by tax shelters and lobbying for loopholes in the wealth tax (which empirical observation leads us to guess that he will get but that it absorbs a large amount of time, effort, and money). The 100x entrepreneur winner in the first round might still be comfortable but likely not enough to fund the same sort of venture as before and the medium sized winners are fewer and even less capable of enlarging the pool of investors and increasing the fairness of terms in the next round of investment in business.

Piketty is trying to claim a moral high ground as early as page 1 but unfortunately for him, he is a policy villain. He seems to ignore that R > G is a price signal. This price signal is an encouragement to enter the field of capitalist and invest. Taxing the wealthy is a strong signal not to invest too much, diverting resources.

Piketty claims that "violent political conflict" is something that "inequality inevitably instigates". I look forward to seeing the data that proves this claim because I do not believe it to be true. Comfortable members of the middle class are not going to be going out into the streets because the rich are getting more comfortable faster. They are especially not going to be doing it when the path to their own riches clearly remains open if they wish to exert themselves. Inequality, per se, does not lead to violence. Additional factors have to be present.

I'll leave a placeholder here regarding Piketty's discussion on oil prices and urban land as he explicitly says that he'll provide a nuanced discussion later. Suffice to say his introductory remarks do not instill confidence. That the Chinese have (wisely or foolishly) built many empty cities demonstrates that increasing the supply of urban land is not that difficult. As for oil, there is a ceiling price to oil, and it's dropping. Fischer Tropsch plants can convert other hydrocarbons to liquid fuels. So long as the extensive investment costs can be recovered, a persistent level of high oil prices is simply not going to happen and that is putting aside the more exotic substitute goods of electric and fuel cell powered vehicles.

We are barely into page 7 of a 35 page introduction and this is already getting long for a blog post so I will stop here and add a 'part I' to my title.

Update: Piketty partially addresses the issue of substitute goods in footnote 3. I say partially because he claims that finding these substitute goods "can take decades to accomplish" which is weasel wording at best. Modern economies research pieces of substitute goods, often decades before they are generally needed and leave the results in patent offices and scientific journal, dormant until we approach the conditions where they become practical whereupon the vision of riches leads to their resurrection more often than not. Large price swings actually create a positive influence in this process as can be seen in the fits and starts refinement process that has made Fischer Tropsch a practical substitute good for drilling oil. At this point, it is only the long lead times for recouping investment and the uncertainty of how quickly other substitute goods for transportation fuel will emerge that are holding back this technology.

it's become clear to me that footnotes are where Piketty is going to be burying the inconvenient facts he must cover to save his reputation while minimizing the number of people who actually walk away with an appreciation of those facts. This is not quite an approach that is devoted to the honest search for truth.