2 Apr 2016

On Picketty’s Capital: Part One

There is a substantial amount of literature already in existence concerning Thomas Picketty’s Capital in the 21st Century. Although it may seem a little superfluous, then, to add my own thoughts, I have two good reasons for going so. The first is that as an A-level economics student, it is beneficial for me to gain a good understanding of the theses presented in Capital; and what better way to do that than by writing on it?

The second is that I have a number of minor observations regarding Picketty’s work, especially in historical terms, which I feel I ought to share.

So, with that, allow me to present my thoughts.

Capital in the 21st Century: A Bold Proclamation

The most obvious thing that immediately strikes me when reading Capital is the sheer scope of the thing. Picketty, unlike many economists, doesn’t bother with narrow micro-analysis of what is, in both historic and economic terms, an insignificant period of time. Picketty’s work spans centuries of data, not decades.

I feel this gives Picketty a perspective very much lacking in the works of other economists. Whereas other economists make bold proclamations on the basis of insufficient data—for example, by heralding a new age of growth following only two decades of postwar economics—Picketty can take a much more long term and nuanced view of economic history.

It’s particularly fascinating to see how the so-called ‘conservative revolution’ of the 80s very much resembles the economic order prevalent throughout the 19th century and into the Great Depression. I therefore find it ironic that Thatcherites claim to be ‘modern’ (and the leftists backward, by implication) when their economic orthodoxy is the very same that dominated the Victorian era all the way up to the Great Depression.

Picketty’s work also sheds light on what we’ve known for some time, but which too many economists still fail to realise: the three postward decades known as the Trente Glorieuse were Europe playing catch-up, hence the high rate of growth. A very similar thing seems to be occurring in China.

Picketty, interestingly, predicts that Europe and America’s currently high share of world output (close to half, for little more than a tenth of the population!) will decline due to two factors: firstly, nations like China and India closing the gap on per capita economic income; and secondly, low demographic growth in Europe and America compared to the rest of the world.

I feel Picketty’s analysis, while not unreasonable, is perhaps a little optimistic. I for one don’t share Picketty’s belief that the rest of the world will catch up to Europe, Japan and America too soon. China’s growth seems to be stalling (though the time period is too brief to be sure) and I suspect political factors will keep Africa and the Middle-East trapped in 3rd world conditions for time to come.

That’s the thing with economics: politics matters. Terrorism and religious fundamentalism, not to mention civil war and regional conflict, will plague the Middle-East for the foreseeable future. I’m not sure how far China can get with its approach to education, workers’ rights and business practices. And Africa’s success in combating corruption and foreign ownership has been mixed.

Speaking of foreign ownership, Picketty does make some strong points. In particular, he debunks the neoclassical theory of international investment:

In theory, the fact that the rich countries own part of the capital of poor countries can have virtuous effects by promoting convergence. If the rich countries are so flush with savings and capital that there is little reason to build new housing or add new machinery (in which case economists say that the “marginal productivity of capital,” that is, the additional output due to adding one new unit of capital “at the margin,” is very low), it can be collectively efficient to invest some part of domestic savings in poorer countries abroad. Thus the wealthy countries—or at any rate the residents of wealthy countries with capital to spare—will obtain a better return on their investment by investing abroad, and the poor countries will increase their productivity and thus close the gap between them and the rich countries. According to classical economic theory, this mechanism, based on the free flow of capital and equalization of the marginal productivity of capital at the global level, should lead to convergence of rich and poor countries and an eventual reduction of inequalities through market forces and competition.

This optimistic theory has two major defects, however. First, from a strictly logical point of view, the equalization mechanism does not guarantee global convergence of per capita income. At best it can give rise to convergence of per capita output, provided we assume perfect capital mobility and, even more important, total equality of skill levels and human capital across countries—no small assumption. In any case, the possible convergence of output per head does not imply convergence of income per head. After the wealthy countries have invested in their poorer neighbors, they may continue to own them indefinitely, and indeed their share of ownership may grow to massive proportions, so that the per capita national income of the wealthy countries remains permanently greater than that of the poorer countries, which must continue to pay to foreigners a substantial share of what their citizens produce (as African countries have done for decades). In order to determine how likely such a situation is to arise, we must compare the rate of return on capital that the poor countries must pay to the rich to the growth rates of rich and poor economies.

On top of that, he also provides an empirical argument:

Furthermore, if we look at the historical record, it does not appear that capital mobility has been the primary factor promoting convergence of rich and poor nations. None of the Asian countries that have moved closer to the developed countries of the West in recent years has benefited from large foreign investments, whether it be Japan, South Korea, or Taiwan and more recently China. In essence, all of these countries themselves financed the necessary investments in physical capital and, even more, in human capital, which the latest research holds to be the key to long-term growth. Conversely, countries owned by other countries, whether in the colonial period or in Africa today, have been less successful, most notably because they have tended to specialize in areas without much prospect of future development and because they have been subject to chronic political instability.

On Points of History

Since Picketty’s work draws from data as early as 1700, and even as far back as year zero, historical knowledge and accuracy is obviously relevant to his analysis.

Picketty draws a surprising amount of data from literary sources. Jane Austen and Balzac feature in particular. I find these literary sources absolutely fascinating: it reveals a world where money was not only near constant and inflation minuscule, but also in which inequality is well known and quantified.

For example: Picketty mentions that in Jane Austen’s works, a person was only considered wealthy if he or she were able to afford a house, a minimum number of servants (especially maids) and were able to buy proper clothing and arrange suitable transport. To do that, by Jane Austen’s approximation, one needed around the order of 900 pounds a year.

The average worker wage at that time was 30 pounds a year.

What’s especially fascinating to me is not only how well known and extreme the level of inequality was, but how it compares to the 21st century. These days, you don’t need to earn on the order of 3/4 of a million pounds a year in order to afford a nice house, car and clothes; or indeed a vacuum cleaner.

But why is this? Evidently, clothing and domestic chores have become cheaper owing to mass production and the invention of washing machines.

But inequality—is it really that different from the Victorian era? There are people earning a good deal more than £750,000 a year in the world.

Anyway, this is a topic I suspect Picketty will address in later chapters.

I did find a historical point to quibble. Picketty claims Americans have a more benign view of capitalism than do Europeans because the former have always had private property rights—the US government at one time had high rates of marginal taxation and public investment programmes, but it never had the kind of sweeping nationalisation that Britain and France did following the war.

After all, in America the state did not own half of the people’s homes (as it did in Scotland for some time), it did not own car companies like Renault, it did not own banks, it did not own telecom, rail or airlines companies.

But I think Picketty is ignorant of American and European history here. America has always had the Free Man (TM) complex: as Picketty himself mentions, Jefferson had that idea of a nation of free landowners living in equality. These free landowners owned their own land, their own houses, and could live largely indepedently from the government.

We Europeans, on the other hand, see capitalism as something deeply Victorian in nature. We see the work houses of the poor; the vagabonds looking for work, persecuted by the authorities; child workers; and factories with 60 hour weeks, abysmal working conditions, and squalor. The European view of capitalism is Dickensian, not Libertarian.

America’s capitalist fantasy (and it is a fantasy, make no mistake) came about because of a transient state. America, when founded, was a vast territory that experienced high population growth, both internally and from immigration. As Picketty himself makes clear, the abundance of land and the high demographic growth were strong convergence forces that kept inequality under control.

But while the American Dream may have been plausible in the 18th and early 19th centuries, it was bound to run into the realities of capitalism sooner or later. America’s useful land wasn’t infinite. Massive population growth (from 3 million in the 1770s to 300 million today) and massive CO2 pollution—America has one of the largest per capita CO2 emissions in the world, at 17 tonnes per year—cannot be sustained indefinitely by the planet. There are no more Indians left from which to steal land and gold. (See: Oklahoma Land Race, and the Black Mountains of Dakota.) The days of slavery are over.

Picketty himself covers some of this quite well. He has extensive data on how much capital slaves constituted in the Southern states, for example—up to 300% of national income, which is a considerable figure.

But he hasn’t yet put these points together.

My Early Conclusion

So far Picketty’s Capital has proven illuminating, intriguing and relevant to the modern world. I feel much of his analysis is spot on, in part because of the vast amounts of historical data he’s amassed—but also because of his ability to clearly and logically formulate arguments and see problems in other arguments. His points regarding neoclassical international trade theory are especially adroit, but his ability to draw on literary sources as a way of enriching our understanding of economic history is also impressive.

That said, there are a few minor flaws. The first is that thus far, he’s made a few assertions which he hasn’t really backed up a posteriori or indeed a priori. For example: he claims that inequality has forces of divergence and forces of convergence. The most important example of the latter he claims to be the ‘diffusion of knowledge and skills’. Unfortunately, that seems a bit vague to me, and he hasn’t elucidated on what he means either through empirical case studies or with thought experiments.

I suspect he may detail this later on, though, so I’ll refrain from giving firm conclusions at this point in time.

Anyway, those are my thoughts so far. If you found this interesting, keep following: I’ll be writing more as I progress.

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