Piketty Takes Income As Exogenous , Which Leads To Problems

From Tyler Cowen.

"Here is one good part of a consistently good and interesting review:

    Most of the analysis in the book is more about accounting than economics. Piketty takes nearly everything as exogenous then divides things arithmetically. His ubiquitous r > g heuristic takes both sides of the inequality as given for almost the entire book. Lines like “the richest 10 percent appropriate three-quarters of the growth” (297) enable lazy readers to avoid thinking about what actually determines income. Language about “appropriation” suggests that we live in an endowment economy, as does the claim that post-World War I wealth inequality fell “so low that nearly half the population were able to acquire some measure of wealth” (350). Endogeneity, anyone? Taking income as exogenous leads to other large problems with inference, such as the claim that “meritocratic extremism can thus lead to a race between supermanagers and rentiers, to the detriment of those who are neither” (417). Piketty does not consider the possibility that this race results in more income than otherwise, nor does he consider the notion that an increase in the bargaining power of elite executives could actually come at the expense of capital owners rather than workers. I’m not making an argument for either here; I’m simply suggesting that Piketty’s ideological quips don’t deserve the certainty with which he delivers them. Models with endowment economies have their purposes, but a 600-page book should be able to relax such strict assumptions. His criticisms of mathematical economics (32, 574) are not surprising given that he relies so heavily on assumptions and mechanisms that would be highly vulnerable to criticism if they were forced into the transparency of a formal model."

Why Piketty’s book is a bigger deal in America than in France

From Tyler Cowen. On The Upshot I have a new piece, co-authored with Veronique de Rugy, here is an excerpt:

 …the book’s timing may be behind the state of French debate. Had it been released in the halcyon days of Mr. Hollande’s 2011 presidential campaign, when many French considered soak-the-rich talk and 75 percent marginal tax rates to be practical fiscal strategies, Mr. Piketty’s book might have made a bigger splash in France. Today, with the economy still struggling, Mr. Hollande is talking about tax cuts rather tax increases. The 75 percent rate has suffered constitutional challenges, and even celebrity backlashes, such as when Gérard Depardieu pursued and received Russian citizenship to lower his tax rate. Mr. Hollande seems to be steering France away from its traditional role as a defender of high taxes and toward some structural reforms, albeit at a slow pace. During his New Year address, Hollande even turned into a rhetorical supply-sider, making the case for cutting taxes and public spending, improving competitiveness, and creating a more investor-friendly climate. In any case, the French appetite for stiff tax increases has diminished.

…Finally, some other French economists have taken the lead in challenging Mr. Piketty’s empirical claims. One recent paper by four economists at l’Institut d’Etudes Politiques de Paris challenges Mr. Piketty’s view that inequality has increased because the return to capital has been greater than general growth in the economy. The current shorthand is “r > g.”

The paper argues that the higher growth of capital rests entirely on returns to housing, and takes technical issues with the book’s treatment of housing, too. If Mr. Piketty’s argument depends on housing, it hardly seems to match his basic story about the ongoing ascendancy of capitalists.

Environmentalists continued to cry wolf when their doom-saying forecasts failed to materialize.

See Getting Overheated by James Huffman, WSJ. Mr. Huffman, dean emeritus of the Lewis & Clark Law School, is a visiting fellow at the Hoover Institution. He is the author of "Private Property and State Power" and "Private Property and the Constitution." Excerpts:

"Even so, environmentalists continued to cry wolf and were undeterred when their doom-saying forecasts of global famine and ecological ruin failed to materialize. The consensus collapsed, and the public grew skeptical, especially the people bearing the significant and often unintended costs of regulation. The acid-rain and environmental-racism scares, writes Mr. Allitt, "turned out to be evanescent." Yet companies had spent hundreds of millions on regulatory compliance. Many apple farmers were put out of business in 1989 by what proved to be baseless claims that the chemical Alar was causing cancer in schoolchildren. And numerous Northwest communities were devastated in the 1990s by a 90% cut in public-land timber harvests, which crippled the timber industry to save the Northern Spotted Owl.

Scientists later found that the greatest threat to this owl was its cousin, the Barred Owl. The environmental lobby seldom acknowledged its failures—or even its successes. Since 1990, there has been a 90% reduction in automobile emissions (and a 99% reduction since 1960), yet the car remains public enemy No. 1. Despite widespread recognition that ethanol has few if any environmental benefits, subsidies and mandated use persist—and food prices have been driven higher by the diversion of corn from food to fuel production."

"Mr. Allitt's account falls short in two important respects. He misunderstands "free-market environmentalists" and bundles them with the "Sagebrush Rebellion" of the late 1970s and the "Wise Use" movement of the late 1980s."

"Free-market environmentalists urged property-based solutions, spurring tradable emission permits, congestion pricing on roadways, volume-based trash-collection fees, transferable ocean-fisheries quotas, and numerous other market approaches. Even EPA administrators "eventually realized," in Mr. Allitt's words, "that it would be better to allow manufacturers to trade in the right to pollute.""

"Thanks to bipartisan legislation of the 1960s and '70s, which opened the courthouse doors to both sides of the environmental divide, scarcely a timber sale or urban-development plan moves forward without courts being asked to assess whether the developer or the government has properly weighed the pros and cons."

Guess Who Makes More Than Bankers: Their Regulators

In 2012 at the Federal Deposit Insurance Corp. the average pay was $190,000. At the Federal Reserve? It won't say.

Click here to read the WSJ article. Excerpts:

"the average annual salary of a bank employee was $49,540 in 2012, not much higher than the average annual across all occupations, $45,790.'

"Before the Dodd-Frank Act, the average employee of a federal bank regulatory agency received 2.3 times the average compensation of a private banker. By 2013 this ratio increased to more than 2.7—and in some cases considerably more.

The average compensation at the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corp. (FDIC) and the Consumer Financial Protection Bureau (CFPB) exceeded $190,000 in 2012. "

"At the OCC, secretaries make on average $79,182 per annum. Motor vehicle operators (the agency's limo drivers) at the FDIC earn $82,130. Human resources management trainees at the CFPB make $110,759 a year."

"In 2012, 68% of FDIC and CFPB staff—and 66% at the OCC—earned above $100,000 a year. Nearly 19% of the CFPB and OCC staff earn more than $180,000 a year. At the OCC, 10.5% of workers earn above $200,000 a year, at the FDIC 9.3%.

Fewer than 7% of employees in any of these regulatory agencies earned less than $50,000. In other words, 93% of the employees in these federal bank regulatory agencies earned more than the average banker's salary in 2012."

"The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 permitted federal bank regulatory agencies to establish their own compensation and benefits without the approval of the Office of Personnel Management."

"Salary premiums are especially large for easy-to-fill jobs that require no specialized, hard-to-hire skills."

"all federal bank regulatory agencies (except the Fed) are now allowing employee unions to negotiate compensation. Only a few other, small, government agencies can set employee pay independent of the government's general scale."

"Who pays for these generous salaries? Bank shareholders pay directly through insurance premiums on deposits and examination fees levied by the bank regulatory agencies."

"The runaway labor costs of these regulator agencies are not subject to congressional control, and they add up. Employee compensation accounts for about 80% of the operating costs of bank regulatory agencies. If the average regulatory employee's compensation were equalized between bankers and regulators, the direct cost of bank regulation would fall by more than 50%."

Student-Debt Forgiveness Plans Skyrocket, Raising Fears Over Costs, Higher Tuition

Some Law Schools Advertise Their Own Plans to Cover Loan Repayments

Click here to read the WSJ article. Excerpts:

"Government officials are trying to rein in increasingly popular federal programs that forgive some student debt,"

"law schools are now advertising their own plans that offer to cover a graduate's federal loan repayments until outstanding debt is forgiven. The school aid opens the way for free or greatly subsidized degrees at taxpayer expense."

"At issue are two federal loan repayment plans created by Congress, originally to help students with big debt loads and to promote work in lower-paying jobs outside the private sector. 

The fastest-growing plan, revamped by President Barack Obama in 2011, requires borrowers to pay 10% a year of their discretionary income—annual income above 150% of the poverty level—in monthly installments. Under the plan, the unpaid balances for those working in the public sector or for nonprofits are then forgiven after 10 years. 

Private-sector workers also see their debts wiped clean—after a longer period of 20 years"

"the future cost of the 2011 program, known as Pay As You Earn, could hit $14 billion a year."

"There is currently no limit on such debt."

 "promising huge debt forgiveness could make borrowers and schools less disciplined about costs. Colleges might charge more than they would otherwise, leading students to borrow more.

Federal data show tuition and fees are up more than 6% a year on average in the past decade,"

"the administration has pushed other changes, such as extending the forgiveness window to 25 years for the most-indebted students."

"The plans' long-term costs have greatly outpaced the government's predictions. In the last fiscal year, debt absorbed by the repayment plans from the most widely used student-loan program—Stafford loans—exceeded government expectations from a year earlier by 90%."

"in 2007, Congress allowed borrowers working in nonprofit and government jobs to have unpaid debt forgiven after 10 years, and cut monthly payments for new borrowers to 15% of discretionary income.

In 2010, it cut those payments to 10% for borrowers who took out loans from 2014."

Solow On Piketty

Nobel Prize winner Robert Solow gives him a very favorable review. See Thomas Piketty Is Right. But this part is interesting.

"He is quite aware that the underlying assumptions could turn out to be wrong; no one can see a century ahead. But it could plausibly go this way."

That does not seem like a strong enough endorsement to go with very high wealth and income taxes.

Mankiw On Piketty

See First Thoughts on Piketty. Excerpts"

The book has three main elements:

1. A history of inequality and wealth.
2. A forecast of how things will evolve over the next century
3. Policy recommendations, such as a global tax on wealth.

Point 1 is a significant contribution. I like this part of the book a lot.

Point 2 is highly conjectural. Economists are really bad at such things. In particular, the leap from r>g to the conclusion of a growing role of inheritance in society seems too large to me. Many capital owners consume much of the return on their capital, so wealth does not grow at rate r. This consumption ranges from fancy cars and luxurious vacations to generous charitable giving. In addition, unless mating is perfectly assortative, or we return to an era of primogeniture, wealth per family shrinks as it is split among children.  So, from my perspective, Pikettty tries to draw way too much from r>g. 

Point 3 is as much about Piketty’s personal political philosophy as it is about his economics. As we all know, you can’t get “ought” from “is.” Like President Obama and others on the left, Piketty wants to spread the wealth around. Another philosophical viewpoint is that it is the government’s job to enforce rules such as contracts and property rights and promote opportunity rather than to achieve a particular distribution of economic outcomes. No amount of economic history will tell you that John Rawls (and Thomas Piketty) offers a better political philosophy than Robert Nozick (and Milton Friedman).

Tyler Cowen On Piketty

See Why I am not persuaded by Thomas Piketty’s argument. Excerpts: 

1. If the rate of return remains higher than the growth rate of the economy, wages are likely to rise and quite a bit.  ...namely that capital accumulation bids up wages.  Piketty suggests we are headed back to something resembling the 19th century.  Well, that was a pretty good time for the average working person in Western Europe"

"... the (risk-adjusted) return on capital hasn’t been that high lately and it has been falling for decades.  This combination of variables — low returns and stagnant wages — does not refute Piketty but it doesn’t exactly fit into his mold either."

2. The crude seven-word version of Piketty’s argument is  “rates of return on capital won’t diminish.”  Is that really such a powerful forecast?  I say over the next fifty or one hundred years we don’t have a very good sense of which factors will show diminishing returns and which will not.   At many points in the Piketty book he seeks to have it both ways: loads of caveats, but then he falls back into the basic model, and he and his defenders cite the caveats when it is convenient.

3. Piketty’s reasons why rates of return on capital won’t diminish are fairly specific and restricted to only a small share of capital.  He cites advanced financial management techniques of the very wealthy and also investing abroad in emerging economies.  Neither of these covers most capital, and thus capital returns as a whole may not be so robust.    Again, is there any particular reason to think either of these factors will outrace the basic logic of diminishing returns, They might, to be sure.  They also might underperform.  In any case this is pure speculation and Piketty’s entire argument depends upon it.

4. The actual increases in income inequality we observe are mostly about labor income, not capital income.  They don’t fit easily into Piketty’s story"

5. Piketty converts the entrepreneur into the rentier.  To the extent capital reaps high returns, it is by assuming risk (over the broad sweep of history real rates on T-Bills are hardly impressive).  Yet the concept of risk hardly plays a role in the major arguments of this book.  Once you introduce risk, the long-run fate of capital returns again becomes far from certain."

Arnold Kling On Piketty

See Robert Solow on Piketty. Excerpts:

"Let me be blunt: Piketty’s nightmare scenario, in which capital accumulates and has a high return, is a terrific scenario for wages in absolute terms. If workers care about what they can consume, as opposed to the ratio of their net worth to that of the capital owners, they would hate to see any policy that might interfere with the high rates of investment that Piketty is envisioning. Note, however, that I personally would not concede that the distinction between workers and capital-owners is as clear-cut as it is in the Solow growth model.

The tone of Solow’s review is generally laudatory. It also is by far the clearest explanation of Piketty’s argument that I have read. It reflects Solow’s command of the logic of economic growth as well as his abilities as a teacher.

I think that Solow arrives at a higher evaluation of the book than I would for two reasons. First, Solow gives Piketty the benefit of the doubt on nearly every uncertain issue. For example, on the crucial assumption that Piketty makes that the rate of return on capital remains steady even as the capital-income ratio creeps ever higher, Solow writes,

Maybe a little skepticism is in order. For instance, the historically fairly stable long-run rate of return has been the balanced outcome of a tension between diminishing returns and technological progress; perhaps a slower rate of growth in the future will pull the rate of return down drastically. Perhaps. But suppose that Piketty is on the whole right.

On another issue, the fact that inequality is high between different workers, not just between workers and capitalists, Solow offers a hand-waving defense of Piketty. Solow writes,

Another possibility, tempting but still rather vague, is that top management compensation, at least some of it, does not really belong in the category of labor income, but represents instead a sort of adjunct to capital, and should be treated in part as a way of sharing in income from capital…

it is pretty clear that the class of supermanagers belongs socially and politically with the rentiers, not with the larger body of salaried and independent professionals and middle managers

To this, I would say: why draw the line at supermanagers? Why not say that the salaries of college professors that are paid out of university endowments are “a way of sharing income from capital”? The way I look at it, the amount of income that does not represent “a sort of adjunct to capital” (including human capital) is miniscule, perhaps less than 1 percent of GDP.

My second disagreement with Solow is that he, like Piketty, omits any discussion of risk as a component of “r.” In that regard, Tyler Cowen’s skeptical review better accords with my own thinking.

The way I see it, Piketty and Solow work with models that incorporate homogeneous workers (with no differences in human capital) and homogeneous capital (with no differences in ex ante risk or ex post returns). The real world is so far removed from those models that I simply cannot buy into the undertaking."

Garett Jones Critiques Piketty

See Living with Inequality: Has Thomas Piketty really found "the central contradiction of capitalism"? Garett Jones is an associate professor of economics and BB&T professor for the study of capitalism at George Mason University. The book he reviews is Capital in the Twenty-First Century, by Thomas Piketty. Excerpts from the review:

"Piketty claims to have uncovered "the central contradiction of capitalism.""

"at some times and at some places, the interest rate is greater than the economy's growth rate."

"capitalists will take over more and more of the economy until something genuinely awful happens, Piketty says. He is vague about what this awfulness might consist of,"

"elites can buy massive political influence, pushing the government to favor well-connected insiders and in the process slowing down the economy."

"So is the central contradiction a [bad] thing? Barely. Even capitalists consume, and they can consume quite a lot."

"Saving is mostly just delayed consumption, as generations of economists have taught, and the only way for capital to grow exactly at the interest rate is for nobody to consume it. Every bit of consumption pushes down the growth rate of capital."

"But between the possibility of spendthrift descendants who fritter away her fortune and the possibility of multiple descendants who divide it into tiny slices, there's good reason to expect the long-run trend will be for the capital of billionaires to grow at about the same rate as the overall economy. Since capital helps the average worker do her job, we should hope that the world's billionaires will be frugal rather than reckless,"

"There's an extra reason to think that capital isn't going to permanently grow at a faster rate than the overall economy: Piketty says it won't. He places great weight on the mainstream economic idea that in the long run the natural tendency of market economies is for capital and the economy to both grow at the same rate,"

"there's no inherent tendency for capital to outpace the economy forever, even when Piketty's "central contradiction" of high interest rates holds. The reason is simple. If the first machine is more productive than the second (i.e., diminishing returns), and if machines wear out and fall apart at a fairly predictable rate—a depreciation rate, in accounting-speak—then it's a safe bet that in the long run capital and the economy will grow at about the same rate."

"if interest rates are high, business owners look for alternatives to capital (such as workers); private demand for capital thus shrinks."

"But while Piketty's contradiction is less an iron law and more a chalkboard speculation, there's still plenty of room for class warfare in our future. A final way to see if capitalists are going to exercise unprecedented influence in the economy is to see whether their share of the economy is at unprecedented levels. Here, Piketty's arduous historical research pays off. For the two countries for which he has data going back more than a century—Britain and France—the answer is clear: Capitalists are claiming a substantially smaller share of the economic pie today than they did in the mid-19th century. Back then capital income was a bit more than 40 percent of total national income. Now it's a bit under 30 percent. So if capitalists—savers, landowners, entrepreneurs, and all the rest—are going to become a bigger deal in the future, they've got a long way to go before they're at 19th-century levels."

"Market-oriented economies that learn to live with inequality will reap the rewards: More domestic capital for workers to use on their jobs, more foreign capital flowing in to a country perceived as a safe investment, and a political and cultural system that can spend its time on topics other than the 1 percent. Market-oriented economies that instead follow Piketty's preferred path—taxing capital heavily, preferably through international consortiums so the taxes are harder to evade—will end up with less domestic and foreign capital, fewer lenders willing to fund new housing projects, fewer new office buildings, and a cultural system focused on who has more and who has less."

"Any tax on capital is a bad idea in the long run, and that the overwhelming effect of a capital tax is to lower wages. A capital tax is such a bad idea that even if workers and capitalists really were two entirely separate groups of people—if workers could only eat their wages and capitalists just lived off of their interest like a bunch of trust-funders—it would still be impossible to permanently tax capitalists, hand the tax revenues to workers, and make the workers better off.

Why? Because the tax on capital would shrink the supply of machines, which workers use to become more productive and earn more."

"a bountiful supply of capital tends to push interest rates in a direction that diminishes whatever is left of Piketty's central contradiction. The "global savings glut" that Ben Bernanke wrote about a decade ago may last quite a while, and that's good for global productivity."

Piketty's Tax Hikes Won't Help the Middle Class

A post by Megan McArdle. It is about Thomas Piketty’s "Capital in the Twenty-First Century." Excerpts: 

"What I want to quarrel with is not the book’s methods or conclusion, but with the general idea that income inequality is the most important thing going on in the world. In terms of how it matters to lived human experience, I doubt it even makes the top 20.

I am not disputing that something unhappy is going on in the global economy. Nor am I disputing that this unhappiness is unequally distributed. But the proportion of this unhappiness due to income inequality is actually relatively small -- and moreover, concentrated not among the poor, but among the upper middle class, which competes with the very rich for status goods and elite opportunities.

If we look at the middle three quintiles, very few of their worst problems come from the gap between their income and the incomes of some random Facebook squillionaire. Here, in a nutshell, are their biggest problems:

1. Finding a job that allows them to work at least 40 hours a week on a relatively consistent schedule and will not abruptly terminate them.
   
2. Finding a partner who is also able to work at least 40 hours a week on a relatively consistent schedule and will not be abruptly terminated.
   
3. Maintaining a satisfying relationship with that partner over a period of years.
   
4. Having children who are able to enjoy more stuff and economic security than they have.
   
5. Finding a community of friends, family and activities that will provide enjoyment and support over the decades.
   

This is where things are breaking down -- where things have actually, and fairly indisputably, gotten worse since the 1970s. Crime is better, lifespans are longer, our material conditions have greatly improved -- yes, even among the lower middle class. What hasn’t improved is the sense that you can plan for a decent life filled with love and joy and friendship, then send your children on to a life at least as secure and well-provisioned as your own.

How much of that could be fixed by Piketty’s proposal to tax away some huge fraction of national income from rich people? Some, to be sure. But writing checks to the bottom 70 percent would not fix the social breakdown among those without a college diploma -- the pattern of marital breakdown showed up early, and strong, among welfare mothers.

Writing checks to the bottom 70 percent would probably alleviate some of the worst stresses of being a single mother -- but even in Scandinavia, the children of single parents still don’t do as well as children raised in intact households. Similarly, an unemployment check eases the financial stress of joblessness, but not the psychological pain of being out of work. To the extent that it helps people to stay on the dole and look for a perfect job that doesn’t exist, it may make people less happy, not more so.

Writing checks to the bottom 70 percent will not prevent a factory from moving to China or find meaningful replacement work for the 50-year-old accountant who has been there for 20 years. It will not bring back the feeling that you can expect each year to be better than the last in tangible ways."

"But when you look at places where a large percentage of the people are completely dependent on government benefits, you don’t really see a great explosion of human flourishing. Nor do I think we would see it if only the checks were larger. Checks do not fix the psychological pain of unemployment or the emotional deprivation of single parenthood. They do not increase social cohesion. They don’t even necessarily cut down on crime; while you’d think there would be an obvious connection between economic conditions and crime, apparently there isn’t."

Obama uses statistical fraud to accuse dry cleaners of gender discrimination, just like his fraud about the 23% pay gap

See Obama uses statistical fraud to accuse dry cleaners of gender discrimination, just like his fraud about the 23% pay gap by Mark Perry of  "Carpe Diem."

"The extent of President Obama’s “revolting pay gap demagoguery” and willingness to spread “statistical frauds” about women’s issues to gain popularity with female voters apparently has no limits. Last week he accused America’s dry cleaners of engaging in systematic and unfair gender discrimination by charging women higher prices than men. Watch the video above as Obama, surrounded by women, says:

We’ll talk about dry cleaners next, right? [Watch all of the women shake their heads in agreement.] I don’t know why it cost more for Michelle’s blouse than my shirt. We got to make sure that America works for everybody.

Obama’s accusation that dry cleaners discriminate against their female customers is based on the same statistical fraud that he uses to attribute the entire 23% unadjusted gender pay gap to gender discrimination by falsely assuming that he’s comparing wages of men and women doing the exact same work. In the case of dry cleaners, Obama’s new statistical fraud is based on the faulty assumption that dry cleaners engage in gender-based discrimination by charging women more than men for having the exact same clothing item cleaned. 
 
Following Obama’s false claims of gender discrimination last Tuesday, the female Executive Director of the National Cleaners Association responded later the same day with this letter to Obama, here’s an excerpt:

Imagine my distress when during your remarks about Pay Fairness, you segued into a smear on the quintessential small business, the dry cleaner, by suggesting you should be targeting them for gender biased pricing. Mr. President, for dry cleaning services, gender pricing is a myth, and we can prove it with the math!

We hope that once you understand the math, you will follow up your national conversation about dry cleaners by publicly correcting the mistaken impression that the media has helped to foster among many Americans, including our First Family

As an industry, dry cleaners do not charge more for a woman’s shirt than a man’s shirt, they charge more for a hand ironed shirt than they do a machine pressed shirt. If you check your own dry cleaning bill, you’ll find that YOU pay more for the laundering and finishing of your hand ironed tuxedo shirt, than you do for the automated processing of your everyday traditional dress shirt! The price is in the math as calculated by the labor required not the gender of the client!

Simple math. Hand ironing takes more time and requires more skill, and therefore costs the cleaner more to produce. Because it costs more to produce, he charges more for the work. 

Hopefully, now that you understand the terrible injustice that has been done to the nation’s dry cleaners, and have made the issue part of the national conversation, you will see how you were misled and take steps to undo the hurt and damage that has been inflicted on fair minded, hard working small businesses.

Cordially,
Nora P. Nealis
Executive Director

Bottom Line: Just like Obama’s wage gap demagoguery implies that companies like Ford Motor Company hire male engineers for $100,000 but then pay women with the same exact credentials and experience a salary of only $77,000, Obama accuses dry cleaners of charging women more than men to have the exact same shirt cleaned and pressed. In both cases (wages and dry cleaning), Obama’s engages in the politically-motivated statistical fraud of comparing apples to oranges, and then uses fraudulent conclusions to appeal to female voters: women are paid less than men for doing the exact same work, and women pay more than men for having the exact same item dry cleaned. Complete false conclusions in both cases."