Deirdre McCloskey Versus Thomas Piketty

See Has Thomas Piketty met his match? Well, I think I might have met his match. She's called Deirdre McCloskey. By Evan Davis of the BBC. Excerpt: 

"McCloskey, by contrast, has long argued that economists are far too preoccupied by capital and saving. She doesn’t even like the word capitalism, on the grounds that capital is not what got us where we are today. ‘If Scotland is trying to become Holland, then capital accumulation is how to do it. That will double your income, maybe triple it.’ But for her, that sort of accumulation is a scratch-card-sized prize — and the lottery jackpot beckons. She enthuses about the Great Enrichment of the 19th century. ‘What happened, understand, is not 100 per cent growth, but anywhere from 2,900 per cent growth to 9,900 per cent growth. A factor of either 30 or 100.’

That jump in incomes came about not through thrift, she says, but through a shift to liberal bourgeois values that put an emphasis on the business of innovation. In place of capitalism, she talks of ‘market-tested innovation and supply’ as the active ingredient of our economic system. It is incidentally a system ‘drenched’ in values and ethics overlooked by economists.

Professor McCloskey has a point, of course. Think of the Bill Gates and Steve Jobs, big wealth accumulators in recent times. It wasn’t the magic of compound interest on capital that made them rich; it was intellectual property. They created billions of dollars of business from virtually nothing at all. If you measure the profits as a return on the small amount of initial capital invested, then it looks huge; but capital was no more important an ingredient of the original Apple or Microsoft than cookies or cucumbers.

And to me, this is one big distinction at the heart of the wealth equality debate: whether capital — past accumulation of savings — gets to devour the future, or whether the future is created afresh by each generation. This argument is a struggle between those who think riches are created from riches, and those who think riches are created from rags. Are big profits best viewed as a generous return on capital, in the way that worries Piketty? Or as coming from innovation that ultimately benefits us all?

The answer to that question determines what should be done about inequality. Piketty wants a progressive tax on wealth to prevent high returns entrenching the power of the richest. McCloskey, needless to say, is not keen on redistribution. Taking from today’s rich may give you a one-off uplift in the incomes of the poor of, say 30 per cent, she says; but that is nothing to the uplift from innovation and growth, which can double incomes every generation.

So much for the central disagreement between them. Here’s my problem. Many people with strong views on inequality consciously or unconsciously think of this as a binary choice: profits go to either a deserving or undeserving rich, depending on your view. It’s all about capital, or all about wealth creation. But I struggle to see it that clearly. I’d like to know how much of the return on capital that so concerns Piketty is actually income earned from entrepreneurial wealth creation. I’d also like to know how important that income is to innovation.

Piketty is well aware of this vulnerability in his argument. ‘The return on capital often inextricably combines elements of true entrepreneurial labour, pure luck and outright theft,’ he says. But it doesn’t seem to bother him very much. He points out that Liliane Bettencourt, heiress of L’Oréal, who ‘has never worked a day in her life, saw her fortune grow exactly as fast as that of Bill Gates’. And he has his doubts about whether Bill Gates’s fortune is a good example of true entrepreneurship or monopoly profit anyway.

Like Piketty, Deirdre McCloskey in principle recognises there may be an opposite view to her own. But in practice, she hurridly dispenses with it. ‘You have to ask what the source of the inequality is. If the source is stealing from poor people, I’m against it. But if the source is, you got there first with an innovation that everyone wants to buy, so you get paid some crazy sum, you ought to be paid so much, don’t you think?’

For McCloskey, entrepreneurial wealth creation is not only the star of the show, but the only member of the cast. She barely recognises the idea that business could legally make profits without at the same time creating value. Fussing about inequality is unnecessary when there is growth and innovation to promote. She is always happy to give a brief history lesson to support her point: ‘Inequality rose in the early 19th century in Britain and the United States. Then it fell. Then it rose. Now we’re talking about the early 20th century. By the early 1920s, inequality was the same as it is now. Then in the 1930s it reversed, and it went down, to the 1970s. Then it started going up. In none of these cases did it change enough that equality was the issue that faced the working class.’ It is innovation and growth that matters.

She is admirably pure in her view, but is it as black and white as she portrays it?

Bill Gates or Liliane Bettencourt? They co-exist, of course, and have both had a pretty good time of it in recent decades. The question is which one better characterises the very rich. And also which risk you would rather take: taxing the Bills at the risk of deterring them from creating Microsofts? Or not taxing the Lilianes, at the risk of letting them become ever wealthier and more powerful while sitting at home doing nothing?"