Piketty Corrects the Inequality Crowd

The economist’s book caused a sensation last year, but now he says the redistributionists drew the wrong conclusions.

From the WSJ. By Robert Rosenkranz. Mr. Rosenkranz is a financier and economist who promotes civil discourse as founder of the Intelligence Squared U.S. debates.

Excerpts:

"Though his formula helps explain extreme and persistent wealth inequality before World War I, Mr. Piketty maintains, it doesn’t say much about the past 100 years. “I do not view r>g as the only or even the primary tool for considering changes in income and wealth in the 20th century,” he writes, “or for forecasting the path of inequality in the 21st century.” 

Instead, Mr. Piketty argues in his new paper that political shocks, institutional changes and economic development played a major role in inequality in the past and will likely do so in the future.

When he narrows his focus to what he calls “labor income inequality”—the difference in compensation between front-line workers and CEOs—Mr. Piketty consigns his famous formula to irrelevance. “In addition, I certainly do not believe that r>g is a useful tool for the discussion of rising inequality of labor income: other mechanisms and policies are much more relevant here, e.g. supply and demand of skills and education.” He correctly distinguishes between income and wealth, and he takes a long historic perspective: “Wealth inequality is currently much less extreme than a century ago.”"

"The r>g formulation always struck me as unconvincing. First, Mr. Piketty’s definition of r as including “profits, dividends, interest, rents, and other income from capital” conflates returns on real business activity (profits) with returns on financial assets (dividends and interest).

Second, it ignores the basic rule of economics that when supply of capital increases faster than demand, the yield on capital falls. For instance, since the great recession, the money supply has grown far more rapidly than the real economy, driving down interest rates. Returns on government bonds, the least risky asset, are now close to zero before inflation and negative 1% to 2% after inflation. In today’s low-return environment, with the headwinds of income and estate taxes, it becomes a Herculean task to build and transmit intergenerational wealth."

"The Initiative on Global Markets at the University of Chicago asked economists in October whether they agreed or disagreed with the following statement: “The most powerful force pushing towards greater wealth inequality in the U.S. since the 1970s is the gap between the after-tax return on capital and the economic growth rate.” Of 36 economists who responded, only one agreed."