How Piketty Misses the Point

By Deirdre N. McCloskey writing for Cato. Excerpts:

"Piketty’s worry about the rich getting richer is indeed merely the latest of a long series going back to Thomas Malthus, David Ricardo, and Karl Marx. Since those founding geniuses of classical economics, trade-tested progress has enormously enriched large parts of humanity — which is now seven times larger in population than in 1800 — and bids fair in the next 50 years or so to enrich everyone on the planet. And yet the left routinely forgets this most important secular event since the invention of agriculture — the Great Enrichment of the last two centuries"

"The technical flaws in Piketty’s argument are pervasive. When you dig, you find them. The fundamental problem is that Piketty does not understand how markets work. In keeping with his position as a man of the left, he has a vague and confused idea about how supply responds to higher prices. Startling evidence of Piketty’s miseducation occurs as early as page 6.

He begins by seeming to concede to his neoclassical opponents: “To be sure, there exists in principle a quite simple economic mechanism that should restore equilibrium to the process: the mechanism of supply and demand. If the supply of any good is insufficient, and its price is too high, then demand for that good should decrease, which would lead to a decline in its price.” The words I italicize clearly mix up movement along a demand curve with movement of the entire curve, an error of first-term college students. The correct analysis is that if the price is “too high” it is not the whole demand curve that “restores equilibrium,” but an eventually outward-moving supply curve. The supply curve moves out because entry is induced by the smell of super-normal profits."

"Piketty does not acknowledge that each wave of inventors, entrepreneurs, and even routine capitalists find their rewards taken from them by entry. Look at the history of fortunes in department stores. The income from department stores in the late 19th century, in Le Bon Marché, Marshall Field, and Selfridge’s, was entrepreneurial. The model was then copied all over the rich world. In the late 20th century the model was challenged by a wave of discounters, and they then in turn by the internet. What happens is that the profit going to the profiteers is more or less quickly undermined by outward-shifting supply. The original accumulation dissipates. The economist William Nordhaus has calculated that the inventors and entrepreneurs nowadays earn in profit only 2 percent of the social value of their inventions."

"Piketty’s definition of wealth does not include human capital, owned by the workers, which has grown in rich countries to be the main source of income, when it is combined with the immense accumulation since 1800 of capital in knowledge and social habits, owned by everyone with access to them."

"f human capital is included — the ordinary factory worker’s literacy, the nurse’s educated skill, the professional manager’s command of complex systems, the economist’s understanding of supply responses — the workers themselves, in the correct accounting, own most of the nation’s capital — and Piketty’s drama falls to the ground."

"Piketty’s own research suggests that only in the United States, the United Kingdom, and Canada has income inequality increased much, and only recently. In other words, his fears were not confirmed anywhere from 1910 to 1980; nor anywhere in the long run at any time before 1800; nor anywhere in Continental Europe and Japan since World War II;"

"On the basis of the Forbes lists of the very rich, Piketty notes, for example, “several hundred new fortunes appear in [the $1 billion to $10 billion] range somewhere in the world almost every year.” Which is it, Professor Piketty? Apocalypse or a steady share of rich people constantly dropping out of riches or coming into them, in evolutionary fashion?"

"Piketty does not reflect on why inequality by itself would be bad."

"But the fact that many rich people act in a disgraceful fashion does not automatically imply that the government should intervene to stop it. People act disgracefully in all sorts of ways. If our rulers were assigned the task in a fallen world of keeping us all wholly ethical, the government would bring all our lives under its fatherly tutelage,"

"The focus on relative wealth or income or consumption is one serious problem in the book. Piketty’s vision of apocalypse leaves room for the rest of us to do very well indeed — rather non-apocalyptically — as in fact since 1800 we have. What is worrying Piketty is that the rich might possibly get richer, even though the poor get richer, too. His worry is purely about difference, about a vague feeling of envy raised to a theoretical and ethical proposition."

"The economists Xavier Sala-i-Martin and Maxim Pinkovsky report on the basis of detailed study of the individual distribution of income — as against comparing distributions nation-by-nation — that “world poverty is falling. Between 1970 and 2006, the global poverty rate has been cut by nearly three quarters. The percentage of the world population living on less than $1 a day (in PPP adjusted 2000 dollars) went from 26.8% in 1970 to 5.4% in 2006.”"

"The economist Steven Horwitz ...summarizes the results of a study by Julia Isaacs on individual mobility from 1969 to 2005: “82% of children of the bottom 20% in 1969 had [real] incomes in 2000 that were higher than what their parents had in 1969. The median [real] income of those children of the poor of 1969 was double that of their parents.” There is no doubt that the children and grandchildren of the Dust Bowl refugees in California, for example, are much better off than their fathers or grandfathers."

"The most fundamental problem in Piketty’s book, then, is that he misses the main act. In focusing solely on the distribution of income, he overlooks the most surprising secular event in history: the Great Enrichment of the average individual on the planet by a factor of 10 and in rich countries by a factor of 30 or more."

"What caused the Great Enrichment? It cannot be explained by the accumulation of capital,"

"The original and sustaining causes of the modern world were indeed ethical, not material. They were the widening adoption of two new ideas: the liberal economic idea of liberty for ordinary people and the democratic social idea of dignity for them. This, in turn, released human creativity from its ancient trammels. Radically creative destruction piled up ideas,"