Income inequality: Danger ahead in the 21st Century

If brevity is the soul of wit, verbosity is a fool’s companion. Thomas Picketty’s tome, Capital in the Twenty-First Century, endeavors to chart the history of capitalism since medieval times into 21st Century, then warn of the danger of income inequality and offer solutions.

Predicting the 21st Century is pure folly. Prior to the assassination of the Archduke Franz Ferdinand of Austria in Serbia a hundred years ago, few could have predicted this event would lead to a world war that slaughtered more than 8 million men, and a discombobulated peace treaty that inspired yet another world war, which killed more than 40 million. The 20th Century is, perhaps, an extreme example of chaos, but it is humankind’s most recent century.

Paul Krugman called Capitalism in the 21st Century a “tour de force of economic modeling”, so I read it. Picketty begins his narrative with an impressive dissection of historic financial and tax records through the ages and provides two simple equations, which one could pass over to get to the meat of his argument: rising wealth inequality is destabilizing. He shows through historic records how growth in traditionally agricultural societies was less than 1 percent. Then he showed how the growth rate in industrial societies has increased immensely, but it still low by populist standards – maybe to 3 percent growth a year. That in itself is fascinating.

Picketty states two “Fundamental Laws of Capitalism”, two simple equations. He offers these formulas to provide a basis for his claim that unlimited returns on investments are existentially dangerous for the financial system. His equations, while problematic, don’t buttress his thesis, but undermine it.

For the record, he pronounces his name pik a TEA.
For the record, he pronounces his name pik a TEA.

The irony is his anthropologic etiology of centuries of financial history provide a powerful argument in itself why the expectation of high return investments in a low growth economy is dangerous. So why he offers his two bogus equations is a mystery. Perhaps academia trusts numbers more than words.

First, Picketty asserts (as though he were Isaac Newton), “The First Fundamental Law of Capitalism”, α = r x β, where α = capital share of income and is the product of r (return on investment) and β (k/y or capital / income). It is not a law, but a definition. It is, as Picketty even admits, an “accounting identity”.

Then Picketty asserts the “The Second Fundamental Law of Capitalism”, β = s/g, (savings / growth). His equation is a leap of faith, not intellect. He asserts that k/y = s/g, or that k = y x s/g. When I read this, I was confused. I thought if the rate of growth (g) approaches zero, the capital (k) spirals toward infinity. It made no sense.

So I looked up k/y and found the textbook model for the capital-to-income ratio (k/y), is not s/g, but rather s/(g+δ), where δ accounts for capital depreciation. This way the denominator is never zero. Picketty also claims the savings rate (s) is constant. It’s not nor could it ever be.

forbsgraphic-02Again I was mystified.

A schoolchild could tell you that greater disposable income will naturally lead to a greater rate of savings.

Picketty’s book also reminded me why economics today is less of a science and more of a religion. Economists believe in either the economic theories of John Maynard Keynes or Milton Friedman, but rarely both. However, Isaac Newton’s theories are immutable, even as they were adjusted with the addition of 20th Century physics.

And when Newton discovered mathematical abnormalities in his theories, such when a denominator approached zero, he invented calculus. Calculus proved zero is not just a number, but an incredibly interesting and rich concept. Hundreds of years before Einstein’s idea of a singularity, we learned that sin(x)/x = 1, as x approaches 0. That is pretty damn cool.

I suppose one could believe a thick book is intellectually superior to a thin pamphlet. Edward Everett may have had this bias prior to penning his two hour sermon for the commemoration of the National Soldiers’ Cemetery at Gettysburg prior to hearing Abraham Lincoln’s “few appropriate remarks”.

After 400 pages of questionable algebra sans calculus, Picketty gets to the thesis of his book, that r > g (return on investment is greater than growth), and that capital should be taxed so as to correct for spiraling wealth disparity between rich and poor. He calls it a “utopian” idea.

2014-01-17-MLKsNightmareIt isn’t and the disparity can’t spiral unabated ad infinitum. If increased social disparity is not leveled through progressive taxes or public policy, upheaval would unfortunately correct for a lack of governing. The 20th Century was rife with war and tragedy, and there is no indication that this trend will cease in the 21st Century.

As a solution to the problem of increasing wealth disparity, he proposes taxing capital. He points out that real-estate is taxed and why not property in general? However most property, such as stocks, is transportable, whereas real-estate remains fixed in place. It is impossible to move a parcel of land, whereas most monetary assets can be moved from one country to the other with ease.

He points out that China has restrictions on how many assets can be removed from China. It’s an anomaly, because even though China has enjoyed some of the highest growth of any nation at any time in recorded history, this restriction remains an anachronistic nationalist holdover from China’s Communist past. Then he marches on to reassert his own utopian idea despite the multiple failings of any idealistic ideal of Communism.

forbesgraphic-01What made this book particularly frustrating for me was while vast income inequality is the antithesis of democracy, equality and freedom, Picketty’s arguments are unsound. His equations are lousy and his proposals are impractical. The United States was founded as a contrast to royalty, landed gentry and nobility. The United States was founded as perpetually young state, reinvigorated by capitalism, work and invention. In this spirit, or in the spirit of the Declaration of the Rights of Man, as he sights, Picketty is right to question and propose alternatives to perpetually rich classes.

While I agree with his assertion that soaring income inequality is unhealthy to civilization, I question the methodology and means of his arguments at almost every turn. (I also wonder why he didn’t have an effective editor who would have chopped and distilled his book to one quarter of its size.)

Picketty pointed out that labor is often less well rewarded than a return on investment, and this is a fundamental problem with ever higher income inequality. The true American welfare queens are people such as the Walton family, heirs to over $150 billion in assets. It is the Age of Inheritance or “patrimonial capitalism.” It is anti-egalitarian inefficiency, benefiting so few to sit on so much.

Utopia isn’t needed here. We cannot live forever and neither should our wealth. Once we die, most of our assets should be dispersed into the national pot as a new generation invents once again. We don’t necessarily need a tax on living capital, as it is unenforceable and impractical. Each nation could (and has) put stiff progressive taxes on incomes at high levels. A solid inheritance tax of 75 percent is sufficient to keep the Forbes 400 list populated by a majority who worked for their wealth, rather than those who won the “genetic lottery”, as Warren Buffett calls such heirs.

My proposal is that all money from estate taxes fund free higher education for all United States citizens. This would empower all citizens to take jobs to fuel the increasingly sophisticated economy. This would be good for them and society alike, and mixes up the meritocracy stew.

Mine is not a “utopian” idea to merely redistribute wealth, but a practical solution to empower the minds of our citizenry, culture and workforce into the 21st Century.