Notes on Inequality
| Peter Klein |
Everyone’s talking about inequality. I confess don’t find inequality terribly interesting, intrinsically. Of course, inequality that results from special government privilege — the incomes of top executives at Lockheed Martin or Goldman Sachs, the speaking fees earned by Hillary Clinton, the wealth of US sugar farmers — should be analyzed and criticized, and those privileges removed. Firm policies that result in pay differentials — pay-for-performance schemes, for example — are important and interesting, not because they generate inequality per se, but because they have systematic and significant effects on firm behavior and performance. Of course, inequality may have important long-run social and cultural effects, but these are highly speculative and not obviously actionable.
I haven’t yet read Thomas Piketty’s new book but am aware of — and amazed by — the buzz it’s generating. I suspect most of the excitement reflects confirmation bias: people who think inequality is the major issue of our time naturally think this is the most important economics book of the decade, probably before reading it. (Naturally, I’d love to exploit that formula in marketing my own books.)
I do have a few thoughts on how the discussion is framed, in light of Piketty’s work. First, Piketty and his admirers define “capital” as a homogeneous, liquid pool of funds, not a heterogeneous stock of capital assets. This is not merely a terminological issue, as those familiar with the debates on capital theory from the 1930s and 1940s are well aware. Piketty’s approach focuses on the quantity of capital and, more importantly, the rate of return on capital. But these concepts make little sense from the perspective of Austrian capital theory, which emphasizes the complexity, variety, and quality of the economy’s capital structure. There is no way to measure the quantity of capital, nor would such a number be meaningful. The value of heterogeneous capital goods depends on their place in an entrepreneur’s subjective production plan. Production is fraught with uncertainty. Entrepreneurs acquire, deploy, combine, and recombine capital goods in anticipation of profit, but there is no such thing as a “rate of return on invested capital.”
In short, profits are amounts, not rates. The old notion of capital as a pool of funds that generates a rate of return automatically, just by existing, is incomprehensible from the perspective of modern production theory. Solow states: “The key thing about wealth in a capitalist economy is that it reproduces itself and usually earns a positive net return.” This is a nonsensical statement from the point of view of microeconomics, entrepreneurship, uncertainty, innovation, strategy, etc.
Basically, I can’t grasp the point of computing the long-term rate of return on capital, and comparing it to the long-term rate of economic growth. I hear from third parties that Piketty’s calculations (the early work was done with Emmanuel Saez) are thorough and careful, and I have no reason to doubt the empirical part of the book. But it seems like a useless exercise to me — I don’t know what the underlying constructs even mean.
Of course, there are many other issues related to the interpretation of these data and what they mean for social mobility, fairness, etc. For example, there may be much more vertical movement than Piketty’s admirers admit — few people remain in one part of the income distribution all their lives. And most Americans are capitalists, with some of their financial wealth invested in equities through their retirement portfolios. So the link between (say) stock-market performance, rents on land and natural resources, and interest returns and the distribution of financial wealth among individuals is complicated.