Notes on Inequality

23 April 2014 at 10:32 am 19 comments

| 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.

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19 Comments Add your own

  • 1. Jim Rose  |  23 April 2014 at 5:17 pm

    Great post. I stop reading at the word marx unless it is jon elster.

    Rawls should be the sensible starting place of any concerns with equality that are not based on envy.

  • 2. Brian  |  23 April 2014 at 10:42 pm

    Ugh…another blogger spouting off about this book before he/she even reads it. If the internet breeds anything it’s pure ignorance.

  • 3. Peter Klein  |  23 April 2014 at 10:44 pm

    Brian, read more carefully. This blogger is spouting off about “how the discussion is framed, in light of Piketty’s work.”

  • 4. Alex  |  24 April 2014 at 10:09 am

    I believe Brian makes a valid point. While you state that your commentary is about the framing of the discussion, your post is about how you don’t understand Piketty’s approach. You argue based on your belief of what his argument probably is. Perhaps if you read the book you will be able to “grasp the point” and be able to form a rebuttal that can be taken seriously.

  • 5. Peter Klein  |  24 April 2014 at 11:13 am

    Sigh…. I understand the general approach quite well. It is hardly original to Piketty. My comments are directed to the capital theory debates of the 1930s and 1940s between Knight and Hayek, for example, and how those frame the current debates on inequality and growth (e.g., between Piketty and his admirers and detractors). I take no position on whether Piketty’s arguments about the long-term relationship between r and g are correct because, obviously, I haven’t studied his calculations. And I’m sure his text contains many interesting and valuable observations, insights, and nuances. More power to him. But this has little to do with the discussion above, which is hardly a “rebuttal” to Piketty. (The statement, “I don’t know what the underlying constructs even mean,” is obviously rhetorical — it’s a way of saying that “rate of return on capital” isn’t a logically coherent construct.)

  • 6. Umut Koc  |  25 April 2014 at 3:30 am

    Matthew Yglesias interviews Thomas Piketty:

    “The history of capital that I’m trying to tell you is this book is certainly multidimensional. The story of real estate is not the story of business capital, and it’s not the story of land capital, and it’s not the story of slave capital, and it’s not the story of financial capital, or the story of public debt.

    Capital is multidimensional, and each single asset has its own valuation problem. It’s always difficult to put a price on capital. It’s always difficult to put a price on everything. You always have social conflict, compromise, imperfect competition, bargaining power, explaining how differently positive different assets.

    When I do sum all these assets and their market value, I do not mean to suggest that this is an adequate summary of everything. I am very much aware that this operation of summing up everything as a single market value of all capital assets and call it K, and this is capital, it’s an incredibly abstract operation.

    I think it can be useful for some purpose, as long as we have a critical eye and keep a critical eye on what it means. One should not put too much weight on this abstract operation, and on how much I believe in it.

    I certainly do not believe in a model with a single form of capital. The one good model where we produce apples and capital is just a physical accumulation of apples is not an adequate model to describe any society at any period in time.” (

  • 7. Peter Klein  |  25 April 2014 at 7:07 am

    Yes, this is what people using the approach Piketty favors have said since the 1930s. “In treating capital as homogeneous, we do not mean that it actually is homogeneous, only that we can model it as homogeneous for analysis and policy recommendations.” Apparently Piketty does not provide any explanation for how a blob of K generates profit (or return) (that’s what Jamie Galbraith tells me, anyway — hope Brian and Alex will allow me to comment on Galbraith’s review, which I did read). As Foss and I argue in our 2012 book, profit (and loss) results from differences in the skill with which entrepreneurs deploy heterogeneous capital resources among alternative uses under conditions of uncertainty. Without heterogeneity, uncertainty, and entrepreneurship, there is no explanation for profit or growth — only the arbitrary idea of capital as a pool of funds that automatically, indeed magically, reproduces itself.

  • 8. More on Piketty | Nick Freiling  |  25 April 2014 at 7:17 am

    […] A friend informed me of economist Peter Klein’s apt analysis of the inequality debate as it relates to Piketty’s book Capital in the Twenty-First Century. From Klein’s blog: […]

  • 9. buckwheaton  |  25 April 2014 at 2:20 pm

    “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.”

    You are so right since capital is heterogeneous.

    I view the return on capital as a multi-dimensioned vector, rather than a scalar number. The reason for this is that a material component to rate of return are the risk factors of that return over time, along with the contractual details of that return, such as frequency of payment, whether there is a balloon payment on a certain date, etc. For example, a particular company can pay its dividend this year, but what dividend can it pay in two years?

    Moreover, different circumstances dictate the need for different types of return, especially given the differences in tax treatment of capital gains vs bond interest vs dividend income, short/long term, etc.

  • 10. Henri  |  26 April 2014 at 4:37 pm

    Inequality is probably intrinsically more interesting if you are the one getting the raw deal. Given the way the political system is organised, inequality seems to be a big issue for democracy and can become an issue for the legitimacy of the contemporary social order. Martin Wolf brings this up nicely in his FT column on the book. It also seems quite defeatist to say that inequality is not actionable.

    There must be some really good point that I don’t quite grasp here, but there are financial markets that makes wealth a pretty fluid thing? I mean surely you take any family of significant wealth, their assets are either well diversified or their value is protected against fluctuations through some financial instruments. If most assets have some approximate price and most wealthy individuals are diversified, then indeed does it not make a whole lot of sense to look at average return to capital rather than return to individual assets?

    Things look very different from “production theory” and financial theory, but I would assume financial theory to be much better suited since the interest is on individuals/families and not firms.

    It seems that you are discussing entrepreneurship, while the point of the book is ownership? Perhaps you are not interested in the cultural-political discussion the book is launching, but the claim that its a nonsensical discussion to have seems almost… desperate?

  • 11. Peter Klein  |  26 April 2014 at 6:08 pm

    Piketty’s book is currently #1 on My most recent book is sitting at #2,993,595. Talk about raw deal! Henri, I’m sure you’ll join my call for a steeply progressive tax on book sales. Obviously every sale Piketty gets is a sale that would otherwise have gone to me. Shall we just cap total sales, or sales per month? Piketty’s obviously gotten far more than his fair share of aggregate sales.

    Anyway, if you want to compute year-to-year changes in the financial wealth of various individuals and households, and put them in arbitrary groups, and track them over time, then be my guest. But there is no economic process underlying any sort of “long-run rate of return to (financial) capital.” The numbers you get are just statistical artifacts. As I noted in the post, maybe they have some broader social or cultural impact. But real wealth and growth are not generated by some mysterious (and automatic?) process, but by savings, investment, and entrepreneurship. (Note that Piketty only wants to tax nominal wealth, excluding debt — he thinks savings and investment are a drag on economic growth, borrowing and spending its drivers. Or so I hear.)

  • 12. Henri  |  27 April 2014 at 12:25 pm

    You are having a completely different discussion here. “Piketty’s obviously gotten far more than his fair share of aggregate sales” is so disingenuous my head hurts. I don’t know any review (and I’ve read many) where the book is portrayed to advocate barriers to market competition. Rather, he is suggesting that if he makes 100m and does not waste it, government should tax him 1% of that (1m dollars) annually. Given the level of misunderstanding, perhaps it is wise to generally comment on books one has read.

    I am not a great believer in some uniform economic processes underlying anything, but surely if you think you are discrediting his ideas or opinions by appeal to a lack of some specific underlying economic process you are missing the whole point. Do you think there is a specific “economic process” underlying gender pay cap, for example? Do you think there was such a thing 30 years ago?

  • 13. Peter Klein  |  27 April 2014 at 12:49 pm

    The book-sales analogy was directed not at Piketty’s analysis, but at the banal remark that inequality is intrinsically more interesting when one is getting the “raw deal.” I guess I should be really interested in differences in book sales. Hmmm, I’m not.

    Incidentally one could make a serious point here. Influence and social status, if we could measure them, are probably distributed far more unequally than financial wealth. This is probably particularly true in Piketty’s home country. I wonder if he thinks it’s interesting — even more so, a grave social and moral issue — that French intellectual elites have so much more influence and status than French truck drivers.

  • 14. Some Quotes on Piketty and Capital | Nick Freiling  |  28 April 2014 at 8:32 pm

    […] statement Peter Klein has called “nonsensical from the point of view of microeconomics, entrepreneurship, uncertainty, […]

  • 15. philippe101  |  30 April 2014 at 7:25 pm

    “he thinks savings and investment are a drag on economic growth, borrowing and spending its drivers. Or so I hear.”

    I very much doubt any economist would consider investment to be a drag on economic growth.

    Keynes pointed out that an increase in saving could lead to a reduction in overall demand, leading to a reduction in economic growth, but he always emphasised that investment was the main driver of growth. He just refuted the neoclassical belief that an increase in saving necessarily results in an equal increase in investment.

  • 16. Peter Klein  |  30 April 2014 at 8:58 pm

    Indeed, Keynes asserted these things. He made a number of other, equally incorrect, claims.

  • 17. philippe101  |  30 April 2014 at 10:48 pm

    I think Keynes was correct, as do many, many economists. But I guess you must be right because… because… you work for the von Mises Institute, Auburn Alabama?

  • 18. Peter Klein  |  30 April 2014 at 10:51 pm

    Yes, sad, isn’t it? But I aspire to be something greater, like an anonymous internet commentator.

  • 19. nfreiling  |  7 May 2014 at 8:48 am

    “There was and is always the choice between maintaining, increasing, or consuming capital. And past and “present” experience tells us that the decision in favor of consumption of capital is far from being impossible or improbable. Capital is not necessarily perpetual.”


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