Freedom, Markets, and Well-being Fall 2018

Piketty on Inequality


Professor Brown presented two slide decks (these are both on Sakai). The one titled “Distribution of Wealth, US 1989–2013” was on the effects of recessions on different quintiles and the other was an overview of Thomas Piketty’s Capital in the Twenty-first Century.

The upshot of the first set of slides is that people at the bottom of the income distribution suffered more in the 2008 recession than their counterparts had in earlier recessions. This is especially curious because we thought the 2008 recession was due to a collapse in housing prices and the people at the bottom don’t generally own real estate. So the collapse in the value of that kind of asset should not have had that large an impact on their wealth. What we are learning is that they were carrying a lot of non-housing debt. When credit seized up and there was a spike in unemployment, they either couldn’t roll over their loans or they lost the ability to pay them back.

The slides about Piketty begin with Thomas Malthus (1766-1834), David Ricardo (1772-1823), and Karl Marx (1818-1883). They all tried to use economic theorizing to make predictions about the broad course of society. While theoretically elegant, none of their theories was backed by decent empirical evidence.

By contrast, Simon Kuznets (1901-1985) had terrific data. But it only covered a period in history when inequality was unusually low.

Piketty has the same theoretical ambitions as Malthus, Ricardo, and Marx. But he also has data that both similar in quality to Kuznets’s as well as vastly more extensive. Kuznets had data on the US for part of the twentieth century. Piketty has data for hundreds of years covering a dizzying number of countries. It is the combination of theoretical ambition, stellar data, and the importance of its topic that makes this book so remarkable.

Our discussion

One point that came up in our discussion concerned what appears to be two different things that Piketty says in explaining the recent increase in inequality.

On page 20, he says that it is due to changes in taxation: “the resurgence of inequality after 1980 is due largely to the political shifts of the past several decades, especially in regard to taxation and finance” (Piketty 2014, 20).

A few pages later, he seems to blame poor corporate governance that allows managers to inflate their salaries.

I will show that this spectacular increase in inequality largely reflects an unprecedented explosion of very elevated incomes from labor, a veritable separation of the top managers of large firms from the rest of the population. One possible explanation of this is that the skills and productivity of these top managers rose suddenly in relation to those of other workers. Another explanation, which to me seems more plausible and turns out to be much more consistent with the evidence, is that these top managers by and large have the power to set their own remuneration, in some cases without limit and in many cases without any clear relation to their individual productivity which in any case is very difficult to estimate in a large organization. (Piketty 2014, 24)

Professor Brown suggested that these things are related. When the tax rates on the highest incomes came down, corporate managers had a greater incentive to claim more salary for themselves. I mentioned the possibility that this might have something to do with the law governing corporate management. I don’t know the details, but I gather that German firms have labor representatives on their boards while American firms typically do not. I should add that the only reason I know about this is that Senator Warren floated an idea about corporate governance reform over the summer. Be careful of what you learn from politicians and political parties! They aren’t disinterested pursuers of the truth. That said, the idea at least sounds meritorious.

I also think that we will miss something if we just look at how profits are divided up between labor, management, and shareholders. I believe that a part of the reason why most people’s wages have been flat is that inflation in the cost of health care has been greater than the rise wages. That money isn’t going to managers or shareholders; it’s going to doctors and health care providers. There is an old, but informative, short piece by Uwe Reinhardt on how much doctors and surgeons in the US make that is worth reading on this. As a supplement, you can see more recent data from 2016.

What’s Up Next?

Piketty’s theory is that inequality in the wealthy countries is returning to its historical norms after a period when it was unusually low between World War II and the 1980s. This is certainly interesting. But it isn’t necessarily bad.

Here is why Piketty thinks it matters.

When the rate of return on capital exceeds the rate of growth of output and income, as it did in the nineteenth century and seems quite likely to do again in the twenty-first, capitalism automatically generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based. (Piketty 2014, 1)

There are two questions about this.

First, Piketty’s theory is that the historical rates of inequality happened because the returns to capital exceed the growth of the economy: r > g. But the rise in inequality that we have seen since 1980 is due to wages, not returns on capital. Some people are earning extraordinarily high compensation for their labor; they aren’t getting rich by investing capital. So why think we are going back to historical norms if the cause of inequality in our society is abnormal?

Second, Piketty’s introduction does not really explain what he means by calling inequalities “arbitrary” and “unsustainable.” Nor does he go into what he means by “meritocratic values” or explain why inequality undermines them and democracy. (This isn’t a criticism; there is only so much one can do in an introduction.)

Chapter 11, on inheritance, should address both points. We will talk about that next time.

Update: Piketty is Doing Politics

Piketty is writing papers about political behavior now. Here’s an interesting fact. After the second world war, the voters with the most education voted for right wing parties. Starting about 1970 (in the US and France) and 1985 (in the UK), they start splitting evenly between right and left wing parties. Now they favor left wing parties by between 12-24% (UK, US, with France in the middle).

Here’s an Oxford University economist summarizing Piketty’s data and speculating on what might be driving the phenomenon he notices.

Extra: Retaliation for Cyber Attacks

One thing that came up is what war among the .1% will be like. I mentioned that the US considered deleting Putin’s bank accounts as retaliation for interfering in the 2016 election but decided against it. It’s from an interview by Dave Davies with David Sanger. Sanger is a national security correspondent with the New York Times who has just published a book on this topic called The Perfect Weapon.

SANGER: So there were two big decision points and, I think, Dave, you could say two big errors here. The first was the United States was very slow on the detection of what was going on with the Russians coming into the DNC. As one person said to me, it’s not simply that we had our radar off like at Pearl Harbor. He said, we hadn’t even built the right radar system to see this.

The second problem was the one that you just identified. Once the White House was aware of it, then the question came, what do you do? And I went out and interviewed everybody I could find who had gotten involved in that debate. And there are many people, including Victoria Nuland, who was the head of Russian affairs over at the State Department, who wanted to hit Putin very hard, expose his own connections to the oligarchs, where he’s put his money.

Sort of basically say, you want to play this game? Two can play this game. That got overruled. There were people who came in and said, let’s disconnect the Russians from the world financial system. Well, that seemed like a really good idea until someone put up their hand and said, well, you know, the moment you do that, there’s no way to pay them for the gas that’s going into Europe and the Europeans are going to freeze.

So they couldn’t go do that one.

DAVIES: And can I just go back to the attack on Putin himself? There was this thought you could expose his secret assets, I think maybe even make some of his money disappear.

SANGER: Right.

DAVIES: What were the objections?


DAVIES: Risks.

SANGER: …The Federal Reserve doesn’t like any idea in which you sort of legitimize going into a central bank and making money disappear because they think at that moment, you have started the war of all against all and everybody will lose confidence in the financial system - again, the fear factor that we discussed. There were concerns that you could expose Putin’s connections to the oligarchs and the Russians would yawn.

Oh, that’s news, Vladimir Putin’s got a lot of money coming in from the oligarchs, this just in, you know? So they were worried that it might not be all that effective. But President Obama had a particular fear. And his fear was escalation. We do something to Putin - and Putin was already inside, they knew, the registration systems in Arizona and Illinois. They suspected there were attacks on…

DAVIES: The voter systems, yeah.

SANGER: The voting systems, not the systems where you actually cast your vote because those are pretty well off-line but the system where you register to vote. So that if you showed up, Dave, at your polling place on Election Day and they might say, well, thanks for coming in, Dave, but we show that you moved to New Mexico three months ago.

And you could imagine the chaos that could be played with there. And those are outward-facing systems, those are connected to the Internet. So you could cause a lot of chaos in that. And President Obama’s concern, and I fully understand it, was they could come back and cause chaos in the election. Why was that a concern? Because Donald Trump was already running around saying this election has been rigged.

And they all thought in the White House, Hillary’s going to win and Trump is going to turn around and say, the election was rigged for her, and that will create chaos. And they didn’t want to play into that narrative. And they thought that was the most likely outcome. It never dawned on them that Hillary might lose and that it would go the other way. And so they thought they had time.

They thought that they could deal with the Russians and retaliate against the Russians after Hillary Clinton was elected and then hand the plan off to her. Well, it didn’t turn out that way.

As you can see, they considered several ways of retaliating and could not settle on one. They thought they could let the next administration make that decision. But sometimes crime pays.

Update December 6: Why Do the Rich Want More Money?

One question that I have about Piketty’s research is why the rich want more money. Piketty has shown that the growth in inequality is largely due to massive gains for the extremely wealthy: fractions of the top 1%. While he thinks that this will lead to inequality due ot inheritance in the future, at present, inequality is mostly due to wages. The super rich are doing something to accumulate all this wealth and Piketty plausibly assumes that they will fight to keep it and make even more.

Why? After your first, oh, hundred million dollars, what can you buy that you couldn’t otherwise afford? Sure, more stuff. But why would you want it? Wouldn’t you have sated even your wildly unreasonable desires long before you got to that point?

More to the point, why put in the effort to accumulate more? Why not enjoy what you’ve got?

It turns out that people study the super rich to answer this very question. They say that most people ask themselves two comparative questions: (1) “Am I doing better than I was before?” and (2) “Am I doing better than others?” Furthermore, they claim, we are uncomfortable with qualitative answers such as “I’m a better parent than I used to be” or “I’m an unusually good neighbor.” So we rely on things that can be quantified to answer our questions. We accumulate stuff that we can count, like money, houses, boats, and so on, in order to answer our questions about the course of our lives.

The research Norton has conducted illustrating this phenomenon is dispiriting. In a paper published earlier this year, he and his collaborators asked more than 2,000 people who have a net worth of at least $1 million (including many whose wealth far exceeded that threshold) how happy they were on a scale of one to 10, and then how much more money they would need to get to 10. “All the way up the income-wealth spectrum,” Norton told me, “basically everyone says [they’d need] two or three times as much” to be perfectly happy.

In a way, it’s a highly reflective process. We accumulate all this stuff not to use or enjoy it, but because it helps us to answer questions we have about our lives. We’re trying to scratch an intellectual itch, in other words. If we didn’t ask the question or if we didn’t care about the answer, we wouldn’t do it. That said, some of this behavior just sounds pathological.

The novelist Gary Shteyngart also has firsthand experience seeing how rich people think about their wealth. The protagonist of his recent novel, Lake Success, published a few months ago, is a New York financier, and in the course of researching the book, Shteyngart cultivated friendships with more than a dozen highly wealthy, mostly male hedge funders … One thing Shteyngart noticed after spending time with this crowd was how competitive they were. “They’d compete against one another on their Bloomberg terminals all day and then at the end of the day they would play competitive poker with each other,” he says; this spirit of one-upmanship pervaded even the donations they made to charities. Shteyngart speculates that underneath this competitiveness is a need to seem smarter and more capable than their peers: Managers of hedge funds can sometimes get rich from making one or two bets that had more to do with luck than anything else, which might make them feel like their intelligence is in question even if their money stands as evidence of their professional success.

These people have a third question. It’s something close to “am I worthy?” or “do I deserve this stuff?” They’re pretty sure the answer is “no,” but they want it to be “yes” so they keep doing the only thing they can think of that might lead them to believe the answer is “yes,” namely, compulsively competing with one another.


Piketty, Thomas. 2014. Capital in the Twenty-First Century. Translated by Arthur Goldhammer. Cambridge: Harvard University Press.