Larry Summers has an excellent review of Thomas Piketty’s Capital in the Twenty-First Century. In many ways, his reaction is similar to Greg Mankiw’s. He agrees completely with the factual record but does not fully endorse Piketty’s proposed explanation for the patters or Piketty’s policy recommendations. Some excerpts that caught my eye …
On Piketty’s argument that the returns to wealth are “largely reinvested”:
The determinants of levels of consumer spending have been much studied by macroeconomists. The general conclusion of the research is that an increase of $1 in wealth leads to an additional $.05 in spending. This is just enough to offset the accumulation of returns that is central to Piketty’s analysis.
On the prevalence of inherited wealth among the ultra-rich :
[…] the data […] indicate, contra Piketty, that the share of the Forbes 400 who inherited their wealth is in sharp decline.
On the role of labor income:
Piketty, being a meticulous scholar, recognizes that at this point the gains in income of the top 1 percent substantially represent labor rather than capital income, so they are really a separate issue from processes of wealth accumulation. The official data probably underestimate this aspect—for example, some large part of Bill Gates’s reported capital income is really best thought of as a return to his entrepreneurial labor.
On the substitution of capital and labor in the future:
[M]y guess is that the main story connecting capital accumulation and inequality will not be Piketty’s tale of amassing fortunes. It will be the devastating consequences of robots, 3-D printing, artificial intelligence, and the like for those who perform routine tasks. Already there are more American men on disability insurance than doing production work in manufacturing. And the trends are all in the wrong direction, particularly for the less skilled, as the capacity of capital embodying artificial intelligence to replace white-collar as well as blue-collar work will increase rapidly in the years ahead.
My comments:
Larry’s remarks about the role played by labor income in generating much modern inequality has received some attention from readers and seems to cause some discomfort for those who are strongly tied to the traditional narrative of class struggle between the capitalist owners on the one hand and the workers on the other. (For some reason, John Quiggin really wants us to believe that this source of income inequality will go away.) Indeed, this feature of modern society does not fit particularly well with the kind of wealth tax Piketty himself advocates.
It’s actually not surprising that a good deal of income inequality flows directly from labor income differences rather than differences in capital holdings. If you think of a typical “ultra-rich” person, it’s quite likely that you are going to think of someone who gets his or her income from labor rather than capital income. CEOs for instance are largely compensated for their “work” rather than their ownership. The same is true for hedge fund managers [1], actors, stars athletes, rock stars, TV hosts, Oprah Winfrey, J.K. Rowling, and so on … [2]. Even among people in the broader (more terrestrial) 1 percent – doctors, lawyers, financial analysts, building contractors, etc. – you often find examples of people who are highly compensated for their work rather than their financial (or other capital) wealth.
Summers’ comments on labor and capital substitution are also interesting. Traditionally in our models we are accustomed to assuming that capital accumulation enhances labor productivity and thus wages. Empirically, countries with high capital to labor ratios also tend to have high wages. This doesn’t have to be the case however. The type of input substitution that Summers is drawing attention to is real and could be an important determinant of compensation in the future.
[1] The classic case of this concerns “carried interest“. Carried interest is income earned by fund managers that is tied to the overall performance of the fund. If the fund manager is managing his or her own money then this income would be a mix of labor and capital income. If however the manager is directing investments of someone else’s money (pretty common today) then the payment is entirely for their effort. This would be entirely labor income. There is an effort on the part of hedge fund managers to have this income treated as capital gains income rather than labor income because the tax rates on capital gains are much lower than the tax rates on labor income. This is just an effort to dodge taxation however. The payment is a payment for labor in this case and it should be taxed exactly the same as typical labor income.
[2] While I’m not so sure that CEO’s “deserve” their extraordinary income I am willing to believe that celebrities like Oprah Winfrey and J.K. Rowling have made contributions to society that are in rough proportion to her compensation. J.K. Rowling, for instance, deserves every penny she has earned from Harry Potter. Rowling has been paid an astonishing amount for her work — I think about $1 billion — but this is nothing compared with the amount of money governments spend to try to improve education in the world. Every year the U.S. government spends more than $50 billion on education at the Federal level. What Rowling has managed to do for reading for young kids is staggering particularly given the E-culture/ immediate gratification world we live in. She probably deserves more, not less…