Thomas Piketty Winning Business Book Of The Year Is Like Luis Suarez Winning Football Ambassador Of The Year

 

The recent bestseller “Capital in the Twenty-First Century” by the French Marxist economist Thomas Piketty has been rattling a few cages this year, and I now hear it has been named the 2014 Financial Times and McKinsey Business Book of the Year. Week after week we keep seeing politicians, social commentators and bubble gum celebrities making allusions to his book and how it can influence society positively. I had meant to write about this sooner, so let's see what all the fuss is about, shall we?

So what actually 'is' the fuss all about?

 

Piketty's central thesis is that income inequality is likely to increase to devastating effect as the accumulation of large capital brings the rich ever further from the poor.

 

Is he onto something?

 

The answer isn't an all out 'no', but alas, there are all sorts of ways in which Piketty is allowing his readers to be skewed by a false picture. I will paint what I think is a more accurate picture.

 

Thanks, but there's no denying the fact that the free market is a heartless system that causes lots of poverty, corruption, exploitation and maltreatment, and that it needs endless tweaking to make it less repugnant, is there?

 

That is the first and perhaps most important assumption that needs correcting, because the only people who would say such a thing are people who don’t understand what the free market is. The free market is literally the sum total of all the billions of units (pounds, dollars, Euros, etc) that have been exchanged in mutually beneficial transactions. Therefore, the free market cannot be a bad thing - and save for some necessary light regulation from the government (anti-monopoly regulations, health and safety laws, Pigouvian taxes, etc) there is not much the government can ‘tweak’ to make the market any better than it already is, because no politician knows the incentives and desires of the individuals better than they know themselves. Critics of the free market are only criticising instances where the free market has not been allowed to operate. Where there is poverty, corruption, exploitation and maltreatment, there is a lack of freedom, and thus the qualities related to those mutually beneficial actions dissipate.

 

But nevertheless, big corporations deserve their share of public opprobrium, don't they?

 

Sometimes, but that general assumption is the next big error that needs correcting. Corporations often get hit with criticism - but a lot of the time the criticisms are absurd. Most large corporations control a huge share of a particular market niche between them - but if the market exists because of the corporations' innovations, it is foolish criticising them because they are supplying to meet a demand*. In most cases it is only through outperforming their competitors that corporations get such a lion's share of the market (as Tesco, Sainsbury's etc show).

 

So, many of the people that complain about inequality are unwittingly doing their bit to engender more of it?

 

Yes, but that's fine. When Sainsbury's shareholders become rich it is because the general public spend their money in the stores, preferring it goes to Sainsbury's in exchange for groceries instead of going to George Osborne in exchange for public services. The same is true of rich people like 2014 headline-grabber Gary Barlow - when millions of pounds are spent on Take That CDs the public is saying they are willing to pay the price of seeing Gary Barlow becoming rich in exchange for hearing his music on their CD player. It may upset the likes of Piketty** that he lives in a world in which this can happen, but the wealth of people like Gary Barlow comes from mutually beneficial transactions, where a lot of people distil a lot of pleasure from his music in making him wealthy (even if he is not my cup of tea).

 

And Adam Smith's 'invisible hand' metaphor is important in all this too, right?

 

Yes, in society, the Smithian invisible hand acts as a social mechanism that channels collective objectives toward meeting the needs of the people that make up that society, by ensuring competition between buyers and suppliers, which channels the profit motive of individuals into providing products that society desires at prices which are rarely above cost. This means that in a market in which consumers are free and happy in being able to make mutually beneficial transactions, it would be expected that sellers or entertainers who could make a lot of people happy would naturally have a lot more capital than the majority of people who can't. This is what makes the argument for laissez-faire economic philosophy so compelling - it is that markets automatically channel self-interest toward socially desirable ends. 

 

Piketty's tax projection on capital seems to want to tweak the status quo with some radical tax reforms on capital. However, the Chamley-Judd Redistribution Impossbility Theorem demonstrates a proof that it’s actually impossible to make the worker, or the workers, better off by taxing capital.

 

Wow, that's news to me. Why haven't more people heard of the Chamley-Judd theorem?

 

Yes, why isn’t this proof more widely known? I suspect the reason is the same reason a lot of libertarian qualities are not widely known – they involve lateral brainpower to work out, but also they are largely unappealing to the majority of people who prefer leftist delegation rather than laissez faire individual responsibility.

 

Is that everything?

 

Not quite. The global evidence of wealth-sharing just doesn't support Piketty either. Here are a few facts that the economic left will find uncomfortable. The past year has seen more wealth generated than any time before - but also it has never been spread so evenly either. In the year 2000 the UN's MDG 2015 target was to halve the number of people without drinking water and the number of people living on less that $1 a day. It achieved this with time to spare.

 

The vast majority of this mass escape from poverty is happening not through government aid (although that is vitally important) but through free market of global capitalism. In the past decade or so we've seen tens of millions of people lifted out of poverty; child labour has fallen by a third, as well as extraordinary advances in standards of living in the world's poorest countries. There is still plenty to do, but all this improvement has been going on, and at a time when rich personal wealth has grown too.

 

I heard that Thomas Piketty’s book favours the solution of heavily taxing capital – he’s apparently even calling for as much as an 80% income tax rate on earnings of £500,000 or more.

 

Such a desire is so absurd that one wonders if Piketty has a VIP card in Cloud-Cuckoo-Land. For a very short while taxing at such high rates may bring about an immediate redistribution of wealth in a way that isn’t completely disastrous. But as anyone on the outside of Cloud-Cuckoo-Land knows – increased tax rates does not mean long-term tax revenue can be increased. Once you reach a tipping point, tax hikes will only disincentivise innovation, and cause a contraction in the markets of labour and consumption. Moreover, if you tax capital income and transfer that revenue to workers, then long term there will be a diminished capital stock. And considering that capital stock is what workers rely on to generate wages, the tax on capital will diminish their wages.

 

So, to summarise

Not having read the book, I don't know how Piketty thinks a global tax system would work, or what kind of tax it would be. He was probed about this earlier in the year on Newsnight by Jeremy Paxman but he didn't give an answer. But even without having studied Piketty's every detail I have no trouble seeing that a global tax system intended to redistribute wealth from rich to poor is full of complex problems. If we try to imagine it at a microcosmic level, we can propound some kind of tax system that correlates income with consumption. Tax on consumption can target individual earnings but it doesn't always achieve this. If Alan Sugar and I both buy an HP laptop, then any sales tax or value-added tax is borne equally by both of us. Whereas if consumption tax was geared more specifically towards luxuries such as buying Ferraris and private jets, then I'm not likely to pay as much as Alan Sugar.

 

The good thing about trade is that diversity in the market is what gives us excellence of opportunity and consumptive satisfaction. If we were all farmers, or all taxi drivers, we’d be all but flatlined by homogeneity. Taxi drivers don't need other taxi drivers, what they really need is people needing lifts, and mechanics, and petrol and food sellers. If a taxi driver loves making a living driving his cab, and you can't drive, you'll find it easy to get a ride and he'll find it easy to transport you. If the reverse is true, you'll be the driver and he or she the one being transported.

 

This template serves to inform us about the whole system of a market economy - we innovate because we interact with a diverse range of people that have different needs, skills, and experiences to us. Clearly an underlying factor in all of this is that incomes are diverse too. You're just not going to get an economy in which everyone has the same capital or anything close to the same. A rich department store owner won't stay rich for long if no one will work on his tills or in his store room. I don't think that anyone sensibly denies that diversity of income is a good and necessary thing. Consider that if everyone earned too much to be a taxi driver then there would be no one to transport you ten miles across town in rapid time; or if everyone earned too much to be a dentist then most of us would have bad teeth and be in lots of pain.

 

So it's not inequality that's the problem, it's how much. But that then begs the question - how much is too much? To answer that we need to look at some recent history. With good government policies (when good often means 'few'), a stable society, rule of law and protected ownership rights, we find that inequality lessens over time, not increases. History shows us that rich countries are more equal than poor countries. It's true that even in rich countries there is wealth stratification in terms of income, but that is offset by the fact that those without earned income have welfare and many public service benefits not found in the poorest countries. If you're one of the poorest people in the UK you still have many of the standards of living that the poorest in the world could only dream of.

 

Furthermore, after taxation, disposable incomes are much closer in rich countries than poor countries. The Financial Times research brought the conclusion that global inequality was on the rise, but that it peaked in the year 2000 and has been declining in the 14 years since. It's perfectly understandable why this is the case - in the eighties and nineties the global financial boom and technological exponentiation left behind countries that didn't have a stable society, a rule of law and protected ownership rights. In other words, without those basic fundamentals, as well as proper access to the global market, a lot of countries couldn’t enjoy the benefits of capitalism because they couldn't partake in it as fully as others.

 

One of the main troubles with the Piketty-esque socialism is that it has redistributive policies that forget the main wisdom of absolute improvement. That is, what matters most is how well people are doing in absolute terms, not in relative terms. One look at historical trends, particularly since the Industrial Revolution, has shown that capital accumulation has brought about growth in living standards that people like the Ancient Greeks or Romans couldn't have imagined. The reason being: unlike in, say, the Roman dictatorship, it is not just the owners of capital who benefited, it is workers too. Future capital accumulation may increase inequality, or it may narrow it - but that doesn't really matter, as long as everyone's absolute well-being continues to progress as it has in the past 150 years (give or take a few backslides in some areas).

 

This is one of the fundamental errors of Piketty's thesis - he wants a global, information-sharing effort whereby large capital is never under the radar, enabling huge tax efforts against the wealthiest. But even aside from the practical difficulties of this (which even Piketty admits are enormous), it is hugely undesirable. It is standard textbook stuff that when capital increases the absolute wages of the workers associated with that capital will rise too. What Piketty is asking for, then, is a system which makes the workers a little bit poorer in order to make the rich a lot poorer.  

 

Don’t forget too that when someone accumulates lots of capital it generates other people’s opportunity to earn a living. My impression is that those outside of the top-earner category think that the richest few have colluded to be in league with each other, rigging the wealth in their own direction through State-cronyism rather than earning their money fairly through the open market. If so, they haven’t done a very good job of it when you consider how much tax they pay, and the multiple times that their capital is taxed.

 

If you earn £1 and use it to buy a share of stock, you’re taxed when you earn the £1, then again through corporation income, then again through stock dividends, then again through capital gains when the stock is sold, and in many cases for a final time through inheritance tax when you pass it on. When you think of it like that, it’s easy to see why the Chumley Judd theorem states that capital taxation should be zero, and that we should discontinue capital taxation, enriching everyone in the process. And given that wages are determined by capital rates, the Chumley Judd theorem naturally entails that discontinuing capital taxation will be better for wages too.

 

But the story goes deeper, because to understand how money changes hands is to understand that taxes on capital and taxes on wages are knotted together - it’s just that the rope extends between lengthy time periods. When you tax labour directly the tax occurs equally in the periods, but when you tax capital you concentrate the tax to an earlier period in the cycle. Equally, when you tax capital you indirectly tax labour, because the capital ‘now’ was earned in the past ‘then’ by labour – so a tax on that labour then would have reduced the capital now and the concomitant income stream. This means that even discontinuing capital tax still hurts capital owners indirectly through taxes on labour.

 

When you see inequality occurring in individual nations, you can seek solace in the fact that it almost certainly means that inequality is decreasing at a globalised level. It's fairly obvious why; those who can expand their enterprises beyond their own borders are those who are providing prospects to people in other countries. As a consequence their wealth will rise, which increases the gap between them and their fellow countrymen and countrywomen.

 

Suppose Adele is not a global superstar but instead only known in the UK. Her record sales, concert tour revenue, merchandise, magazine deals, sponsorship, and so forth would also be confined to the UK. She'd be one of the richest women in the UK, but not by as much as if she became a worldwide phenomenon. When Adele went global then suddenly her record sales, concert tour revenue, merchandise, magazine deals and sponsorship were no longer confined to the UK, they extended to America, Sweden, Japan, and so on. In the globalised process Adele became richer, which also meant the wealth inequality between her and the majority of Britain increased. The point being, while inequality inside particular countries is rising (mostly countries on the up), as one would expect from increased globalised markets, inequality at a global level is falling, also due to increased globalised markets.

 

Lastly, a word from others

Surprisingly, Paul Krugman, who many believe to be one of the world’s most sound economists, is in some way convinced by Piketty;

 

From Paul Krugman...

 

" “Capital in the Twenty-First Century,” the new book by the French economist Thomas Piketty, is a bona fide phenomenon. Other books on economics have been best sellers, but Mr. Piketty’s contribution is serious, discourse-changing scholarship in a way most best-sellers aren’t. And conservatives are terrified. Thus James Pethokoukis of the American Enterprise Institute warns in National Review that Mr. Piketty’s work must be refuted, because otherwise it “will spread among the clerisy and reshape the political economic landscape on which all future policy battles will be waged.”

 

Well, no worries Paul, there have been quite a few substantive counterattacks to Mr. Piketty’s thesis. All I've seen in recent months is that there is evidence that Piketty Can’t Even Get His Basic Tax History Right, as well as some other indictments of his thesis by well respected economists (see here, and here, and here, and here, and here, and in particular here).

 

And as Bob Murphy points out in this article, Piketty's weighty tome does not seem to be a set of ideas about how we can help the poor - it is mainly a lament against the rich, and a cynical desire that they'd be a lot poorer. Murphy also criticises Piketty for an omission which I often have to point out when I debate with hard leftists who have a bee in their bonnet about expanded capital in concentrated areas - that it just won't do to pay no regard to how rich people became rich in the first place, as my article here points out.

 

* It is worth noting that marketing strategies are often manipulative - but there is, as usual, an easy solution - don't buy into it if you can help it. The moment you don't worry about status and social pressures attached to faux-prestige, you are no longer subsumed by it. But there's no denying it's there. If the ‘invisible hand’ that drove Adam Smith’s economy is the consumer’s liberty in freely chosen acquisition and the seller’s liberty in freely chosen products, then what drives the modern consumer-based ethos is more like an ‘invisible fist’.  Behind the scenes of broken Britain – be it the drugs, celebrity obsession, binge culture, or what have you – is an invisible fist that tries to alter people’s psychology.  Beliefs and values are psychologically driven; therefore the way to drive people into the habits consistent with acquisition is to wave the invisible fist in a way that consumers see nothing but an innocuous hand.  The teenage girl who wants to get on reality TV and be like her pop star idol may feel like she is pursuing an innocent ambition, but unbeknown to her she is under the thrall of the invisible fist of greed acting behind the scenes.  Whether the attention is on subscription to TV channels, travelling, hotels, cosmetics, clothes, media magazines, CDs, DVDs, concert tickets, websites, or whatever – the girl (like millions of others) is ensnared by corporate machinations, intent on making themselves richer and her poorer. That's why, if you're no longer seduced by the futility of relative trend status in competition with your peers, you'll be inured to it.

 

** I note that Piketty had been topping the Amazon sales list in several countries, including America. This is hugely ironic of course, not just because his anti-wealth, anti-inequality diatribe will probably make him wealthy, but because every economic leftie who buys his book is doing their bit to make the world a little bit more unequal. :-)