“There are no other choices. Either abstain from isolated interventions in the market or transfer the entire production and distribution management to the authorities.” (Ludwig von Mises)
The planned economies of Eastern Europe collapsed over 25 years ago. The liberal way of democracy and a market economy had won. Karl Marx seemed dead as a doornail; his idea of a planned economy had been defeated by the free market. Francis Fukuyama then prophesied about “the end of history’, a proclamation that in hindsight was obviously premature. Five years ago, the worldwide financial crisis revealed the Achilles’ heel of the market economy: an unstable financial sector and an unequal distribution of income and capital. Since then, the world has been waiting with baited breath for the financial sector to be repaired, but an end does not seem to be in sight. There is also growing unease regarding the unresolved question of distribution. However, unequal income distribution is not the only cause for concern. The power and influence of increasingly concentrated capital is fuel for many debates at the moment. Thomas Piketty recently hit a nerve with his rather hefty tome “Capital in the Twenty-First Century.” Apparently Karl Marx is only seemingly dead because, according to Piketty, if we continue on like this, the end of capitalism is only a matter of time.
Is Inequality Destroying Capitalism?
Market-based economies are supported by the wide spread idea of economic efficiency without “ifs and buts.” There is indeed no system that better organizes the allocation of resources. However, the unequal distribution of income and wealth is a clear Achilles heel. For several decades, inequality has been growing in prosperous countries. If Thomas Piketty is to be believed, this development will only continue. This growing inequality is on the verge of destroying the market economy system and capitalists with an “obscene” amount of earnings who accumulate capital in a Scrooge McDuck fashion are to blame. Money and capital go hand in hand with power and influence. The dangerous influence of highest income groups on politics in their own “pro-business” interests and not “pro-market” interests should not be dismissed. Indeed, this only hinders the market and incites the “Gallic fear” of dynastic developments.
The question of distribution is actually far more complex. Income is converging worldwide, driven by globalization and technological advances. Less affluent countries are catching up noticeably. The worldwide distribution of incomes is becoming more equal, a development which was recently analyzed by Angus Deaton. Within individual countries, however, income is diverging. This applies to the distribution of income both before and after redistribution. The process of unequally distributed income has been in motion in the USA since the mid-1980s. In Europe, it began nearly a decade later. The focus of distributional debates has shifted with time. Originally, the rise in poverty was the concentration in politics. Then, the focus was shifted to the middle class, who had been more or less ignored when compared to both the upper and lower classes. Since the financial crisis, almost all attention has revolved around the top 1% of earners, while the disparity among the other 99% is often unmentioned.
Since political debates have focused on the highest income brackets, more attention has turned to income generated from capital. Many believe this to be an important driver behind skyrocketing incomes. However, that was simply untrue (until now). Before the financial crisis, the highest income groups became even wealthier because the earnings of “Topstars”, “Wallstreet”, and “Mainstreet” were all high. Globalization has also played a role in this development, ensuring that “the winner takes all.” The highest earnings (top 1%) however, were obtained mainly from work. As before, capital incomes are relatively insignificant. However, they grow more rapidly than all other sources of income. Thomas Piketty believes that in the future, capital income will grow even faster than those from work. This would clearly not be good for the economy. Assets would remain concentrated only among the rich, whose incomes would increase exponentially, while their power and influence would grow. Ultimately, capitalism would be destroyed.
The World According To Thomas Piketty
Thomas Piketty’s ideas are based on four principles: 1) Returns from capital (r) will grow faster than the gross domestic product (g) in the future. His argument for this development is supported by two reasons: on one hand, the population growth in affluent countries remains slower than ever before, meaning an important driver of economic growth has also slowed. On the other hand, the “low-hanging fruit” of innovation (Tyler Cowen) has already been harvested to a great extent and all important innovations have already been made (Robert Gordon). In this sense, the growth of labor opportunity, which is the second important driver behind the economic growth, will only stagnate further. Both these developments mean that the gross national product will continue to grow very slowly. In contrast, Piketty assumes that revenue from capital will also remain stable in the future, basing this conclusion on past developments. Indeed, it is remarkable that capital gains (gross) have hardly changed over time. It is also likely to continue in this manner in the future.
2) The already unequal distribution of wealth will be even more unequal in the future. Wealth is already highly concentrated as it is, and if in the future income from capital continues to grow faster than income from work, inequality will only worsen. Capital stock measured by gross domestic product will assume the same values common in the 19th century. According to Thomas Piketty, this problem arises because increasing income is becoming more concentrated than ever before. Even today, assets are largely in the hands of the top income brackets, accumulated by their high savings rates. If income from capital grows faster than that income that is obtained through work, growth collects at the top. This affects the distribution of income by making it disparage even further, as increasing capital income accounts for a larger portion of income.
3) The political influence of the wealthy will continue to increase. The voices of the voters are not of equal value. It has often been suggested that the power of money among the upper income brackets exercises great influence on political decisions. The wealthy with extremely high earnings are able to influence policy in their favor. This “crony capitalism” comes in many forms. Financial benefits such as tax loopholes and subsidies are one thing, but political barriers to market entry for new competitors is another story entirely, effectively damaging not only the economy, but democracy as a system, as well. This distorts the allocation of resources, paralyzes economic growth, makes the distribution of income and wealth unequal, and stops social mobility. A greater concentration of wealth contributes to the fact that capitalists are not only destroying capitalism, but also damaging the essence of democracy (“one man, one vote”).
4) Capitalism can only be saved, if capitalists are prevented from amassing huge amounts of wealth. Unlike Karl Marx, Thomas Piketty does not go as far as to suggest private property be abolished entirely. Instead, he supports the idea of a high progressive income tax and a global wealth tax. A progressive income with “optimal” tax rates of 73-80% would prevent top earners within a company from dipping further into pension funds. This would make it more difficult for them to accumulate huge fortunes via their already high incomes. A progressive property tax of up to 10% per year would skim large fortunes and if imposed worldwide, evasion opportunities would be minimal. The distribution of income and wealth would become more even, power and political influence would decrease, and “capitalism” would become more efficient and just.
How Justified is the “Gallic Fear”?
The four elements of Piketty’s world are not set in stone. Various forces of criticism gnaw at them. 1) The gaps between growth of income from capital and growth from work will not grow wider. It is pure speculation to assume that gross national product growth will decrease while capital returns remain high. The objection here is regarding the growth of gross national product. With a growing world population, immigration in wealthy countries will increase, a development that will be partially compensated by a decrease in fertility. The widespread pessimism that suggests the rate of technical progress will continue to fall is also pure speculation. History has shown that the potential of ground-breaking inventions is systematically underestimated in open markets. But even if a larger gap between (r) and (g) should develop, it should be taken into consideration that capital returns would sink. The law of diminishing marginal returns cannot be overridden.
2) Various forces are actively diluting the concentration of capital. In wealthy countries, assets have been unequally distributed since the 1980’s, albeit to different extents. The degree of inequality is once more approaching levels that have not been seen since both World Wars. It is, however, disputed, whether the wealth of the top 1% of earners has actually grown in recent times. Much more significant is the fact that forces are in motion that counteract the concentration of wealth. The number of children and their descendants also dilute assets through means such as divorce, poor asset management, taxes, donations, and extravagance/waste. However, “asset mobility” is more important still. Experience indicates that it is difficult to remain at the top. The “Buddenbrooks-Principle” is at play. The top 1% can always accumulate a larger portion of a country’s assets, but there are always others scrambling for a position at the top.
3) The danger of “crony capitalism” exists, but it will likely decrease in the future. It is disputed empirically that those with large fortunes attempt to gain influence in politics. This means companies as well as individuals, with large companies having an advantage over smaller companies. In established democracies, it is controversial whether individuals with large assets actually possess such influence. Oligarchic conditions, such as those in Argentina, Russia and Ukraine are also unlikely to develop in the future. Furthermore, contrary to Thomas Piketty’s U-shaped long-term prognosis, the importance of inherited “old” assets is actually on the decline once more. In the U.S. the percentage of inherited assets in total net assets over the past two decades has actually decreased by over 30%. On the other side, assets created through own endeavors are increasingly more important. Technological advancements and globalization promote entrepreneurial activities, thereby increasing the probability that “new” capital will be created and decreasing the likelihood that “cronyism” will continue to reign supreme.
4) Introducing a progressive property tax is essentially playing with fire. Whoever decides to progressively tax large fortunes is faced with a fundamental problem: the distinguishment between “good” and “bad” assets. Thomas Piketty, like many others before him, assumes that inherited wealth is “bad” as no work is required. For him, L’Oréal heiress Lilane Bettencourt is a perfect example of “bad” wealth. Power and influence of such wealth is like mold growing on the face of economic development. “Good” assets, however, are those that an individual has accumulated through concrete effort, preferably through innovative entrepreneurial activities. Microsoft-founder Bill Gates or Apple-creator Steve Jobs exemplify the creation of “good” assets. Their success was not based on “old” money they simply inherited; it was created out of virtually nothing. This “new” wealth does not merely benefit select individuals, it creates prosperity for all. It also has the advantage of accelerating asset mobility. This is not only more efficient, but fairer, as well.
Capitalism Without Capitalists?
Thomas Piketty‘s precipitous thesis that proposes capitalism is destroying itself is rather unconvincing. Nevertheless, such an unequal distribution of income and wealth is risky for the economy, especially if social (intra- and intergenerational) mobility is low. Piketty’s proposed remedy to the issue of distribution is, however, is not advisable. What he has put forward is essentially a Marxist strategy. Under his plan, the “capitalists” would not immediately be expropriated, but gradually through the progressive taxation of high income and wealth. This approach would only serve to stall the engine of economic prosperity: private enterprises. He follows the same misguided logic of many socialists. They believe that gross national product is pre-existing and only needs to be redistributed. In actuality, it must first be created. If incentives for economic actors are removed through excessive redistribution via the tax-transfer system, the necessary goods will not be produced at all.
A nationally organized capitalism with private capitalists acting as jesters reduces the economic basis of governmental redistribution, a fact Thomas Piketty should be well aware of, given the tax-policy disaster brought about by socialist French President Francois Hollande. The government is interfering more often in the market. “Crony capitalism” is particularly pronounced under state capitalism with domestic capitalists. In fact, many countries are already suffering the effects of “cronyism.” However, an excessive tax-transfer system is no adequate solution. The concerns raised by Thomas Piketty regarding monopolistic pensions for top managers and an unequal distribution of wealth are legitimate, but these dangers are more effectively offset through the means of market-based competition. The apparently inherent anti-market tendencies of capitalists can best be controlled if good and factor markets worldwide are opened as much as possible.
Competition is the greatest instrument of disempowerment (Franz Böhm). Those aiming to curb excessive income and asset positions would do well to remember this fact. An intense competition in good and factor markets breaks old power structures and paves the way for more social mobility. The distributive Achilles heel of market economies is also better protected. However, the most important tool in the fight against the unequal distribution of income and wealth is efficient investment in human capital. Even Thomas Piketty would agree. An employee’s earnings can be enhanced in a market economy if they are able obtain a capital income in addition to an earned income. Employee profit sharing is a step in the right direction and is far superior to employee equity participation or so-called “investment wages”. Stronger funded pension schemes are yet another way of sharing raising profits from capital with employees.
Capitalism is in the process of becoming undone, slowly being destroyed by capitalists themselves. This is the core claim presented by Thomas Piketty in “Capitalism in the Twenty- First Century.” In order to save capitalism, he believes capitalists should be blood let. He proposes progressive income and wealth taxes as a way of drastically narrowing their scope and supports a stronger state involvement in and subsequent suppression of the market. This strategy would destroy capitalism once and for all. The best way to limit economic and political power without effecting incentives is more intense competition. In essence, more, not less market is needed. The reduction of disparity requires a bit more. Those wishing for a large share of profits from capital must first put on their capitalist hats. By investing in human capitalism, employees become (human) capitalists. Profit sharing within a company means they too receive a share of the capital income. This also applies for stronger funded pension schemes. Goals for redistribution cannot be met by working against the market, but by working with it. That’s something even French socialists should be able to understand.
Tylor Cowen (2010): The Great Stagnation: How America Ate All The Low-Hanging Fruit of Modern History, Got Sick, and Will (Eventually) Feel Better. Dutton Books, Penguin Group
Angus Deaton (2013): The Great Escape: Health, Wealth, and the Origins of Inequality. Princeton University Press
Thomas Piketty (2014): Capital in the Twenty-First Century. Harvard University Press
Raghuram Rajan und Luigi Zingales (2003): Saving Capitalism from the Capitalists. Unleashing the Power of Financial Markets to Create Wealth and Spread Opportunity. Princeton University Press
Hinweis: Dieser Beitrag ist die englische Version von “Rettet den Kapitalismus vor den Kapitalisten! Thomas Piketty auf den Spuren von Karl Marx”, der am 15. Juni 2014 in diesem Blog erschienen ist. Margaret Sloop hat den Beitrag übersetzt. Herzlichen Dank!
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