IMF economist questions Piketty’s explanations for rising inequality

Capital in the Twenty-First Century the English version of the 2013 French book on inequality written by Thomas Piketty, a professor of economics at the Paris School of Economics, created a sensation when published in the US in 2014, entering The New York Times bestseller list and drawing positive reviews from leading economists. Last week, in an IMF working paper, Carlos Góes writes that while Piketty's "work is likely to remain influential in the times to come" and is “rich in data, the book provides no formal empirical testing for its theoretical causal chain.”

What is at issue here is not that income inequality has not grown in advanced countries in recent decades — last week we reported on German research which shows that after taking account of income transfers and rising employment, inequality has fallen in the past decade — but if Piketty's explanation for rising inequality is not credible, then forecasts of future trends are also undermined.

Piketty's main argument comes from a formula r > g, which states that the net rate of return to capital (r) exceeds the growth rate of output (g).

In effect returns on capital— e.g. profits, interest and rent that are mainly captured by the rich, outpace economic growth and thus teh gap between rich a poor widens over time.

Góes says in his paper that he looked at three decades of data from 19 advanced economies. “I find no empirical evidence that dynamics move in the way Piketty suggests,” he writes.

In fact, for at least 75% of the countries examined, inequality responds negatively to r − g shocks, which is in line with previous single-equation estimates by Acemoglu and Robinson (2015). The results also suggest that changes in the savings rate, which Piketty takes as relatively stable over time, are likely to offset most of the impact of r − g shocks on the capital share of the national income. Thus, it provides empirical evidence to the model developed by Krusell and A. Smith (2015), who say Piketty relies on flawed theory of savings. The conclusions are robust to alternative estimates of r − g and to the exclusion or inclusion of tax rates in the calculation of the real return on capital.

Measures of inequality should take political factors such as institutions and the evolution of technology into account according to Daron Acemoglu of the Massachusetts Institute of Technology and political scientist James Robinson at Harvard University.

“Different dimensions matter for different questions, and often, what really matters for measuring inequality is the bottom of the distribution,” Prof Acemoglu told The Wall Street Journal. “For example, is it really relevant whether Bill Gates is 50 times as rich as a regular software entrepreneur, or 100 times? It’s better to have a dashboard approach than looking too much at one number.”

Acemoglu and Robinson write in their paper:

...the quest for general laws of capitalism is misguided because it ignores the key forces shaping how an economy functions: the endogenous evolution of technology and of the institutions and the political equilibrium that influence not only technology but also how markets function and how the gains from various different economic arrangements are distributed. Despite his erudition, ambition, and creativity, Marx was led astray because of his disregard of these forces. The same is true of Piketty’s sweeping account of inequality in capitalist economies.

Per Krusell of the Institute for International Economic Studies, University of Gothenburg and Anthony A. Smith, Jr. of Yale University, write in their paper:

Our conclusion is not to sanction complacency about the future developments of wealth inequality. To the contrary, we consider the topic very important from both a positive and a normative perspective, and we particularly perceive a major need for theory in trying to interpret past movements in wealth inequality. Without Piketty’s impressive data work, these movements would have been neither emphasized nor quantified. Looking forward, what are reasonable theories that might undergird quantitative predictions for the evolution of inequality? In his book, Piketty proposes another theory, one we have not reviewed here, that stresses the comparison between the rate of return on capital and the growth rate. To make his arguments, he uses a rather abstract mathematical model (see Piketty and Zucman 2015) showing how, under certain mild conditions, a wealth distribution with a realistic Pareto-shaped right tail emerges as an equilibrium outcome. (The thickness of this tail is then shown to vary directly with the difference between the real return and the growth rate.) Quantitatively restricting models to match this and other features of the wealth distribution will be very important going forward, in our view, and we look forward to further developments along these lines. Without such theory development, we will be sorely short not only of predictions for the twenty-first century but also, and perhaps more importantly, of coherent arguments about the welfare consequences of different policy suggestions aimed at containing future wealth inequality.

The following are extracts of 3 US reviews of Piketty's book:

It seems safe to say that Capital in the Twenty-First Century, the magnum opus of the French economist Thomas Piketty, will be the most important economics book of the year ― and maybe of the decade. Piketty, arguably the world’s leading expert on income and wealth inequality, does more than document the growing concentration of income in the hands of a small economic elite. He also makes a powerful case that we’re on the way back to ‘patrimonial capitalism,’ in which the commanding heights of the economy are dominated not just by wealth, but also by inherited wealth, in which birth matters more than effort and talent. (Paul Krugman New York Times 2014-03-23)

Piketty’s treatment of inequality is perfectly matched to its moment. Like [Paul] Kennedy a generation ago, Piketty has emerged as a rock star of the policy-intellectual world...But make no mistake, his work richly deserves all the attention it is receiving...Piketty, in collaboration with others, has spent more than a decade mining huge quantities of data spanning centuries and many countries to document, absolutely conclusively, that the share of income and wealth going to those at the very top ― the top 1%, .1%, and .01% of the population ― has risen sharply over the last generation, marking a return to a pattern that prevailed before World War I...Even if none of Piketty’s theories stands up, the establishment of this fact has transformed political discourse and is a Nobel Prize–worthy contribution. Piketty provides an elegant framework for making sense of a complex reality. His theorizing is bold and simple and hugely important if correct. In every area of thought, progress comes from simple abstract paradigms that guide later thinking, such as Darwin’s idea of evolution, Ricardo’s notion of comparative advantage, or Keynes’s conception of aggregate demand. Whether or not his idea ultimately proves out, Piketty makes a major contribution by putting forth a theory of natural economic evolution under capitalism...Piketty writes in the epic philosophical mode of Keynes, Marx, or Adam Smith...By focusing attention on what has happened to a fortunate few among us, and by opening up for debate issues around the long-run functioning of our market system, Capital in the Twenty-First Century has made a profoundly important contribution. (Lawrence H. Summers Democracy 2014-05-01)

In its magisterial sweep and ambition, Piketty’s latest work, Capital in the Twenty-First Century, is clearly modeled after Marx’s Das Kapital. But where Marx’s research was spotty, Piketty’s is prodigious. And where Marx foresaw capitalism’s collapse leading to a utopian proletariat paradise, Piketty sees a future of slow growth and Gilded Age disparities in which the wealthy ― owners of capital ― capture a steadily larger share of global wealth and income...Piketty’s Capital in the Twenty-First Century is an intellectual tour de force, a triumph of economic history over the theoretical, mathematical modeling that has come to dominate the economics profession in recent years. Piketty offers a timely and well-reasoned reminder that there is nothing inevitable about the dominance of human capital over financial capital, and that there is inherent in the dynamics of capitalism a natural and destabilizing tendency toward inequality of income, wealth and opportunity. (Steven Pearlstein Washington Post 2014-03-28)

Charts adapted by The New Yorker from the originals in Thomas Piketty’s “Capital in the Twenty-first Century.”