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It seems like discussion of Piketty’s Capital has run its course and much of the commentary has moved on (though not necessarily from the broader topic) so now is as good time as any to peer back and reflect on how the debate around the book ended (if such a thing can be summarized). From my own vantage point, the debate about the book (not necessarily the discussion) stalled out around a single question, so I will do my best to restate and clarify that question so as to focus where more evidence and argument is needed, should this be a conversation anyone wishes to resume. None of this is new, exactly, but it’s worth recanting given the importance of the question and the stakes surrounding it.

Around 1800 AD, living standards in some countries began to rise substantially, and over the past 200 years, that rise (as measured in GDP per capita) has been on the order of a factor of 50. This generally seems to correlate with other indicators of increased living standards to a degree that, with some exceptions (such as thinly-populated resource-rich countries) it is generally, though not universally, accepted practice to use GDP per capita as a good-enough shorthand for broad living standards. Whatever the case, exactly how and why this increase transpired is still a matter of debate, in no small measure because most people would find it desirable to replicate the phenomenon in those areas that have not yet experienced it. Indeed, some countries that did not begin experiencing the phenomenon in its initial emergence have experienced it since, leaving, essentially, three groups of countries – those who have experienced it, those who have not, and those in transition.

Piketty’s book, while not exclusively, overwhelmingly is focused on the first kind of country. A compelling portion of his narrative is documenting that transformation, yet the broader focus of the book is on what has transpired since that transformation was consolidated in the era following the Second World War. There are two key factors to be documented. The first is that the countries that have fully experienced this transformation are themselves not ‘complete’ in this regard – average living standards (recent economic troubles excepted) continue to rise and are generally, though not universally, expected to continue to rise in the absence of extreme calamity on the scale of global catastrophic climate change. The second is the change in the distribution of income – since a moment of ‘peak equality’ in roughly 1970, most of the countries Piketty analyzes have seen a sharp increase in inequality, the specific degree of which dependent on method of measurement but whose general contours is not really disputed. This, Piketty and many other believes, poses a problem for these countries that is not alleviable solely by continuing increases in average living standards or aggregate wealth and income growth.

Piketty devotes a lot of space to developing a simple model of how the aggregate quantity and distribution of capital can drive income inequality. This remarkably simple model requires only three input variables – the growth rate of the economy, the average return to capital, and the savings rate (perhaps better phrased as the rate of capital formation relative to national income) – to generate a long term prediction of two key ratios: the ratio of capital to income, and the capital share of national income. From there, wealth inequality can be used directly to compute a floor on income inequality – for example, if 1% of the population owns 50% of the national wealth and the capital share of income is 30%, then that 1% captures, at a minimum, 15% of national income.

And here we arrive at the crux of the debate. Piketty’s model implicitly assumes a certain exogeneity between those three input variables and the two ratios they converge towards, ie, that they are not inherently correlated with each other. This exogeneity poses a fragility in Piketty’s model and a challenge to mainstream economic theory. The fragility is that, if they are strongly correlated (in the direction such correlation is expected), and especially if there is iterative feedback between them over time, then Piketty’s model no longer produces outcomes in which wealth inequality drives income inequality. The key example here is the average return to capital; were it to fall in proportion to the rise of total capital accumulation, then the capital share of national income would be invariant to the quantity of capital, and thus largely undermine the mechanism by which present wealth inequality drives future income inequality. Furthermore, were this anticipatable decline in the in return to capital to drive a decline in savings, the capital/national income ratio would converge at a substantially smaller value than that projected by extrapolating from the initial period. This further depresses the likelihood of ever-increasing wealth-driven income inequality.

This is also precisely the challenge to mainstream economic theory. These correlations and feedbacks are precisely what are predicted by fundamental, strongly-held ideas about economics held by economists; most centrally that investment behavior is driven by that most central economic force, supply and demand. Piketty, however, is not simply laying down an alternative model, but an empirical challenge to this challenge. The most crucial assertion made by his model – that the return to capital fails to decline in proportion to the supply of capital – is not simply a theoretical alternative but one derived from the meticulously researched and calculated estimates in his unprecedented data. As I myself pointed out in my write-up of Piketty’s book, the data show that the return to capital is sufficiently resilient to its accumulation to justify Piketty’s model. At least, that is, without controlling for any additional factors.

And here is where debate stalled, with one side asserting that theory demands these variables be tightly correlated, and the other side responding that empirics demonstrates that they are not. The problem, of course, is that macroeconometric panel empirics is extremely sensitive to model specification, to the point of being perhaps the perfect example of how any decent statistically-versed researcher with strong priors can generate the outcomes from the data they which to receive. Certainly it is more than possible to generate a superfluity of complex models demonstrating the theoretically-predicted correlations, and these models will collectively have zero persuasive power because it is trivially easily to create as many or more equally-plausible equally-complex models that demonstrate the obvious.

Why does this all matter, to the degree it’s worth recounting in such detail to the tune of a thousand words? Because it strikes directly at the heart of the most important argument for tolerating high income inequality.

There are basically three arguments in favor of tolerating high income inequality, which I will attempt to summarize as fairly as I can.

  •  The ‘Just Deserts’ Position: incomes reflect the inherently just outcomes of markets. Beyond a certain threshold to prevent the worst form of miseries, it is therefore a violation of justice to take from the deserving and distribute to the undeserving.
  • The ‘Pink Salt’ Position: income inequality is irrelevant except to the irremediably envious, resentful, or spiteful. What matters is preserving and increasing human happiness, which is largely driven by civil liberties, non-market institutions such as family and community, and the secondary impacts of economic progress.
  • The ‘Golden Egg’ Position: income inequality may be ceteris paribus bad but aggregate economic growth is extremely good to a degree that in most plausible scenarios swamps income inequality. Furthermore, income inequality and economic growth may be conjoined outcomes of our economic system and cannot be modified independently. Therefore, we should be extremely cautious about attempting to alleviate income inequality through policies that slow the rate of economic growth, as this may reduce not just aggregate utility but the utility of those benefiting directly from redistribution.

It will shock nobody to hear that I reject outright the first argument in the strongest possible terms, and the second in quite strong terms as well. Indeed, I believe that the majority of Americans, and certainly the majority of voters in developed countries, disagree with those arguments as well. It is that third argument that gives pause to many – including, to a degree, me (though that pause is still far from convincing in my own case). The average person living in a developed country today as compared to a person living in that same country in 1800 is vastly better off, and it is not impossible to imagine that the average person living in a developed country in 2100 will be vastly better off than that average person today. Impeding our shared progress in that regard could simultaneously defer developments that improve the quality of most lives while simultaneously deferring developments (like innovation in renewable energy sources and storage) that could mitigate or reverse the worst consequences of economic growth to date.

This all converges on something of an ironic surprise. In this debate, it has been the left that has been advocating, implicitly or explicitly, on behalf of the resilience of capitalism (broadly defined) and its ability to deliver human prosperity, whereas it has been the right that has claimed, implicitly or explicitly, that capitalism and the prosperity it delivers is fragile, so much so that even increasing post-market redistribution (as opposed to pre-market regulatory redistribution through minimum wages, stronger protections for unions, and abridging the current rights and privileges of lenders and shareholders) could, to use a tired aphorism, kill the goose that lays the golden eggs. This ideological positioning isn’t wholly novel, and whether it is instrumental and ephemeral or representative of something larger remains to be seen; but it is notable, and worth pondering for what it says about the state of both the contemporary mainstream left and right movements in the United States (if not beyond).

First, read David Dayen on Darden, Starboard, and how many private equity and hedge funds are basically, well, if looters is a strong term, let’s call it strident, not inaccurate.

The short version is that a standard maneuver in the outside financier playbook is to find a company that is, basically, two companies – one providing goods or services, the other a large landowner. They then split the company in two and profit as landlords regardless of who they lease their space to.

This plays into an old hobby horse of mine, which is the nature and purpose of the firm. In the theoretical world of neoclassical economics, with low transaction costs and information approximating perfect, it doesn’t really make sense for these two companies to be one company – or at least, not any more sense than it does for them to be two.

But there is substantial value in them being unified. In cyclical economies defined by uncertainty and high transaction costs, many companies face cyclical fluctuations in revenue but not expenses, leaving them vulnerable to fixed cost shocks that may not be ameliorable by spending down savings or accessing credit, especially since credit tends to be scarcest just as these shocks are fiercest. That means a restaurant chain, for example, could be put out of business simply by failing to pay its rent during lean years even if it was flush during expansions. This is a deep myopia of the highly financialized capitalist system we current have. Investors both fail to recognize fusing land ownership with other industries to be, essentially, a form of saving and/or cost smoothing and wouldn’t care anyway because why not just juice the stock or pay out a massive dividend and bail.

Capitalism in many ways truly does thrive on creative destruction – and if anyone seems ripe to be creatively destroyed, it appears to be Olive Garden. Yet by making creative destruction such a shibboleth we’ve lost sight that there is also value in its opposite – institutional preservation. Institutions are repositories of knowledge. Destroying them can destroy the knowledge they hold collectively. Putting their existing stock of resources can involve tremendous transaction costs. Making more institutions more vulnerable to cyclical fluctuations means more institutions will implode when economies cycle, which exacerbates those cycles and destroys value unnecessarily.

A great example of this was the auto bailouts. These were high-fixed-cost manufacturers exceptionally vulnerable to a deep cyclical shock. There was no private finance ready to see them through uncertainty to profitability. So the state invested in forestalling the needless implosion of these institutions because the alternative was imposing not just needless private costs but also bearing large socialized costs from the wrenching transition to whatever followed the liquidation of the American auto industry. Without picking apart every controversial aspect of the program, it makes perfect sense in principle but only if you acknowledge the limitations of private markets to mitigate against widespread disasters with socialized costs.

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Kevin Drum’s fantastic piece on our robot future is best read in tandem with Peter Frase’s piece Four Futures. Whiel Drum’s piece is much more detailed on the likely path technological progress will take, Frase’s piece by virture of its author’s more heterodox perspective more easily grasps something Drum struggles with. Namely: work is not the point.

We (meaning those humans lucky enough to live in the developed world) currently live in a society where, to a large degree with some variation, the social contract is as follows: if you can work, you likely must; but in exchange, your needs will be met and above-and-beyond that you will be given claims on the output of our socioeconomic system, and if for some reason you are temporarily without work you need not fear the worst.

This system developed because it was optimal; it was optimal because, in a post-industrial world aggregate social wealth is a positive externality, ie, the product of everybody working was more than the sum of its parts. Therefore, while the system could bear a certain amount of free riding, too much and you lose the broad sense of stability and security that knits the whole thing together and therefore implosion.

However, systems that emerge for practical reasons often become reified into self-justifying ideological constructs; that is, when it is advantageous for humans to believe in something, they do, and once the belief system takes hold widely and firmly enough it tends to persist past its usefulness. And so it will be with work – the idea that hard work is in-and-of-itself a good, as opposed to merely a means to an end both individually and collectively, will die hard.

But, die it must. For when the robots and computers lead to prosperity not merely orders of magnitude higher than we currently experience but orders of magnitude of orders of magnitude higher, tethering the rights to claim a share of that prosperity with once’s willingness to toil, despite both the uselessness of the toil and it’s lack of meaning to the toiler, will be simply cruel. Therefore, when Drum says “we’re not prepared for [a future of mass unemployment]” and frets about redistribution of income and capital he’s implicity buying into the idea that employment is the end and not merely the means to broad-based prosperity. A world where nobody is employed and everyone has everything is utopian, not dystopian. This world will be so different from ours that it will be difficult to even apply the current frame of post-industrial early-informational capitalism to it.

This is not to say we are in for a future of couch potato-ism. While some will certainly opt for that, there will likely still be a value on participatory activity and a value on things created by humans. Which is to say, there will be a lot of artists and artisans, a lot of restaurants, a lot of informal sports leagues, a lot of therapists. People will still compete for status, always, forever. But what there won’t be is a necessity to sit in a cubicle or stand on a factory floor or behind a cash register for forty hours a week. And we’ll all be better off for it.

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In one of those "let’s defy common wisdom/sense!" kind of things, Matt Levine of Dealbreaker says something badly in need of correction:

1. You were shorting a thing that you were selling to your customers! This is what drove Congress bonkers. But that’s what selling is. If you have 20 apples and sell me 15, you now have fewer apples, and I have more. If apple prices decline, I am worse off, and you are relatively protected. Banks, which are always long some risks and short some others, don’t see zero as a particularly interesting point on this continuum – if you have 20 apples and sell me 30, and apple prices decline, you make money, but that’s different only in degree, not in kind, from selling me 15 and reducing your risk to 5.

This is silly. Let’s say I’m an apple farmer. And let’s say I love apples. Like, really love apples. For breakfast I have apples. For lunch – more apples. Dinner is apples. Dessert is an apple tart. Me, my spouse, my kids – we are all fiends for apples.

But if I have a worthwhile apple farm I am a) still going to have way, way more apples then my family could eat, and b) still need other stuff I can’t grow from the ground. Ergo, I’m going to want to swap some apples for other stuff – farm equipment, energy, an iPad, etc (or for currency that can be swapped for that stuff). But this doesn’t make me an apple speculator. It’s really about diminishing marginal returns and economies of scale. The apple is worth objectively more to someone who has zero apples and wants an apple then it is to someone who has 100,000 apples and can only eat 40,000.

But let’s say I found an apple with a bomb in it. I could bury it or try to defuse. I could alert the authorities to the situation. Or I could sell you the apple, neglect to mention the strong likelihood that it will explode, then make a huge bet with someone else that by day’s end you’ll be in the ICU with third-degree burns. That’s not capitalism, that’s being a giant asshole, and that’s really what people are accusing Goldman Sachs of here.

Now I’m going to go eat an apple.

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