I read “Capital in the Twenty-First Century” on assignment and I am glad I did because it is a well written, easy to read and profoundly insightful book. It illuminates what capital is and what effects it has in the world to an extent that hasn’t been done before. The book contains lots of insights and it takes down many financial myths that are imposed on us every day.
Even though I read this book on an Austrian mountain I was still witness to the age old workings of capital. The cabin next door belonged to a person who also owned a large chunk of the mountain. On this plot he kept a couple of dozen cows who grazed and calved there by themselves. This herd and therefore this farmer’s capital would thereby multiply every year yielding double digit returns (I estimate anything from 20-80% on the animals).
I’ll treat each of the myths in this post from the copious notes I took while reading the book.
Myth 1: Capital concentration is not a problem
This is the central tenet of the book. The idea that capital is not an issue and will never be again in our societies is disproved. The core equation of r > g states that most of the time the yield on investments is higher than economic growth and even a small difference will have fairly large consequences in the long run.
Those that don’t have any capital (over 50% of society) have no idea what kind of concentrations of capital are available to others nor which mechanisms enable them to create and maintain these quantities of wealth. A lack of widespread knowledge both of the details of capital as of the financial strategies available to elites is a democratic deficit.
“Those who have a lot of it [money] never fail to defend their interests.”
Myth 2: Merit determines what people get
“Modern meritocratic society, especially in the United States, is much harder on the losers, because it seeks to justify domination on the grounds of justice, virtue, and merit, to say nothing of the insufficient productivity of those at the bottom.”
This point is being argued increasingly by for example Alain de Botton on ‘the evils of meritocracy’. It turns out that this argument frames everybody who isn’t rich (usually because of hereditary misfortune) into a loser who who isn’t trying hard enough or is lazy.
This is an absurd piece of reasoning that has been surprisingly predominant in the past decades.
Myth 3: We need 5-10% annual growth
The current consensus seems to be that a growth rate below 2-3% is bad news. Piketty argues that even a growth of 1% year over year will compound to create large amounts of change. This rate of increase is actually exponential growth (for a fairly low exponent) even though Piketty does not call it so.
According to Piketty high growth usually takes place during phases of catch up. Once a country is caught up growth will come down to normal rates. Other countries can and will experience these high growth periods as threatening.
Myth 4: Macro-economists are doing the best job they can
The biggest value of Piketty’s book is that it demonstrates that a realist approach to economy is possible. Many of the insights in the book are not illuminating because of their politics but because this kind of data has never been collected and analysed in this way before. He calls his deductions accounting identities and as such their content isn’t subject to debate as much as their consequences are.
In the book he questions regularly what economists have been doing for the past centuries. Piketty at one point says that Marx could have done a better job if he’d consulted the data that was available to him at the time. I would say that rather than building a realistic and empirical basis for their positions they have undertaken pissing contests between this school and that.
Every graph in the book points to a data series on an accompanying website where you can download an archive with Stata files, Excel files and all of the graphs in the book. Though a somewhat primitive approach, for the field of economy this looks like a revolutionary innovation. This may be a bit of ‘digital social sciences’ happening finally.
The sheer amount of data lends this book a sheen of objectivity. That may explain why so many people who had not read this book totally lost their shit over it. I believe this is a case where the extra credibility lent to something based on data is mostly justified.
At the end of the book Piketty welcomes the empirical research being popularised within economy as part of ‘behavioural economics’:
“Economists today are full of enthusiasm for empirical methods based on controlled experiments. When used with moderation, these methods can be useful, and they deserve credit for turning some economists toward concrete questions and firsthand knowledge of the terrain (a long overdue development).”
Myth 5: Immigration is a bad thing
“In a quasi-stagnant society, wealth accumulated in the past will inevitably acquire disproportionate importance.”
The consensus in Europe is that immigration is a bad thing. Piketty argues that population growth is a factor on top of economic growth (or instead of) to increase a nation’s income.
Myth 6: Debts are neutral
Piketty explains that debts are a transfer from the poor to the rich. Bond holders are almost exclusively rich people either directly or through portfolios who are paid interest by nations as a whole. As such everybody including poor people pay while the only people who benefit are the rich.
This is highly relevant when considering the levels of national debts within Europe and the fact that nation states are being held hostage by lenders whose identities we don’t even know.
Myth 7: Taxation is just about creating revenue
“It is important to understand that a tax is always more than just a tax: it is also a way of defining norms and categories and imposing a legal framework on economic activity.”
Piketty says that even a tax that is too small to make a fiscal difference would be useful because taxation necessitates transparency and mapping. Just as the taxation of land requires a legible cadastral system to know who had what piece of land, creating a fractional tax on capital would shine some light in a dark place.
Myth 8: Inflation is bad
“How can a public debt as large as today’s European debt be significantly reduced? There are three main methods, which can be combined in various proportions: taxes on capital, inflation, and austerity. An exceptional tax on private capital is the most just and efficient solution. Failing that, inflation can play a useful role: historically, that is how most large public debts have been dealt with. The worst solution in terms of both justice and efficiency is a prolonged dose of austerity—yet that is the course Europe is currently following.”
It turns out that inflation is not as bad a thing as it is made out to be. Many European nations have used inflation in the 20th century to greatly reduce their debts. Piketty says above that austerity is the worst thing that you can do in the face of large national debts.
Inflation is however not an uniformly good strategy to get rid of debts because it will disproportionately affect those without real assets (poor people and the lower middle class) i.e. people with a small nest egg in the bank.
In fact later in the book Piketty mentions that Germany has benefited most from inflation during the 20th century but now refuses to let others benefit similarly.
Germany is often exemplarized as an economic example within Europe but this is patently false. Germany is in fact a deeply unfair and hyper-capitalist society which has more similarities with the USA than with any other continental European nation. There is no minimum wage in Germany. Parents can give their children €800’000 taxfree every ten years. The list goes on.
After using inflation to reduce their debts, Germany has in the 90s reformed its social security and labour market to a fairly extreme level. With such a liberal job market it is also economically expedient for them to be an immigration nation pulling in the qualified labour pools of other countries.
Now being the dominant economic power in Europe Germany is using every means at its disposal to stay that way even if it means choking off other European nations. Comparisons of Merkel with Hitler may be absurd, a comparison with Putin seems justified. Just like Putin, Merkel is allowed to stay in power as long as the economy is growing and things are stable.
Myth 9: Supermanagers deserve to make absurd amounts of money
There has been a lot of debate about this already and it is pertinent to Piketty because the people at the top of the income distribution today are people that have both historically accumulated wealth and are in positions where they make a lot of money from their work.
Piketty argues what has been argued in other places as well: there is no proof for increased productivity of supermanagers or for anything else that would merit such disproportionately high pay. A better explanation for it is that there are old boys who determine each others’ renumeration and have no incentive to hold back.
Myth 10: Education should be expensive
Piketty argues that even though education may not be a cure for inequality that open access to higher education for anybody who is able to go is very important for a society.
Unfortunately in the Netherlands higher education is being instrumentalized and financialized. It is becoming unattractive to learn things that do not have a direct market payoff because of the debt you incur while studying. It is fairly obvious that this system disproportionately benefits those with money who are less affected by opportunity cost.
Myth 11: Globalization is bad
Piketty argues that globalisation is good and that countries that close themselves off rarely benefit from it. He uses this as an argument for more taxes: “Absence of progressive taxation may undermine support for a globalised economy.”
Myth 12: The United States have always been a nation of low taxation
“Furthermore, the Great Depression of the 1930s struck the United States with extreme force, and many people blamed the economic and financial elites for having enriched themselves while leading the country to ruin.”
“Josiah Wedgwood, in the preface to a new edition of his classic 1929 book on inheritance, agreed with his compatriot Bertrand Russell that the “plutodemocracies” and their hereditary elites had failed to stem the rise of fascism. He was convinced that “political democracies that do not democratize their economic systems are inherently unstable.”
I was amazed that the United States (and England) for a period of time had incredibly high (confiscatory) taxes on income, capital and estates because: ‘all excessively high incomes were suspect.’ The accumulation of capital was seen as something unhealthy and also as something profoundly illiberal.
Myth 13: Financial transparency is undesirable
“It is particularly striking to discover that the countries that are most dependent on substantial tax revenues to pay for their social programs, namely the European countries, are also the ones that have accomplished the least, even though the technical challenges are quite simple.”
One of the most important solutions and necessities Piketty suggests is to increase the transparency of capital stocks and flows around the world. There are initiatives underway to do this but they will take a long time to implement and will probably be watered down when they get there. Doxing off-shore banks may be the only remedy available to us in the meantime.
Financial transparency for everybody and especially the ultra-rich should be something for which there is a clear majority. The question then remains why it is so hard to push through. Maybe having a president of the European Commission who used to work for the Luxembourg cottage financial industries is not making this any easier?
Knowing whose money is where and where it is going is also necessary during financial crises to be able to take the right action. It would seem obvious but it turns out that during the recent financial crises our governments had to resort to the equivalent of randomly throwing money into black holes.
The initiative Open Spending focuses on making government finances transparent. A similar initiative should push for doing the same with the financial data of public and private companies.
Myth 14: Public wealth will follow after economic growth
Economic growth in an area does not benefit everybody and definitely not equally. Berlin for instance has recently seen a gigantic influx of capital and private wealth. The city finally has budgets in the black again but still has no money to speak of. More correctly: there isn’t any money for better public transportation or to clean school buildings; there is money for large scale construction projects and Olympic bids.
Myth 15: Investors are as useless as a gorilla
“The higher we go in the endowment hierarchy, the more often we find alternative investment strategies,” that is, very high yield investments such as shares in private equity funds and unlisted foreign stocks (which require great expertise), hedge funds, derivatives, real estate, and raw materials, including energy, natural resources, and related products (these, too, require specialized expertise and offer very high potential yields).”
Piketty demonstrates this popular notion to be patently false. It turns out that given enough money you can get both access to more interesting investment opportunities and hire advisors that can get you high yields on those opportunities. He takes the endowment of for instance Harvard as an example where they by investing a small part of their huge capital (of some $30B) they manage to get returns on the order of 10% a year.
The measly one or two percent you and I can get at the bank pales in comparison and does not even keep up with inflation. You could save yourself some trouble and just throw your money into a fireplace.