Homburg: Piketty’s erroneous claim is due to the implicit assumption that savings are never consumed, nor spent on charitable purposes or used to exert power over others. It is only under this outlandish premise that wealth grows at the rate r. If people use their savings later on, as they do in the Diamond model as well as in reality, the growth of wealth is independent of the return on capital. This holds all the more in the presence of taxes...Marginal Revolution
Stefan Homburg on Piketty
Tyler Cowen | Holbert C. Harris Chair of Economics at George Mason University and serves as chairman and general director of the Mercatus Center
10 comments:
No Piketty doesn't assume that. Piketty uses the concept of net domestic product rather than GDP as his measure of annual income. One difference between net domestic product and GDP is that net domestic product reflects "the depreciation of the capital that made this production" possible.
Any income not consumed during the year it is produced is part of national savings and gets added to the capital stock. But there are also reductions of the capital stock each year due to the employment of earlier savings in current production. Those annual reductions are subtracted from GDP (gross income) to get NDP.
In terms of Piketty's variable "r", r is equal to NDP/Wealth, and so the fact that capital is constantly used, and hence depreciated, is already reflected in the calculation of r.
His point is that wealth is consumed, and so the growth in wealth is less than the return on capital. The other issue is that after-tax returns need to be used.
Piketty's argument was that the amount consumed by the extremely wealthy is only a tiny percentage of their wealth, which is what Stefan Homburg ignores. The r>g expression is an approximation.
Technically, the growth rate that matters is the growth rate of the income of the working class, not national income. If your wealth is growing faster than the worker's wages, your relative position is improving versus them. But it may be that CEO income is growing faster than your wealth.
Right. Surplus is divided into labor share and "other." I would not call it "capital share," since it's more complicated that that with a great deal of wealth resulting from rent rather than return on productive investment.
There is also question is whether top management should be included in the wage bill, especially now when management is not paid in terms of ordinary (taxable) income but in other income that has tax advantages. The question is also how much economic rent is involved versus marginal productivity at this level of compensation.
But basically it comes down to the % that actual workers make ("middle class" in the US, where the distinction is among wealthy, middle class, and poor) and where the rest comes from and goes, with the wealthy getting a disproportional share of income and accumulating the bulk of the wealth. Even if the wealthy are consuming a lot, it is luxury goods and Veblen goods that are the accoutrement of status rather than necessities or moderate pleasures.
A lot of the disparity was masked over the past few decades by the tendency of the middle class to rely on debt to support lifestyle in an environment of stagnant wages but rising "prosperity." Now that's over since the GFC and all the talk about inequality is the result of that. This has been exacerbated by the imposition of fiscal austerity that has slowed down the recovery, along with the tighter credit after a financial crisis, which of course ZIRP and QE did nothing to address.
The question is twofold. First, does inequality inexorably result with the neoclassical framework in spite of the model's prediction that marginal productivity in a liberal environment (all the assumptions) tends to equal distribution. Secondly, from the heterodox POV, what role do factors not taken into account in neoclassical economics play in generating rent-seeking and gains from rent?
Brian, it's not just that the wealth that is consumed is small and negligible. It's not. Piketty says it can be as much as 10% of GDP per year. It's that it is already accounted for in Piketty's definition of r. (I posted a clearer and corrected version of the above in a comment at Cowan's blog.)
Suppose W1 is the wealth of some country at the outset of year 1, and that Y is the total national income of that country in year 1. Suppose s is the savings rate in that year, and suppose S is the total national savings for that year. Let X be the total depreciation of national wealth in that year; that is, wealth that is lost either because it is consumed during the production process, or just lost due to waste and decay. Let Z be the total national income that comes from abroad. Finally suppose W2 is the total national wealth at the outset of year 2.
Then we have
W2 = W1 + S
which is equivalent to
W2 = W1 + s(Y)
National income is defined as:
Y = NDP + Z
where NDP is defined as
NDP = GDP - X
So, we have:
Y = GDP + Z - X
and therefore
W2 = W1 + s(GDP + Z - X)
So as we can see, Piketty has accounted for annual depreciation by subtracting it from income before the saved portion of income is added to wealth.
Tom, in Piketty's framework, rents are just a component of the capital share. It's all the income that is derived from what one owns rather than the labor one performs.
Yes, it has to be that way, unless labor is in a position to extract rent, which might be argued under strong unions.
But in the strict neoclassical model there are no rents. Each factor "earns" iaw it marginal productivity, so the result is distribution by "just deserts," i.e., actual contribution. This is the way the model works and it is used performatively to argue that distribution is not an issue.
Heterodox economists bring in rent. Strict marginalists disallow this as "Marxism." Except on the case of trade unionism, of course, although some might also bring in government intrusion such as excessive granting of intellectual property.
Not having read the text but only the reviews, I am unclear how much of a distinction PIketty makes here but it doesn't seem to be enough to get him in trouble with the mainstream that rejects rents as a component of capital share or executive compensation.
Maybe I read that part of the book too quickly, but he defines wealth in terms of financial assets. A rich person will need to sell some of those assets to keep up his or her extravagent life style, which is consumption.
This selling of assets means that the growth of the portfolio would be less than the return on the assets.
Those assets would be sold to some other entity, such as a pension fund. The financial assets themselves are not consumed.
I am less concerned about the real assets behind those financial assts. There is no good link between the real assets and the value of the financial assets. In steady state, there may be, but discount rates have been unstable over recent decades.
"... but he defines wealth in terms of financial assets."
No financial assets are only a component of wealth. He defines it as "the total market value of everything owned by the residents and government of a given country at a given time, provided it can be traded on some market."
People generally own equities, which are pieces of the corporations tgat own the real assets.
He uses estate data to measure wealth. When an estate is valued, the value of the equities on the exchange is calculated, not the value of the physical assets that may be behind those shares.
It's only in the case of family businesses that the firm assets would be pickedup.
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