On Piketty: The charts don’t work

This is a short blog about Thomas Piketty. As such, there are probably three things that are worth saying at the outset. One, I’ve read the book – check. Two, I read it because I am worried about inequality. But three, I’m pretty suspicious of general theories in anything other than philosophy. Most days I’d take a bit of Parfit over a set of charts.

The claim I want to pick up from Piketty’s set is one he repeated during his Newsnight interview yesterday (Wednesday): that higher concentrations of wealth are likely to reduce economic growth. It would be handy if there was a powerful economic argument against wealth inequality but I’m not convinced there is, and Piketty himself supplies some evidence to the contrary.

He has carried out analysis of the return on the capital endowments of U.S. universities over the period 1980-2010. The annual real rate of return across all universities is 8.2% but it is the range that is striking. Universities with endowments less than $100m achieve just 6.2% per year whereas universities with endowments over $1bn manage 8.8% per year. In other words, higher concentrations of wealth deliver higher growth, the opposite of what Piketty claimed on television.

Look at it another way: if every one of a million people has £100 of wealth each, the productive possibilities of those individual pots of money may be limited. A lot of them will probably end up in low-interest deposit accounts rather than get out into the economy searching for yield. Stick all the pots together though and that £100m might be used to buy corporate bonds that allow a business to expand, launch a new product or service or enter a new territory.

But then there are two kinks (at least) in what I’ve just said. The first is that large concentrations of wealth might just go looking for rents – and have the political as well as economic clout to get them and keep them over a long period of time – rather than search for yield via new and productive economic activity. In other words, the holder of the £100m might buy houses rather than invest in a R&D-intensive business, and that housing investment – if reproduced by lots of others – might very well lead to lower growth than if all the money went into business activity.

Piketty has to show though that this is what’s happening if he wants to claim what he does about the link between the concentration of wealth and low growth. As you might expect, this isn’t impossible to do for the UK and indeed there are hints in the book that it is happening even in France. However, even once you’ve proven that to be the case, it may be that the policy implication is to take measures that shift investment from non-productive into productive activity. Stick in a mansion tax and offer R&D tax credits. This is much less revolutionary than what Piketty might prefer to claim, but it might be as far as he can go on the analysis so far.

The second issue though is that you can create the £100m of potentially productive capital investment that I’ve described either by one person holding the whole lot or having effective mechanisms by which the one million holders of £100 can combine their money through an intermediary in order to invest it. What’s interesting about this kink is that to follow through on Piketty’s claim – i.e. greater dispersal of capital leads to higher growth – a really good financial system is a necessary requirement. Left-wing Frenchman relies on the banks to foment the revolution? I think so, though it would have to be ‘socially useful’ banking with incentives on the banking intermediaries to deliver long run returns. And even then it’s more than likely that the growth achieved will be less than what would be possible if one person had the entire £100m from the beginning – indeed Piketty’s own study of university endowments suggests exactly this.

Where does that leave us? I wonder if it means that the charts don’t work in the end to give us what we might need to make an argument against wealth inequality. There may very well be no watertight, universal principle that states: higher concentrations of wealth = lower economic growth. It might even be that the opposite, with a bit of policy intervention to crack down on rentiers, is more likely to be the case. So either this means that post-Piketty we turn away from wealth again and worry about incomes instead; or that we need a bit of philosophy to do the rest of the work on why wealth inequality is a problem.


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