Brad DeLong on Piketty

Brad writes,

We have a world in which some eminent economists (Larry Summers) say r1 is too low, and other eminent economists (Thomas Piketty) say r2 is too high…

The difference between r1 and r2 is the risk premium. In a well-functioning market economy with well-functioning financial markets, there are powerful reasons to believe that this risk premium should be small: less than 1%-point per year. The fact the risk premium appears to me to be 7%-points per year today is a powerful evidence of the profound dysfunctionality of our financial markets, and of their failure to do their proper catallactic job. But that is a separate and largely independent discussion: that is a dysfunction of our modern market economy which is different from either the dysfunction feared by Summers or the dysfunction freaked by Piketty. For the moment, simply note that it is perfectly possible for all three of these major dysfunctions to occur together.

Pointer from Mark Thoma. Read the whole thing. The risk-premium solution was also suggested here in a comment by Matt Rognlie.

So far, the left-wing journalistic verdict on Piketty is rapture. Economists, even those inclined to agree with Piketty’s conclusions, seem somewhat unsatisfied with with his treatment of capital and interest.

Krugman Reviews Piketty

He sticks to economics, which makes the review quite readable. He drops this sentence into the end of a minor paragraph:

the fact is that the most conspicuous example of soaring inequality in today’s world—the rise of the very rich one percent in the Anglo-Saxon world, especially the United States—doesn’t have all that much to do with capital accumulation, at least so far. It has more to do with remarkably high compensation and incomes.

In fact, that is one of the more damning criticisms of Piketty that one is likely to read. Krugman stops short of calling the book an intellectual swindle, but it appears to be one (I have yet to read it).

Suppose we know two things: First, wealth at the high end of the wealth distribution has increased a lot. Second, the share of wages and salaries in GDP has decreased. Do these two things tell us that capital is gaining at the expense of labor?

The swindle here is to treat “capital” and “labor” as homogeneous, separate categories. You are either a worker or a coupon-clipper. In fact, most people are labor-capitalists. They invest in human capital. They decide how much to save and how much risk to take with their savings. And there is a lot of heterogeneity among these labor-capitalists.

Bill Gates, Jeff Bezos, and Mark Zuckerberg are not coupon-clippers. Their wealth comes from a combination of skill and risk-taking.

Looking at the 21st-century economy through the filter of the Marxist categories of “capital” and “labor” is not particularly insightful. This is not a good era for either a plain coupon-clipper or an ordinary worker to accumulate great wealth. For that purpose, it is better to be a successful entrepreneur or a high-skilled worker.

I think that Krugman correctly views Piketty’s scenario dominated by inherited wealth as offering a speculative analysis of the future. It does not well describe the present.

For example, suppose you look at the Forbes 500 or somesuch, meaning a list of the wealthiest Americans. Compare the list in 2010 to the list in the supposedly egalitarian era of 1950-1970. I will wager that the 2010 list has a smaller fraction of inherited fortunes as opposed to fortunes that were amassed by the wealthy themselves.

Moreover, looking at the low interest rate on risk-free assets today, I would say that the near-term future is one in which the inheritors shall be meek. The next generation of great entrepreneurs should easily surpass the heirs of current fortunes.

UPDATE: Steve Sailer has links to some papers on the Forbes 400. In particular, one paper by Kaplan and Rauh, says

We find that the Forbes 400 in recent years did not grow up as advantaged as in decades past. Those in the Forbes 400 today are less likely to have inherited their wealth or to have grown up wealthy.

Ignorance, Exit, and Voice

In this essay, I suggest that even if voters were knowledgeable about issues, our democratic process would still not be as desirable as having the exit option. This is in the context of talking about a recent book by Ilya Somin. In my view, an even more frustrating problem than voter ignorance is the enchantment that many people have with democratically elected leaders.

As I see it, reasonable government, including the protection of liberty, requires those in office to follow norms of behavior that are bound by Constitutional constraints and principles of limited government. The problem with democratic enchantment is that it sanctions whatever majority-elected political leaders can get away with.

Technology or the Safety Net?

The Financial Times reports,

Non-store retail, which includes online shops, recorded a boom in sales – up 31 per cent to $380bn. But the number of establishments rose only 12 per cent to 66,339 while employment in the sector was down slightly.

Pointer from Tyler Cowen. The gist of the article is that the U.S. economy is becoming more capital intensive.

Casey Mulligan, who gave a talk yesterday on his book The Redistribution Recession, says that 2/3 of the shortfall in employment can be explained by additions to the safety net. The big ones are extending unemployment compensation from 26 weeks to 99 weeks and taxpayers now supplying 65 percent of the cost of COBRA (health benefits) for people who lose jobs. Mulligan combines the various safety-net enhancements made since 2007 with standard estimates of how the “wedge” between the net gain to the worker from employment and the cost of compensation to employers affects hours worked, and that is how he arrives at his 2/3 figure.

In short, the economy has become more capital intensive since 2007 in large part due to the expansion of the safety net. Mulligan pointed out that this does not mean that the expansion was wrong, but he says you should not expect to return to the same rate of labor force participation that we had a few years ago as long as the new measures remain in place. And it will get worse once health care reform takes hold–including many Republican proposals as well as Obamacare. I do not have details on how health reform affects employment–that is the topic of Mulligan’s new book.

Mulligan would like suggestions for a title for the new book. I might suggest “Side Effect: Health Care Reform and the Job Market”


Scott Sumner writes,

I distinctly recall that Robert Shiller did not recommend that people buy stocks in 2009. That made me wonder when Robert Shiller did say it was a good time to buy stocks.

Barry Ritholtz writes,

By one metric — Yale professor Robert Shiller’s cyclically adjusted price-to-earnings ratio, or CAPE ratio — stocks are especially pricey. This has become the bears’ favorite valuation measure. But beware of cherry-picking any particular metric that rationalizes your position. Indeed, over the past 20 years, the CAPE measure has pegged U.S. equities as “overvalued” 85 percent of the time.

But for me, the most interesting Shiller-bashing is in the book I am reading by Duncan Watts, Everything is Obvious. He reproduces a chart created by David Pennock and Dan Reeves, using option prices to derive the probability distribution of future stock prices. The chart shows clearly that the uncertainty about future stock prices is much higher than the variation of past stock prices. That is exactly the criticism that I made of Shiller’s famous “variance bounds” estimates when he first published his work on that topic, and which he told the journal editor to reject. I still think that I was right. I should note that Watts does not make the Shiller connection in his book. However, I think that Watts gives us plenty of reason to be cautious about making statements like “Shiller called the housing bubble.”

I wish that more economists were aware of Watts.

My Review of Brynjolfsson and McAfee

Is here. An excerpt:

Back at the turn of the millennium, these applications seemed to Kurzweil to be on the near-term horizon. These strike me as the same applications that Brynjolfsson and McAfee suggest are on the near-term horizon today. While a few of Kurzweil’s other predictions did materialize, and while some of these applications are certainly closer to reality today than they were in 1999 or 2009, we should be wary that some of what The Second Machine Age tells us to expect may not in fact appear for several decades, if ever.

Trying to Understand

I was sent a review copy of The Moral Foundation of Economic Behavior, by David C. Rose. Here is what I think is a key passage, which is italicized in the book, on p. 140:

the moral foundation of economic behavior is a norm of unconditional trustworthiness made possible by a preponderance of people possessing an ethic of duty-based moral restraint while not regarding moral advocacy as a moral duty.

I have not been able to follow the argument in the book. This podcast with Russ Roberts gets me closer. Here is what I think Rose is saying.

1. Trust is difficult as groups get large. You cannot completely rely on incentives, reputation, and the like.

2. The best way to obtain trust in a large group is for people in the group to be committed to following moral rules. They won’t cheat, even if they can get away with it, because they think that it is wrong to cheat.

3. People have two potential motives to break rules. One motive is to obtain personal gain. Another motive is to achieve some higher moral objective. Rose wants to say that either motive serves to undermine trust. Therefore, telling someone to focus on higher moral objectives (to “think globally, act locally”) is to encourage that person to break rules, which ultimately will lead to a breakdown in trust.

Again, I do not necessarily get the argument, so do not take my interpretation as gospel. In a way, I see this through the lens of the alleged distinction between act-utilitarianism and rule-utilitarianism. Act-utilitarianism says that you should choose each act in order to make people better off. Rule-utilitarianism says that you should follow rules that, if they were always followed, make people better off. I see Rose as saying that rule-utilitarianism is better, because act-utilitarians cannot be trusted. The act-utilitarian may break his promise for what he sees as perfectly defensible reasons. The rule-utilitarian keeps his promise, regardless. (There is a well-known philosophical problem with the distinction between act-utilitarianism and rule-utilitarianism. You can argue that the former reduces to the latter, or vice-versa. Try to ignore that philosophical problem here, since Rose himself does not rely on that distinction.)

4. Another way to put this is that there are two types of opportunism. There is selfish opportunism, which is breaking the rules to gain for yourself. And there is what I might call utilitarian opportunism, which is breaking the rules in order to achieve what you think is a higher good. About this utilitarian opportunism, Rose would say that:

a) our moral intuition, which is based on based on small-group society, is that utilitarian opportunism is fine. However, this is incorrect.
b) in fact, in a large-scale society, utilitarian opportunism does as much to undermine trust as selfish opportunism.
c) our current educational system and elite culture, rather than urging people to follow rules, urges them to behave morally. It encourages, in both individuals and politicians, utilitarian opportunism.
d) This trend in education and culture threatens to undermine trust.

Again, I am just trying to understand. Had I been the editor of this book, I would have gone back and forth with the author until I was satisfied that the points were made clearly.

Mokyr vs. Phelps

Joel Mokyr’s review of Mass Flourishing (ungated version, anyone?), and it is not glowing.

Mokyr refers to Mariana Mazzucato’s The Entrepreneurial State, which argues contra Phelps (and contra nearly everyone on the libertarian side of things) that the state has been the font of much innovation.

Mazzucato’s bullishness on government as a source of entrepreneurial flourishing is a strong antidote to Phelps’s dismissive view of corporatism as the source of all evil, although her enthusiasm for state-led innovation is at times overblown; the truth is somewhere in between. Like a bad marriage, innovation and the State cannot live with or without one another. It is a standard dilemma for all capitalist societies.

There must be something about Phelps–style, substance, or both–that puts people off. Recall that he received a lot of pushback when he spoke at a dinner last month. My own review was more on the positive side.

Mokyr locates Phelps’ antipathy toward Schumpeter:

I argued at length in Mokyr (2002) [that] It was not either science or business, but the realization that there are huge complementarities between them that led to success. Phelps notes that Schumpeter made this very point, but then dismisses him as a “pied piper” who misled historians and the general public (p. 10).

Off Topic

Tyler Cowen links to a new book by John Judis on Jewish influence on President Truman’s Middle East policy. I have read and suggested to friends another book on Israeli history that Tyler recommended, Ari Shavit’s My Promised Land. Also, I recommend Like Dreamers, which looks at the 1967 war in terms of intended and unintended consequences. I will not read Judis, because of some completely unrelated personal issues, which I will put below the fold.

Consider this exercise: flesh out an alternate history in which President Truman does not recognize the Jewish state and Israel’s war for independence fails. State what happens to

1. Arabs in the region
2. Jews in the region
3. Jewish holocaust survivors
4. Jews in Russia
5. Jews in the U.S.
6. The rest of the world

Let me sketch out one ideal scenario: Arabs become secure in terms of sovereignty and status. Feeling good about themselves, they give Jews full rights to own property anywhere and engage in commerce with anyone. They establish democratic modern states embodying civil rights and the rule of law. Holocaust survivors and Russian Jews migrate to the region, as do some American Jews (although not as many as actually migrated). The rest of the world lives quite happily.

I do not think of that as the only scenario, or even the most likely. But the larger alternate-history concept might make for an interesting discussion, if it can be kept civil. Continue reading