if the economy is growing at g percent per year, and if it saves s percent of its national income each year, the self-reproducing capital-income ratio is s / g (10 / 2 in the example). Piketty suggests that global growth of output will slow in the coming century from 3 percent to 1.5 percent annually. (This is the sum of the growth rates of population and productivity, both of which he expects to diminish.) He puts the world saving / investment rate at about 10 percent. So he expects the capital-income ratio to climb eventually to something near 7 (or 10 / 1.5). This is a big deal, as will emerge. He is quite aware that the underlying assumptions could turn out to be wrong; no one can see a century ahead. But it could plausibly go this way.
…The labor share of national income is arithmetically the same thing as the real wage divided by the productivity of labor. Would you rather live in a society in which the real wage was rising rapidly but the labor share was falling (because productivity was increasing even faster), or one in which the real wage was stagnating, along with productivity, so the labor share was unchanging? The first is surely better on narrowly economic grounds: you eat your wage, not your share of national income. But there could be political and social advantages to the second option. If a small class of owners of wealth—and it is small—comes to collect a growing share of the national income, it is likely to dominate the society in other ways as well. This dichotomy need not arise, but it is good to be clear.
Both Tyler Cowen and Solow make the same point about wages, but they do so subtly. Let me be blunt: Piketty’s nightmare scenario, in which capital accumulates and has a high return, is a terrific scenario for wages in absolute terms. If workers care about what they can consume, as opposed to the ratio of their net worth to that of the capital owners, they would hate to see any policy that might interfere with the high rates of investment that Piketty is envisioning. Note, however, that I personally would not concede that the distinction between workers and capital-owners is as clear-cut as it is in the Solow growth model.
The tone of Solow’s review is generally laudatory. It also is by far the clearest explanation of Piketty’s argument that I have read. It reflects Solow’s command of the logic of economic growth as well as his abilities as a teacher.
I think that Solow arrives at a higher evaluation of the book than I would for two reasons. First, Solow gives Piketty the benefit of the doubt on nearly every uncertain issue. For example, on the crucial assumption that Piketty makes that the rate of return on capital remains steady even as the capital-income ratio creeps ever higher, Solow writes,
Maybe a little skepticism is in order. For instance, the historically fairly stable long-run rate of return has been the balanced outcome of a tension between diminishing returns and technological progress; perhaps a slower rate of growth in the future will pull the rate of return down drastically. Perhaps. But suppose that Piketty is on the whole right.
On another issue, the fact that inequality is high between different workers, not just between workers and capitalists, Solow offers a hand-waving defense of Piketty. Solow writes,
Another possibility, tempting but still rather vague, is that top management compensation, at least some of it, does not really belong in the category of labor income, but represents instead a sort of adjunct to capital, and should be treated in part as a way of sharing in income from capital…
it is pretty clear that the class of supermanagers belongs socially and politically with the rentiers, not with the larger body of salaried and independent professionals and middle managers
To this, I would say: why draw the line at supermanagers? Why not say that the salaries of college professors that are paid out of university endowments are “a way of sharing income from capital”? The way I look at it, the amount of income that does not represent “a sort of adjunct to capital” (including human capital) is miniscule, perhaps less than 1 percent of GDP.
My second disagreement with Solow is that he, like Piketty, omits any discussion of risk as a component of “r.” In that regard, Tyler Cowen’s skeptical review better accords with my own thinking.
The way I see it, Piketty and Solow work with models that incorporate homogeneous workers (with no differences in human capital) and homogeneous capital (with no differences in ex ante risk or ex post returns). The real world is so far removed from those models that I simply cannot buy into the undertaking.