WASHINGTON, April 22, 2014 — “Capital in the Twenty-first Century,” a recently released book by French economist and Social Democrat Thomas Piketty, has caused quite a stir in the economics profession.
Mr. Piketty’s analysis of historical data is similar to what Karl Marx observed some 160 years ago. Both authors come to the conclusion that Capitalism will lead to increases in income inequality: an inequality that must be definitively addressed. The problem is that both arrived at incorrect conclusions.
Historically, both writers note, there was a clear division between labor and capital, so that as an economy grew, capitalists benefited from this growth much more than labor. Piketty determined that the growth rate of capital exceeded the growth rate of the economy, resulting in a widening income inequality that he deemed to be unfair. Marx’s conclusion was similar but his ultimate solution was far more extreme. He wanted to share all income equally, which, he concluded, would virtually eliminate income inequality. Unfortunately, history since the time of Marx indicates the imposition of this type of system does not work.
Many countries have experimented with socialist systems where the central government attempts to equalize income distribution. The problem is that since each contributor receives the same income regardless of his or her contribution, there is no incentive for anyone to contribute more. As a result such an economy eventually stagnates.
While most countries have abandoned this type of system at least in part, countries like Cuba and North Korea hang on and double-down on the error, resulting is an economy where almost all citizens live at or near the poverty line.
The problem with both Piketty and Marx is that they assume without question that there is a clear division between Capital and Labor, so that some people are defined capitalists while the remainder are designated as laborers. While that division may have been apparent in the historical past, the division today is less clear-cut, although clearly some individuals possess considerably more capital than others.
Today, in fact, almost all people who earn the majority of their income by providing labor to the economy also supply capital. Most workers, at least in the industrialized economies of the West, have saved some of their income and have invested it into financial assets via 401(k)s and similar vehicles even if these workers don’t directly perceive their involvement in the system.
A majority of these retirement accounts are administered by a custodial institution or agent responsible for investing workers’ capital with the aim of earning a better-than-average return. Many workers have other investments as well, such savings or money market accounts where they seek the highest return on that capital subject to the level of risk they are willing to take. This is exactly the same position taken by people who we refer to as Capitalists. And even most of those Capitalists actually go to work and earn income from their labor.
Piketty, like Nobel laureates Paul Krugman and Joseph Stiglitz, argues that the widening income inequality that the U.S. has experienced in recent decades will have negative effects on the over all economy. He concludes that it simply isn’t fair that the top earners have amassed such a significant amount of wealth while the bottom has earned so little. To fix this situation, Piketty says we should impose very progressive tax rates with the largest income earners being taxed in the 70% to 80% range. He even recommends implementing an additional “wealth tax” beyond this.
In other words, Piketty’s solution for reducing income inequality is to pull the top earners down. Of course, a better solution would be to provide the bottom income earners with greater opportunities to move up the income scale. But this option is not considered.
In the last five years in particular, income inequality has worsened in this country primarily because liberal social programs have destroyed the incentive to work. Today in the U.S., only about 63% of the adult population is either working or seeking a job. The rest appear to see no point in it or have simply given up. This employment figure is the lowest in about 50 years.
At the same time the Federal Reserve’s policy of vastly increasing the money supply, primarily by purchasing trillions of dollars in U.S. government debt, has crowded private capital out of the debt market and into equities. The increased demand for stocks has pulled stock prices to record highs thereby increasing wealth for institutions and the professional investment class, disproportionately benefitting high income earners, although indirect stock market investors, via 401 (k)s and other retirement vehicles have also benefitted but to a lesser extent.
However, this situation should be short-lived. The Fed is gradually cutting back on its massive bond purchases and the stock market seems to be stabilizing, so the growth in the wealth effect for high income earners should slow. But the other part of the inequality problem will be more difficult to resolve.
New laws aimed at helping the lower classes are accomplishing just the opposite. Increases in the minimum wage reduce employment opportunities as they provide a disincentive for new hiring. Worse, with Obamacare legislation defining “full-time employment” as a 30-hour work week, the result has become a greater number of part-time workers with obviously lower income. Additionally, increases in food stamps and welfare programs has been proven to isolate and trap individuals and families in a vicious circle of poverty and dependency, sometimes for generations.
Piketty and Marx are largely correct in their analysis of income inequality. But both reached erroneous conclusions on exactly how to reduce inequality, if indeed that goal is even desirable. Taking money from those who have fairly earned it and giving to those who have not is not a good solution.
A more recent look at history would reveal that when tax rates were lower and made less progressive in the 1980s, the economy embarked on a 26-year expansion, save for small hiccups in 1991 and 2001. This expansion resulted in solid growth, improvements in the standard of living and opportunity for everyone. In the process, the unemployment rate fell from more than 10% in the early 1980s to a low of 4% before the current economic debacle erupted.
Historically the US has attempted to have a free market economy based on low taxation and low government involvement in business. This freedom-oriented system allowed the U.S. to evolve from a new “Third World” country status to become the number one economic power in only about 150 years, surpassing every country on the planet, including those in existence for hundreds or even thousands of years.
If inequality is deemed to be a problem, let’s resolve to work on bringing the bottom up, not taking the top down.