Piketty’s Meat and Bones

I have yet to finish reading Capital in the Twenty-First Century. There are many reviews already out, many of them very much worth reading. Two critical reviews by Ryan Decker and Josh Hendrickson. There is also Paul Krugman’s, probably the most widely discussed review to date; Krugman makes some good points against Piketty, but also covers some of the book’s strengths.

The heuristic the book sells to the reader is r > g. That is, if the return on capital is greater than the rate of economic growth, inequality will increase. The concept, explained like that, is somewhat cryptic. It’s an easy heuristic for those who don’t want to get bogged down in the theoretical argument. The theoretical argument is actually not that complicated (theory makes up a very, very small minority of the book). Piketty makes it near the end of the sixth chapter of his book. His argument is that if the elasticity of substitution between capital and labor is > 1, the share of income accruing to capital will grow relative to that of labor.

You actually don’t have to buy the book to access the theory. In my opinion, the theory is not well communicated in the book. It’s available in the free technical appendix. Here is that appendix for chapter six (in case it doesn’t take you directly, the meat and bones starts on page 37),

Download the PDF file .

Quote of the Week

[P]olitical liberalism supposes that there are many conflicting reasonable comprehensive doctrines with their conceptions of the good, each compatible with the full rationality of human persons, so far as that can be ascertained with the resources of a political conception of justice.2 As noted before, this reasonable plurality of conflicting and incommensurable doctrines is seen as the characteristic work of practical reason over time under enduring free institutions. So the question the dominant tradition has tried to answer has no answer: no comprehensive doctrine is appropriate as a political conception for a constitutional regime.

— John Rawls, Political Liberalism (New York: Colombia University Press, 1993), p. 135.

The footnote,

The point here is that while some would want to claim that given the full resources of philosophical reason, there is but one reasonable conception of the good, that cannot be shown by the resources of a reasonable political conception of justice.

China: Future Migration Hotspot?

China is still a sending state, more migrants leave than come in. According to the World Bank, about 1.5 million people emigrated from China in 2012, on net. I am not sure how much of that includes emigration to Hong Kong and Macau. Still, compared to the United States, which received, on net, 5 million immigrants, China does not seem like a major attraction to migrants. But, will China always be a sending state, or will it soon begin to receive net immigration? Immigration is already an important facet of the Chinese economy, and there is reason to suspect that China, like Western Europe and the United States, will, down the road, become a receiving state.

Historically, China has always been a sending state. The World Bank measures net migration as the number of immigrants minus the number of emigrants. China has had a negative figure since 1962, which is when the data I have starts at. But, net emigration does not imply no immigration, and, as their economy continues to grow, with a growing demand for labor, immigrants have turned into vital means for growing productivity. While the amount of net emigration remains significant — although, the data includes emigration to Hong Kong and Macau (two important net recipients of Chinese migrants) —, the number has been steadily decreasing since the early 2000s: from 2.2 million immigrants, on net, to 1.5 million.

The country, however, is going through a structural change. It is going through a process similar to that of the U.S., between 1820–1910. Industrialization has brought with it one of the largest internal migrations in the world, as large amounts of people move between provinces. This includes movements from rural areas to the cities, and movement from poorer (typically, rural and agricultural) to wealthier regions. While there are not always known opportunities for higher paying jobs in the cities — migrants are often displaced by a falling demand for labor in the rural areas —, it is true that Chinese industry is a sponge, in need of a growing labor supply.

Domestic labor is not always enough, especially given China’s low population growth rate (0.5 percent, in 2012). If the demand for labor increases, and the labor supply is more-or-less stable, we should expect higher wages. According to the “neoclassical” theory of migration, where changes in relative wages cause migration between countries, we expect rising Chinese wages to attract migrants. This does not necessarily mean, though, that immigration will occur up until wage rates between countries are equalized — in fact, emigration to China may push wages up, inviting even more immigration.

If there are economies of scale, larger populations mean higher real wageMonopolistically Competitive Markets. As population grows, all else equal, so does output. This lowers the average cost and price, raising the real wage. Larger population also means a larger amount of firms, greater product diversity, and the accompanying welfare gains to the consumer. This result was formalized by Paul Krugman, in his work on trade theory.

Trade, or the movement of goods and capital, creates the same effect as an increase in population: an increase in the division-of-labor. But, if trade is restricted, or if bad policies elsewhere leads to low growth and high unemployment, the movement of labor may replace the movement of goods. Consider some of the “stylized facts” of sending states: history of low growth, extractive political institutions, and relatively low wages. Sending states each have a division-of-labor which is significantly isolated from the world’s. While China’s political climate may still be unattractive to many, the economic factors may grow in relevance. The country is surrounded by many others which are worse-off, and growing Chinese wage rates will become increasingly attractive.

Other factors, besides relative wages, that determines migration are “linkages.” Think of a linkage as a shared history. For example, many Indians migrated to the United Kingdom, because India is a former colony. Similarly, Spain attracts a disproportionate amount of South American migrants, because of their shared history. Countries with linkages are more likely to be involved in a migration pattern than countries without them, all else equal. China has shared histories with not only its neighbors (many of which, however, are also growing and/or prosperous), but also with populations one might at first suspect. The Chinese have invested heavily throughout Africa, and many Africans have migrated to do business in China. As African networks in China grow, this might attract larger flows in the future.

Growth, however, does not always mean less emigration. The evidence shows that growth may actually lead to increasing emigration rates, below a certain threshold per capita income,

Emigration Flow to GDPPC

In early stages of development, other factors may dominate the marginal increase in relative wage. Since the poor are typically credit constrained, rising incomes will help them finance migration decisions. Networks in other countries may also attract large emigration flows. If early flows were restricted by asymmetric information, where potential migrants were simply unaware of the opportunity, growing networks in receiving states will correct this asymmetry and increase the flow of migration. Changes in relative income are important to consider, too. If early growth raises certain incomes disproportionately, the relative wage rates between countries for the non-affected income groups remain the same. Maybe this explains, in part, why China attracts high-skilled labor from South Korea and Japan, but exports low-skilled labor.

But, China’s GDPPC (GDP per capita) is just about at the threshold in the data. According to the World Bank, China’s 2012 GDPPC, in current U.S. dollars, was about $6,000. Net emigration has fallen since the early 2000s, and real wages in China continue to grow. Is China poised to become an important receiving state in the future? This will bring with it interesting problems. An immigration shock provokes hostility amongst a homogenous local population, leading to civil rights issues — issues the Chinese government will have to deal with. It will also have a significant effect on the global economy. The U.S. became a major industrial power in large part thanks to immigration. But, the U.S. started out with a relatively small population. China is already the largest country on Earth and there is still a growing demand for labor, despite the already large labor force. How will the Chinese government approach the “immigration problem?” How will this affect the United States and Western Europe? By 2070, or sooner, we might see large communities of American workers in Beijing!

Rhetoric of Capitalism

In November 1957, just a month after Russia’s Sputnik satellite blasted into space, causing Americans to fear that they were losing in the space rate, Lawrence gave an optimistic address about America’s strengths to students and faculty at Seton Hall University in South Orange, New Jersey. Lawrence told the assembly, “Spread of shareownership in America brings about a silent revolution, and this people’s capitalism is given impetus by the Stock Exchange.” He continued, “The most dramatic feature of this free-enterprise system has not erupted in newspaper headlines. Nor has it been squeezed into the small talk of ordinary parlor conversation. The phenomenon I’m talking about is the gradual emergence of what we have come to call a People’s Capitalism — the ownership by millions of people everywhere, through their stock investments, of our means of production.”

— Janice M. Traflet, A Nation of Smaller Shareholders: Marketing Wall Street after World War II (Baltimore: Johns Hopkins University Press, 2013), pp. 139–140.

Secular Stagnation Modeled

Gauti Eggertsson and Neil Mehrotra provide a formal model of secular stagnation, a theory recently revived by Larry Summers and Paul Krugman. The theory was first proposed by Alvin Hansen in the late 1930s. It’s probably not coincidence that the theory is popular again during a period in which the economic situation — deep contraction followed by a slow recovery (low growth) — is similar. I wonder if the long-term shape of the economy will also turn out to be similar to that of 1929–2001, and if the theory will simply fade out again.

The abstract,

In this paper we propose a simple overlapping generations New Keynesian model in which a permanent (or very persistent) slump is possible without any self-correcting force to full employment. The trigger for the slump is a deleveraging shock which can create an oversupply of savings. Other forces that work in the same direction and can both create or exacerbate the problem are a drop in population growth and an increase in income inequality. High savings, in turn, may require a permanently negative real interest rate. In contrast to earlier work on deleveraging, our model does not feature a strong self-correcting force back to full employment in the long-run, absent policy actions. Successful policy actions include, among others, a permanent increase in inflation and a permanent increase in government spending. We also establish conditions under which an income redistribution can increase demand. Policies such as committing to keep nominal interest rates low or temporary government spending, however, are less powerful than in models with temporary slumps. Our model sheds light on the long persistence of the Japanese crisis, the Great Depression, and the slow recovery out of the Great Recession.

(H/T Mark Thoma)

The Capitalist Mentality

How have views towards the free market changed over time? How society views markets matter, because it may help explain important questions. If, for example, views determined the significant growth rates of the 18th and 19th centuries — after centuries of stagnation —, a change in views could have quite an impact on our future wealth. Indeed, the Great Depression was capitalism’s nadir and communism, socialism, and fascism were at their height between 1920–50. If 1991 shattered the false allure to communism, in 1930 it seemed as if capitalism had failed. Several economists warned of the dangers of anti-liberal and anti-market ideas, arguing that those ideas promote not only low growth, but authoritarianism as well. Some believe that this anti-capitalist mentality has continued into the 21st century. Since the late 1940s, however, the public’s opinion on capitalism has matured and strengthened, and good evidence of this is how the public responded to the 2007–09 crisis.

In certain ways, it seems as if the public’s attitude towards markets has deteriorated over time. The initial reaction to the stock market crash of October 1929 was to blame small investors for making non-expert investment decisions based on emotion. Big finance was not immediately blamed, although its image soon blackened as the world economy continued to plunge, banks began to fail in large numbers, and unemployment rates began climbing to new heights. The 1930s were an “absolute minimum” for free markets, and the experience of the Great Depression continues to inform the public’s opinion. Compare, for example, the initial reaction to the crash of 1929 to that of 2008. Bankers and traders took the brunt of the criticism in 2008; in 1929, they were, at first, given the benefit of the doubt. But, this interpretation leaves part of the story out.

It is true that capitalism’s image was in serious trouble between 1930–50. In A Nation of Small Shareholders, Janice Traflet tells the story of the New York Stock Exchange’s (NYSE) struggle to revive it brand in the face of hostility and mistrust. The initial crash did not immediately wound society’s amicable relationship with markets, but the banking crises, repeated scandals of fraud and theft by part of bankers and wealthy investors, and high unemployment had struck an almost fatal blow. Traflet explains how resistance to regulation and state involvement collapsed by the late 1930s, because, after several crises and scandals, the NYSE and others simply chose to cut their losses and work with regulators, rather than against them. But, by the mid-1950s the situation, for capitalists at least, began to improve. Traflet looks at the NYSE’s advertising program, but external factors were probably even more important for repairing capitalism’s perforated image.

One such external factor was the public’s view of socialism and communism. During the first two decades of the 20th century, many intellectuals held an endearing opinion on socialism. The success of war controls and planning during the First World War served as an important impetus for those looking for a better alternative to capitalism. The initial experience with the Soviet Union was somewhat of a disillusionment — war, famine, and oppression usually are —, but socialist sympathy was at a high point and the Soviet’s rapid industrialization between 1930–50 was inspiring. 1920–40 were the decades of the ongoing socialist calculation debate, where top economics journals became ideological battlegrounds — the possibility for central planning was taken very seriously. “Luckily,” the Cold War would soon change things. Communism, and by extension socialism, became the West’s rival, and between 1950–70 the Keynesian consensus — not quite socialist, but not capitalist enough, either — gave way to a free market revival.

One interesting facet of the revival is the language used to sell capitalism to the people. Financial organizations selling their products, such as mutual funds and monthly investment plans (MIPs), talked about marketplace democracy, shareholding (vs. stocks), and freedom. Capitalism, not communism or socialism, is what empowers the non-wealthy. This is almost a complete reversal from the Great Depression, during which it was the worst off who suffered the most. Capitalism had lost much of its image as a mode of production for owners of capital, at the expense of owners of labor, and gained one of harmony between all classes. This view was not only promoted by industry, but by conservative intellectuals, as well. And, in 1991–92, communism and socialism lost all of its allure as a result of the Soviet Union’s collapse.

While capitalism continued strong during the 1990s, an era of “neoliberalism,” the 2000s is a more ambiguous decade in the context of how the public views markets. The mid- and late 90s are known for a series of crises throughout the world, and the boom of the mid-2000s gave way to the most severe crisis since the Great Depression. Conservatives have interpreted this turn of events as working against free markets. Tom Woods, for instance, declared that we are “back on the road to serfdom.” Oftentimes, rather than looking at the resurgence of popular pro-market sentiment, people look at the growth of the state, concluding that the anti-capitalist mentality has strengthened, or at least gained currency. This interpretation of recent history is problematic, however.

Compare the response to the Great Depression to that of the Great Recession. The 1920s were a period of growing wealth, where all classes seemed to benefit from growth. If Traflet is right, and the initial stock market crash was blamed on the common person (the small investor) instead of on the titans of industry and bankers, pro-market sentiment was very strong prior to 1930. The Great Depression was almost a 180° turn, when markets seemed to benefit only the rich, and at the expense of the poor. That is, the period 1929–33 oversees a dramatic change in public opinion towards capitalism. The 1990s, and even the 2000s, were similar to the 1920s, in that a healthy economy promoted existing market institutions. But, the Great Recession has not had the same effect as the Great Depression, not only in the United States, but also in Western Europe. To be sure, capitalism has received much criticism, but the impetus to choose alternative institutions is weaker — there is much more focus on improving markets. One strong piece of evidence is the pressure to structurally reform markets, and skepticism toward demand-side interventionism.

Why did the Great Recession not cause mass disillusionment with capitalism? First, the extent of the damage has something to do with it. The anti-capitalist mentality is probably stronger in Spain and Greece than in the U.S. or U.K. The two former countries have been hit harder, and a combination of bad demand- and supply-side policy has caused high (20+ percent) unemployment. Still, the extreme right-wing has been benefited almost as much as the extreme left-wing by the depression in those countries. Second, the end of the Cold War. The fall of the Soviet Union, and the gradual “liberalization” of China, shattered whatever credibility non-capitalist institutions, or “modes of production” if you prefer, had. Third, between 1950–06, we had a strong, relatively stable period of growth, where the living standards of all members of society markedly improved. This relates to the role of the end of communism, because elsewhere living standards stagnated or fell as a result of command economies. Capitalism’s great success is more widely appreciated.

The average opinion goes something like this: there are no radical alternatives to capitalism; capitalism is the best we have, it’s just a question of how to achieve robust institutions that minimize the impact of the business cycle. This view stands in stark contrast to average opinion during the 1930s, which did not think very favorably of free markets at all. And that conservatives, and some libertarians, have interpreted the concept of “robust institutions” as evidence of an anti-capitalist mentality actually works in favor of my argument. The standards of the “radical” pro-market advocates have risen. The type of interventions considered “socialistic” or “anti-market” are incredibly tame compared to those of the 1930s — where parts of industry were nationalized, private enterprise was heavily regulated, and public investment stepped to the forefront. We are, on average, a much more market-oriented society today, and the range of allowable changes to these institutions has become much stricter, more narrow. To free market advocates, this is good, not bad, news.

For this reason, the message in books such as The Road to Serfdom no longer resonates with most people. The modern interpretation of this line of reasoning is that any interventionism will eventually lead to full blown socialism. This is not Hayek’s actual argument, who was writing during a period of time in which opinion, intellectual and average, was very hostile towards markets. (In fact, Hayek’s message was, at the time, most popular amongst those looking to synthesize capitalism with a modern liberal democracy.) But, the erroneous interpretation of Hayek is popular because that is the only way one could apply Hayek’s message to the modern context. Many conservatives and libertarians think we are on a road to serfdom, and that there is a strong anti-capitalist mentality that needs to be fought against, but this simply is not so. That The Road to Serfdom is seen, amongst progressive intellectuals, as being mostly wrong is strong evidence that they no longer hold the views Hayek was warning against.

The strengthening of positive opinion towards capitalism is the product of the institutionalization of free market views. Few people believe there is a superior alternative. Communism is seen as a failure. Socialism is taboo. The success of markets in raising the standard of living of all members of society is too obvious to miss. If people advocate intervention, it’s to strengthen markets, not replace them. We are in an era of the pro-capitalist mentality.

Quote of the Week

If The Road [to Serfdom] was often misconstrued as a blast against the welfare state, it found readers in German-speaking Europe where its message was understood the other way around — as an insightful analysis of recent history and as a plea for a system, liberalism, that had never really been tried in Germany. In English, The Road was a conservative manifesto; in Germany, it turned out to be revolutionary. As a result, The Road‘s actual influence on German politics may have been more profound and lasting than it has been in the English-speaking world, a fact usually ignored by American Hayek scholars.

— François Godard, “The Road to Serfdom’s Economistic Worldview,” Critical Review 25, 3–4 (2013), pp. 378–379.