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Unequal theories

28 May 2014 By Edward Hadas

If a man is suspected of murder, arson and speeding, any prosecutor who focuses only on the last charge risks ridicule. That imagined situation has some bearing on recent criticism of Thomas Piketty, the best-selling French anti-inequality economist. The accusations are largely restricted to ways in which he has exceeded the limits of his data.

The Financial Times, the most prominent critic, has identified possible compilation mistakes and biased adjustments in Piketty’s statistics on the history of wealth distribution. This is potentially a bit sloppy, but beyond that it’s hard to get too excited. Revising the questionable numbers would not change the basic conclusion that wealth has become more concentrated in most countries over the last three decades.

More importantly, though, all Piketty’s wealth data suffers from a much more fundamental error: It cannot be telling us what he says it does. In his widely praised book, “Capital in the Twenty-First Century”, he concludes that elites are becoming wealthier and more powerful at the expense of the rest of the population. However, wealth information alone, based on the market value of financial holdings and other real assets, can’t validate that claim. Incomes and, importantly, social factors also need to be considered.

Piketty does look at income inequality, and fewer doubts have been expressed about that data. But the meaning is only slightly clearer. Yes, the top 1 percent and 0.1 percent have been pulling away from the masses, as measured in income declared on tax forms. However, that provides little insight into what is surely the central economic topic: the comparison of how well people can actually afford to live.

This yawning gap won’t be filled by wealth or income data, even if it is perfect. Another much-cited case of doubtful data in economics also obscured a larger analytical problem. In 2011, Harvard professors Carmen Reinhart and Kenneth Rogoff wrote a book about fiscal deficits through history. Like Piketty, their measurements were questioned. Like Piketty, the more serious issue was elsewhere: the failure to explain why the average experience of high-deficit governments – mostly in wartime, under a gold standard or after a commodity price shock – was relevant to the merely recession-struck governments of recent years.

The hallmark formula predicting rising inequality in Piketty’s book, r>g, is actually a bit worse than the typical fine-sounding theory with little grounding in reality. As economist Debraj Ray of New York University points out, the claim that wealth becomes more concentrated when a society’s rate of return on capital (r) is greater than its GDP growth rate (g) is simply false. The two have no direct relationship.

Ray plausibly suggests that Piketty is really trying to discuss the difference in savings rates between rich and poor. However, he only touches on that topic, and the book makes a big deal of the faulty formula.

Few economists, even those who disagree strongly with Piketty’s politics, have pointed out that r>g is nonsense. That’s largely because blind trust in unrealistic formulas is indoctrinated from the first class of the first course in the discipline. It’s a necessary suspension of disbelief, as there is very little in theoretical microeconomics that bears much relation to human reality. Macroeconomics is a bit better but also relies excessively on concepts such as GDP and aggregate demand, which are much easier to work with in theory than in practice.

It is not just theory where Piketty falls short. He also treats history badly. He almost completely ignores the world behind the statistics and he fails to make some basic observations, for example that poverty in rich countries has become much less burdensome.

Then Piketty goes for unsubstantiated predictions based on spurious laws, in particular the supposed natural tendency in capitalism towards an increasing concentration of wealth. To justify that claim, he must treat almost half the period of industrial capitalism, including the development of the welfare state, as a historical exception.

Few observers seem bothered by either the narrow historical vision or the determinism. That is also, sadly, to be expected. Most economists these days do not study much history, let alone the philosophy of history. Besides, many of them are programmed to believe there is a natural tendency towards the universal triumph of what they call market economies, and that colours their assessment of the past.

The gushing praise initially received by Piketty – and by Reinhart and Rogoff before him – is indicative of an inability in economics to tie together theory and experience. The supply of relevant data is often insufficient and the theories are often too unrealistic to be tested.

For an economist, Piketty is well above average in his diligence with data, despite the carping – though he could do better. He may also be above average in theoretical boldness. However, as a thinker about society, he is crippled by reliance on irrelevant statistics and abstract theories. Unfortunately, too many economists, both his fans and his critics, are guilty of the same intellectual crimes.


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