Monday, February 23, 2015

Piketty and Wealth Inequality

Inequality of income is different from inequality of wealth. Income refers to what is gained over a time horizon, often a year. Wealth refers to differences in what has already been accumulated in the past. It is well-accepted among economists that income inequality has risen in recent decades: here's are a couple of my more recent posts on the subjec with some US data and some international data. But when it comes to wealth inequality, the data and the theory are much less clear.

Broad interest in the subject of wealth inequality--whether it has risen, is rising and/or will rise in the future--is a big part of what propelled Thomas Piketty's book Capital in the Twenty-First Century to best-seller status. The Journal of Economic Perspectives, where I have labored in the fields as Managing Editor since the launching of the journal in 1986, has a four-paper symposium in the just-released Winter 2015 issue about wealth equality, with contributions from Daron Acemoglu and James Robinson, Charles Jones, Wojciech Kopczuk, and a response and final word from Piketty. Here are some of the thoughts and insights about wealth inequality that I took away from the symposium.

1) The data on how inequality of wealth has evolved in the past is limited. As Piketty writes:
"[L]ong-run wealth inequality series are available for a much more limited number of countries than income inequality series. In Chapter 12 of my book, I present wealth inequality series for only four countries (France, Britain, Sweden, and the United States), and the data are far from perfect. We do plan in the future to extend the World Top Incomes Database (WTID) into a World Wealth and Income Database (W2ID) and to provide homogenous wealth inequality series for all countries covered in the WTID (over 30 countries). But at this stage, we have to do with what we have." 
2) The wealth inequality data from the few countries in Piketty's book tend to show a dramatic fall in the share of wealth held by the top 1% from levels in the late 19th and early 20th century, and then a much more modest rise in wealth inequality in recent decades. Here's a figure from Chad Jones, using Piketty's underlying data, on the share of wealth (not income!) held by the top 1%. Overall, the big pattern is high and rising wealth concentration during the 19th century, wealth concentration falling or flat up through about 1970, and then a rebound in wealth concentration that is modest by these long-term  historical standards.

3) The factual argument that US wealth inequality is rising sharply in recent decades--rather than rising only modestly as shown in Piketty's data above--ends up relying on a particular method of calculating wealth inequality. Wojciech Kopczuk goes through this issue in some detail in his contribution to the JEP symposium.

Broadly speaking, there are three ways to measure US wealth inequality in recent decades. One way is using data from the Survey of Consumer Finances which is done every three years (most recently in 2013) by the Federal Reserve. A second way is using data from estate taxes over time, which involves figuring out ways to project changes in wealth of the top 1% for the total population based on those who die and file estate tax returns in a given year. Both of these methods show a modest or minimal rise in US wealth inequality in receent decades.

The third method is to look at the capital income people receive as shown in their tax returns, and use that data to estimate their wealth. For example, if someone reports a certain amount of income from bank interest, then by looking at interest rates in the past year, you can make a solid estimate of how much money (on average) was in their bank account. Emmanuel Saez and Gabriel Zucman have published a working paper using this approach that is getting a lot of attention. It is "Wealth Inequality in the United States since 1913: Evidence from Capitalized Income Tax Data,” published last October as NBER Working Paper 20625.

This method requires some extrapolation. In some cases, wealth doesn't throw off income in a given year: for example, an IRA or 401(k) account doesn't show up as income on your taxes; gain in the value of your home doesn't show up as income in a given year; a higher value of a business you are running doesn't necessarily show up as income in a given year; and if you owns stock but don't get paid dividends, it doesn't show up as income. Indeed, as Kopczuk reports, Saez and Zucman estimate that "capital income on tax returns represents only about one-third of the overall return to capital." Even when a capital asset does throw off some income, it can be tricky to know what interest rate to apply so that you can infer the amount of wealth. It's easy enough to look at interest paid by a bank and infer the size of a bank account. But if you have capital gains from selling stock, or from more complex financial assets, inferring the underlying size of the wealth is trickier. Thus, a variety of extrapolation methods are used,  like approximating the value of real estate by the amount of property taxes paid, which shows up as a deduction on a number of income tax forms.

During some periods, this "capitalization method" of estimating wealth tracks the results of the survey and estate-tax methods pretty well. In the last few years, the capitalization method shows more of a rise in wealth concentration at the top 1% in the US economy: in the figure above, the top 1% of the US wealth concentration would have about 40% of total wealth, rather than 30% of total wealth. Piketty says in his JEP essay that he tends to favor the Saez-Zucman estimates over those presented in his book. Kopczuk says that he tends to favor the survey-based and estate-tax methods. Both agree that measuring wealth and matching up the estimates across these three methods is a lively and unsettled area of research.

4) The form in which wealth is held and generated matters: for example, consider wealth from inheritance.  If a rising share of wealth is inherited, then this might be more troubling. However, Kopczuk cites various pieces of evidence for the U.S. that "[t]he importance of inheritances as the source of wealth at top of the wealth distribution peaked in the 1970s and has declined since then."

Or consider wealth from housing. An often-mentioned paper by Odran Bonnet, Pierre-Henri Bono, Guillaume Camille Chapelle, √Čtienne Wasmer argues that esssentially all of the recent variation in household wealth in recent decades is due to a rise in housing prices--and in particular, to the fact that housing has become more expensive relative to renting. Here's their comment from a short summary they wrote about their research paper:
"The impressive success of Thomas Piketty’s book (Piketty 2014) shows that inequality is a great concern in most countries. His claim that “capital is back”, because the ratio of capital over income is returning to the levels of the end of the 19th century, is probably one of the most striking conclusions of his 700 pages. Acknowledging the considerable interest of this book and the effort it represents, we nevertheless think this conclusion is wrong, due to the particular way capital is measured in national accounts.The author’s claim is actually based on the rise of only one of the components of capital, namely housing capital. Removing housing capital, all other forms of capital exhibit no trend in the recent period. At the beginning of the 21st century, other forms of capital are, relative to income, at much lower levels than at the beginning of the previous century."

5) What about the famous r>g? One quick-and-dirty shorthand description of the dynamics of wealth inequality in Piketty's book is that if the rate of return r being received on capital assets is higher than the growth rate g of the economy as a whole, then wealth inequality is likely to grow. Treating this as Piketty's view has some justification. As Acemoglu and Robinson point out in JEP, Piketty makes comments in his book like book like: "This fundamental inequality [r > g] will play a crucial role in this book. In a sense, it sums up the overall logic of my conclusions." Piketty refers to r>g as a “fundamental force of divergence" and at another place refers to "fundamental tendencies of capitalist economies." However, in his JEP essay Piketty offers a differentt tone about r > g than one might expect based on how devoutly the equation was often invoked in discussing the book. Here's Piketty in JEP:
"[T]he way in which I perceive the relationship between r > g and wealth inequality isoften not well-captured in the discussion that has surrounded my book—even in discussions by research economists. ...  I do not view r > g as the only or even the primary tool for considering changes in income and wealth in the 20th century, or for forecasting the path of income and wealth inequality in the 21st century. Institutional changes and political shocks—which can be viewed as largely endogenous to the inequality and development process itself—played a major role in the past, and will probably continue to do so in the future. In addition, I certainly do not believe that r > g is a useful tool for the discussion of rising inequality of labor income: other mechanisms and policies are much more relevant here, for example, the supply and demand of skills and education. One of my main conclusions is that there is substantial
uncertainty about how far income and wealth inequality might rise in the 21st century and that we need more transparency and better information about income and wealth dynamics so that we can adapt our policies and institutions to a changing environment. ... 
The gap between r and g is certainly not the only relevant mechanism for analyzing the dynamics of wealth inequality. As I explained in the previous sections, a wide array of institutional factors are central to understanding the evolution of wealth. Moreover, the insight that the rate of return to capital r is permanently higher than the economy’s growth rate g does not in itself imply anything about wealth inequality. Indeed the inequality r > g holds true in the steady-state equilibrium of most standard economic models ..."
In case you didn't catch all that, Piketty is noting that r>g is not useful for discussing income inequality, and does not necessarily lead to wealth inequality, and that the future of wealth inequality is highly uncertain.  Instead, Piketty argues in JEP that when the difference between r and g is relatively large, it will tend to exaggerate the effect of other changes that make wealth more unequal. As he writes: "To summarize: the effect of r − g on inequality follows from its dynamic cumulative effects in wealth accumulation models with random shocks, and the quantitative magnitude of this impact seems to be sufficiently large to account for very important variations in wealth inequality."

6) If r > g isn't the main driver of wealth inequality over time, what is? Some of the answers include the extent of taxes on wealth, the extent to which wealth is saved or consumed, and even the birth and death rates of the population, which affects how long concentrations of wealth will stay together and how many slices they will be divided into when passed to a new generation. There are questions about whether r is the same across the population, or whether those with high levels of wealth will typically be able to get higher returns than those with lower levels of assets. There are questions about the extent to which whether the new fortunes being created in businesses around the globe will displace earlier fortunes, and whether the new fortunes will be long- or short-lived. There are also events of history like World Wars, and events of politics like surges of populist sentiment. The historical evidence shows that "capitalism," broadly understood, can co-exist with higher and lower levels of wealth inequality, and with rising and falling wealth inequality, so any claim that "capitalism must lead to rising wealth inequality" is clearly incorrect.

In their JEP essay, Acemoglu and Robinson point out that dynamics of inequality over time can lead to quite counterintuitive results unless interpreted in historical context. For example, they point out that measures of income inequality fell as South Africa's apartheid regime came to power early in the 20th century, and then rose after the apartheid regime was ended in the 1990s. But of course, any statement about how the apartheid regime supported greater equality would ignore the political dynamics between groups of whites and between white and nonwhite populations over time.

With regard to the importance of factors that are not r or g, toward the end of his essay in JEP, Piketty writes: "As I look back at my discussion of future policy proposals in the book, I may have devoted too much attention to progressive capital taxation and too little attention to a number of institutional evolutions that could prove equally important, such as the development of alternative forms of property arrangements and participatory governance."

7) Finally, for those whose tastes for all things Piketty were not sated earlier much in this post, here are some additional links.

At the annual meetings of the American Economic Association in Boston on January 3, 2015, there was a session called "A Discussion of Thomas Piketty's "Capital in the 21st Century."  Here are the titles of the papers, and the conference versions can be downloaded at the links shown.

For a criticism of Piketty from another angle, Dierdre Nansen McCloskey offers a review essay of Piketty's book in "Measured, unmeasured, mismeasured,and unjustified pessimism: a review essay
of Thomas Piketty’s Capital in the twenty-first century," written for the August 2014 issue of the Erasmus Journal for Philosophy and Economics. For a sample of the tone, here are McCloskey's concluding two paragraphs:
On the next to last page of his book Piketty writes: “It is possible, and even indispensable, to have an approach that is at once economic and political, social and cultural, and concerned with wages and wealth”. One can only agree. But he has not achieved it. His gestures to cultural matters consist chiefly of a few naively used references to novels he has read superficially, for which on the left he has been embarrassingly praised. His social theme is a narrow ethic of envy. His politics assumes that governments can do anything they propose to do. And his economics is flawed from start to finish. It is a brave book. But it is mistaken.

Antoine Dolcerocca and Gokhan Terzioglu recently interviewed Piketty for the Winter 2015 issue of the Potemkin Review. The title of the interview gives a sense of why it is interesting: "Interview: Thomas Piketty Responds to Criticisms from the Left." For a sample, here is part of Piketty's answer to a question about whether, by advocating a global wealth tax, he is downplaying the class struggle and the role of the state:

I think it would be a big mistake to oppose the objective of global progressive taxation of income and wealth with the objective of class struggle and political fight, for at least two reasons. First, making this tax reform possible would require a huge mobilization. This has always been the case in the past. All the big revolutions engendered a big tax reform. Take the French Revolution, the American Revolution, or World War One: although it was not a fiscal revolution initially, through the Bolshevik Revolution, it had a huge impact on the acceptance of a progressive tax regime and more generally social welfare institutions after World War One – and even more so after World War Two. These were fiercely opposed by the elite and by the right just before these shocks, so this shows that we need a big fight and sometimes violent shocks to make progressive tax accepted. It would be a big mistake to think of progressive taxation as a technocratic process that comes quietly from a minister and experts. This is not at all the history of taxation.
The second reason why one should not oppose class struggle and progressive taxation is that progressive taxation in itself is not enough. I think we also need to have new forms of governance and capital ownership. For instance, in the book I mention the difference between the private and social value of capital in corporations taking the example of German capitalism as compared to Anglo-Saxon capitalism, where I describe the role of workers on the boards of corporations. This probably reduces the market value of corporations, but it apparently does not prevent them from producing good cars. Therefore developing new forms of ownership, new forms of sharing of power between those who own capital and those who own their labor, is extremely important to me. Not only in the traditional manufacturing sector, but in many new sectors, such as higher education, media, culture, etc. the shareholder company is not the end of history and this form of organization and capital ownership is certainly not the future. We need progressive taxation of private capital, and at the same time, a new thinking of what capital ownership means and how we organize its owners. But we should not put these two forms of social progress [class struggle vs. progressive taxation] in opposition. They actually are very complementary, because progressive taxation is also a way to produce a regime based on transparency, on information about income and wealth that is necessary for workers’ involvement in the management of companies. If you do not know who owns your company, and if you do not have financial transparency about the wealth, the income, the profits, and the accounts of your company, how can you participate in decision-making? It would be a big mistake if some on the left believed “progressive taxation, that’s a technocratic thing, we don’t really care. We care about revolution, and capital ownership”. That would be a huge intellectual mistake.