10/20/14

Top 3 Piketty Takeaways You Won't Find Elsewhere

I was traveling for a few months over the summer and I decided that I would use the time to read Thomas Piketty’s Capital in the 21st Century. All 700 pages of it, no excuses. At the time I didn’t know that it was The Most Unread Book of the Summer, or that I could have gleaned most of the same insights by reading a few reviews. Here are three:  

1) Justin Fox: Always very well written 
2) Justin Wolfers: Very good wonky criticism 
3) Matt Yglesias: In four bullet points! 

Now you have my Top 3 Piketty Review Recommendations. Here are my top 3 Piketty takeaways that you (probably) won't find elsewhere: 


1) War is Great for Equality 


Piketty is a definitely a data guy; probably more important than the book are the datasets he assembled on wealth using tax records, extending back to the 19th century in Britain, Germany, and Sweden, and all the way to the French Revolution in France. Capital is full of graphs, but most of them tell the same simple story:



So WWI and WWII—they happened. Thanks, Piketty. Mind blown. 

Essentially Piketty’s data says that before the wars, wealth was highly concentrated. The wars increased equality both by destroying the capital of the wealthy (think bombed houses, defaulted debt, and ruinous inflation), and increasing the wages of the poor (workers remaining behind were able to demand a higher wage, and raises stuck around when soldiers returned). After the wars, both wealth and inequality recovered slowly, today reaching levels that are similar to, but not quite as severe as those before the war. The story of Capital in the 21st Century is the story of one (or two) great events.   

So even though Piketty’s dataset is longer and more complete than anyone else’s, it still doesn’t give us a great feel for the long term evolution of capital. This is, of course, a classic problem in macroeconomics. When Ricardo wrote “On Principles of Political Economy and Taxation” in 1817 he dismissed the divergence between his theory and reality as a consequence of the Napoleonic Wars, writing,
The termination of the war has so deranged the division which before existed of employments in Europe, that every capitalist has not yet found his place in the new division which has now become necessary.” 
He was probably right about the war, but that didn’t make his theory any less wrong. 

As you may have heard, one of Piketty’s primary conclusions is that unless we *ahem* tax the shit out of rich people, inequality will increase without limit. Is he right? I don’t know, but it’s impossible to tell for sure from the data. That doesn’t mean we shouldn’t make predictions, and, having spent a lot of time looking at the data, Piketty is more qualified to make predictions than almost anyone else. He’s also very aware of the limitations of his analysis throughout the book, a fact that makes me respect him. 

Maybe there’s a better solution than taxation. Raising taxes makes people complain, and it can be distortionary, and you have to  actually pass legislation, all things that are not very fun. It would be much easier to just pick a fight. Got to figure out a way to do away with all the killing though. Maybe we should create some kind of really expensive and destructive sport… like remote-controlled starship battles… that would destroy the excess wealth of the rentiers and increase demand for labor to build the machines… yea… star wars…


2) The Supermanger is an English Thing 


The rise of executive compensation has been a hot topic for some time now; in 2008 my Econ 101 professor noted that US CEOs make 200-300x the average worker, more than 4x the ratio in the ‘50s. Today it’s hard to go a week without seeing some story in some online publication about some ludicrous amount of money paid to some executive—everybody loves a little outrage, and it’s an easy article to write.    

Thanks Wikipedia 

I’ve heard many explanations for the rise of the “supermanager.” A common and unpopular explanation is that compensation matches marginal product, and that executives are extremely productive. A common and popular explanation is that executives are greedy oppressors. Unfortunately because executive performance is nearly impossible to measure, no one knows for sure if high salaries have real economic justification, or if we should just *ahem* tax the shit out of rich people.

Piketty confirms that the supermanager is real, but only in English speaking countries: the US, UK, Canada, and Australia  (following a paper in 2006). He suggests two reasons for the difference: corporate governance structures that give executives more control over corporate boards and therefore their own salaries, and lower marginal tax rates that make maneuvering for a larger salary worth it. To me, both of his explanations imply that executive compensation can be explained more by social norms that vary across countries than by “real” economic phenomena.

Income inequality in english vs. non-english speaking rich countries 
Again, is he right? In 2007, a couple of guys named Gabaix and Landier concluded that increases in compensation can be explained by increases in the size of firms, and that cross-country differences in compensation can be explained by the cross-country differences in firm size. If you think that larger firms are a good thing (there is some evidence that they are more productive) and that executives of larger firms deserve higher salaries (also contestable) we’re back to the drawing board. 

So, like always, it’s complicated. But, at least in my mind, Piketty’s simple observation that the supermanager is an English thing limits the possible explanations for the rise of executive compensation. It’s an obvious insight that’s easy to miss, because at first glance executive compensation doesn’t seem to be a cross-country issue, and most studies on the subject focus on data from a single, usually English-speaking country.  

3) You Can Learn A Lot From Jane Austen and Balzac 


Several of the Piketty reviews I’ve read praise the literary allusions that break up Capital’s 700 pages of data. Piketty does refer frequently to literary works. Unfortunately he only refers to two: Jane Austen and Balzac, and while he references most of Austen’s six novels, he only mentions one of Balzac’s 100+. ("The Aristocats" does not count as literary.) At the first, I was charmed, Why yes, Mr. Darcy’s £10,000/year and Vautrin’s speech to Rastignac are good illustrations of the importance of capital in the 18th century! But by the end of the book, I mainly just wanted to strangle all mentioned characters, even dreamy Mr. D.

What? 
Still, Piketty’s literary allusions did remind me of something I think is an important truth: qualitative insights provide important guidance and context for quantitative research. It’s a big world out there, and there is a lot of data. Computers have exponentially increased the efficiency of analysis, but when it comes to recognizing patterns and forming conclusions, most of the time they still can’t beat the mucky, misunderstood magic of the human brain. The problem with the brain, of course, is that it too easily believes wrong things. Data also lies, but if used correctly, usually lies a little less.







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