In my previous post, I discussed the main mechanism laid out by Piketty in his book. Here, I discuss 3 concerns I have with his theoretical model:
1. r > g is a necessary condition for inequality to rise in Piketty's model. The main strength of Piketty's work is his data analysis and here he does a commendable job trying to identify r and g over a millennium:
Piketty argues that r has been approx between 4-5% for most of history and significantly higher than g until the 20th century. He views the 20th century as en exception rather than the new rule: "r fell because of two world wars as the capital stock decreased." However, i find his justification rather uncompelling. If r was 3% during the 1950-2012 period, right after a period of incredible capital destruction, why would r be significantly higher in a long-run equilibrium?
2. The next point is that even if r is high in the long-run, K^ = r only if r is completely re-invested. However, some portion of r is consumed, especially in the form of housing, so it must be that K^ < r; how much less depends on many factors including the rich's marginal propensity to consume, donate to charity, etc.
3. In Piketty's mechanism, X = r * (K/Y) is the capital share of the economy. As (K/Y) increases and r remains relatively flat at 4-5%, X must rise. But we generally believe that there are diminishing returns to resources. Hence as (K/Y) rises, the returns to capital (r) should fall. Piketty handles this criticism by arguing that the elasticity of substitution between capital and labor will increase in the future. A high elasticity of substitution will create uses and generate returns for capital even as its relative stick continues to rise.
I am actually quite sympathetic to a high elasticity of substitution between capital and labor (which I describe in the next post) but in what way is the high elasticity of substitution a feature of capitalism? The substitution between labor and capital could happen, and in my view, could accelerate, but is not a given and hence not a feature of capitalism, which is what Piketty is aiming to describe
1. r > g is a necessary condition for inequality to rise in Piketty's model. The main strength of Piketty's work is his data analysis and here he does a commendable job trying to identify r and g over a millennium:
Piketty argues that r has been approx between 4-5% for most of history and significantly higher than g until the 20th century. He views the 20th century as en exception rather than the new rule: "r fell because of two world wars as the capital stock decreased." However, i find his justification rather uncompelling. If r was 3% during the 1950-2012 period, right after a period of incredible capital destruction, why would r be significantly higher in a long-run equilibrium?
2. The next point is that even if r is high in the long-run, K^ = r only if r is completely re-invested. However, some portion of r is consumed, especially in the form of housing, so it must be that K^ < r; how much less depends on many factors including the rich's marginal propensity to consume, donate to charity, etc.
3. In Piketty's mechanism, X = r * (K/Y) is the capital share of the economy. As (K/Y) increases and r remains relatively flat at 4-5%, X must rise. But we generally believe that there are diminishing returns to resources. Hence as (K/Y) rises, the returns to capital (r) should fall. Piketty handles this criticism by arguing that the elasticity of substitution between capital and labor will increase in the future. A high elasticity of substitution will create uses and generate returns for capital even as its relative stick continues to rise.
I am actually quite sympathetic to a high elasticity of substitution between capital and labor (which I describe in the next post) but in what way is the high elasticity of substitution a feature of capitalism? The substitution between labor and capital could happen, and in my view, could accelerate, but is not a given and hence not a feature of capitalism, which is what Piketty is aiming to describe
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