Thomas Piketty’s Capital in the 21st Century is the most-widely discussed work of economics in recent history. At its centre is the argument that due to the powerful forces generated by the underlying dynamics of wealth, it is most likely that we are heading to a future where inherited wealth will shape economic structures, and lead to widespread inequality. But is his analysis on target? In After Piketty , a cast of economists and social scientists raises several questions, and gets an answer from Piketty. Economist Suresh Naidu asks whether Piketty has said enough on the complex nature of wealth, and suggests that the super-wealthy often use their influence to ensure better returns. An extract from ‘A Political Economy Take on W/Y’:
Thomas Piketty’s book has two interwoven arguments.
The first, the “domesticated Piketty” is a very standard model. It has stochastic and heterogeneous saving rates and uninsurable and undiversifiable rates of return on asset positions. It has competitive markets. It has a production function with a capital-labor elasticity of substitution that is greater than 1. It has a social welfare function that is egalitarian-meritocratic. This domesticated Piketty is an economist’s delight. It combines a positive, quantifiable model of the economy with testable predictions in the context of a well-defined social objective function. It derives an optimal policy prescription. It is articulated in papers with co-authors. It yields a formula for the optimal wealth tax as a policy outcome.
It is, however, institution-and-politics free, and makes Piketty’s project look like an (impressive) extension within a standard macro public finance framework.
I worry that this domesticated Piketty is an ill-suited model for the purposes for which Piketty seeks to use it. Piketty seeks to study the historical variation in wealth inequality. He seeks to place in their proper perspective the institutional changes that explain empirical variation in the economy’s wealth-to-annual-income ratio (W/Y) and thus of wealth inequality. These include: the role of financial markets, market structure in general, and intrafirm bargaining over revenue. But the model of domesticated Piketty has, for these three at least, relatively little light to shed.
But there are shoots of something else breaking through: a “wild Piketty.”
The wild Piketty suggests a different perspective. It sees the economy through a lens in which capital is the alchemy of today’s income transmuted into secure claims on future income that are then bought and sold on asset markets. In this view, institutions of corporate governance, financial firms, labor market institutions, and political influence do most of the work in determining both W/Y and the distribution of wealth. This wild Piketty argument is hinted at in various places in the book, interviews and sundry papers. It is a view of capital as an institutionally defined set of property rights that are then transacted on asset markets. This is where the ideas in Piketty’s book tangential from the perspective of the domesticated Piketty model — the ideas about corporate governance, the speculations about foreign investment and weak property rights in Africa, the musings on whether slaves are net wealth or not — become the main story. In this view, capital is a set of property rights entitling bearers to politically protected rights of control, exclusion, transfer, and derived cash flow. Like all property rights, its delineation and defense require actions of state power, legal standardisation and juridical legitimacy. In the last instance, capital includes the ability to call on the government to secure the promised flow of income against potential violators, be they burglars, fugitive slaves, copyright violators, sit-down strikers, or delinquent tenants.
The political economy view would help us to write chapters in Piketty’s book that are missing from the text but that are essential to fill in gaps in the wild Piketty argument — chapters on finance, market power, and endogenous policy making. We can understand the institutions and property rights that allow capital to accumulate as endogenous to the political system, and as the result the balance of political power across social groups.
Prominent among these institutions is the organisation of the financial sector. Wealth is a price-weighted sum of otherwise incommensurate assets, and those prices are determined in financial markets, which aggregate flighty expectations about the future into prices today. Extensive, if not efficient, financial intermediation comes along with a high wealth/income ratio. The assets are themselves used to organise production with workers to produce goods and services sold to consumers, and the income flow accruing to owners of those assets depends on the wages paid to those workers and the prices charged to those consumers. Protecting the future flows of income accruing to the assets requires deploying the state in a variety of ways, not just via the tax system. This induces feedback loops where inequality in income today moulds a political system that preserves that inequality tomorrow.
Finally, the political economy view lets us see more clearly what is normatively problematic about wealth inequality. Piketty writes in various places that wealth inequality and a society of rentiers is undemocratic, but the links are unspecified. Why should extreme inequality of wealth necessarily imply inequality of political power? But when wealth is understood as police-backed paper claims over resources, rather than the resources themselves, the undemocratic nature of wealth inequality becomes much clearer.
In some ways, the commercialized politics of the twenty-first century offers entirely new tools for superwealth to manage the political system:
We have “markets in everything.” The wealthy can purchase educational reform, the charity of their choice, think tanks, legislative language, political influence, and endless public broadcast of their ideas. Campaign contributions are a good place to start, with there being evidence that political donations a) are a normal good, and b) have, at the top, a wealth elasticity close to 1. This suggests that as the wealth distribution becomes more skewed, the campaign contribution distribution will also become more skewed.
Indeed, Lee Drutman documents an increasing share of traceable individual campaign contributions (close to 25%) coming from the “1% of the 1%,” which is around 30,000 people. But from Brazil to Brussels, and from Washington to Beijing, money and promises of money grease the wheels of politics, sometimes detected, sometimes eliciting a brief round of outrage, sometimes not. It is difficult to celebrate “markets in everything” and not expect generalized corruption as the result. When speech and broadcast media are themselves allocated on markets, and the means to contest elections are allocated via the cash nexus, it is a short step to policy being set by the median dollar.
Suresh Naidu is associate professor of economics and political affairs at Columbia University