Piketty and the Money View

I recently picked up Capital and the 21st Century again. And what's striking to me, on revisiting it, is the contrast between the descriptive material and the theory used to make sense of it.

Piketty’s great accomplishment is the comprehensive data on wealth he has compiled, going back to the 18th century. He deserves nothing but praise for making that data easily accessible. (You could think of his project as an iceberg, with most of the substance hidden below the waterline in the online appendixes.) I have not seen any serious doubts raised about the accuracy of this data; and the descriptive generalizations he draws from it, while not above criticism, are obviously based in a deep study of the concrete historical material. But the connections between this material and the theoretical claims it's mixed in with -- r > g and all that -- are tenuous at best.

It’s important to remember that all the underlying data is in nominal terms. All the empirical material in the book relates to stocks and flows of money. But when he turns to explain the patterns he finds in this data, he does it in terms of physical inputs to physical production. The money wealth present in a country is assumed to correspond to the physical capital goods, somehow converted to a scalar quantity. And the incomes received by wealth owners is assumed to correspond to a physical product somehow attributable to these capital goods. I am hardly the first person to suggest that this is not a sensible way to explain trends in private wealth as measured in money, and the money-income derived from it. But what I haven’t seen people say — even people who jump at the chance to revisit the Cambridge Capital Controversies — is the remarkable difference in the attitudes of Piketty the historian and Piketty the economic theorist to data. Shifts in the scale and distribution of private wealth are described on the basis of years of meticulous study of the tax records of various countries. But the production processes that are supposed to explain these shifts are described without any data at all, purely deductively.  You would think that if Piketty believed that the share of property income in total income depends on physical production technologies, returns to scale, depreciation, etc., then at least half the book would be taken up with technological history. You’d think he would spend as much energy studying the inputs and outputs associated with different degrees of mechanization of major production processes, how long is the useful life of different kinds of buildings in different eras and how much annual maintenance they require, and so on. After all, these are the kinds of factors that he believes — or claims to believe — drive the money-wealth outcomes the book is about. In fact, of course, these topics are not discussed at all. Terms like “production” and “depreciation” are black boxes, pure mathematical formalism. You would think that Piketty, who presents himself as a historian and is admirably critical of the deductive character of so much of economics, would have hesitated before staking so much on deductive, evidence-free claims about physical production.

Because when you take a step back and think about it, this is what Piketty has done:  He has carefully described the historical evolution of monetary wealth, and then postulated an imaginary physical reality that exactly matches that evolution. It’s a kind of economic preformationism, or like the folk psychology that tries to explain your actions by imagining a little homunculus in your head that is choosing them.  The “real economy” in Piketty is just a ghostly mirror-image of the network of money payments and money claims that is actually observed.

* * *

Let me give a concrete example. Piketty shows that around 1800, the wealth-income ratio was relatively low in the United States -- about 300% of national income, compared with 600-700% in England and France. About half of this difference was the lower value of agricultural land, which totaled about 150% of national income in the US and over 300% in both England and France. Piketty suggests that this is because the great abundance of land in the New World meant that its marginal product was relatively low. This sounds reasonable enough -- but it flies in the face of Piketty's larger argument about the capital share. His big theoretical claim is that the capital share is determined by the growth rate of cumulated savings relative to the growth rate of income. And this only works if the return on "capital" is relatively insensitive to its scarcity or abundance. (This is the question of the elasticity of substitution between capital and labor, which has dominated economists' debates about the book.) If having more land makes the share of land rents in national income go down, why won't the growth of "capital" similarly push down its return?

This isn't meant as a gotcha. Piketty frankly acknowledges the problem. He suggests two possible solutions: First, constant returns might only apply over some range of capital-output ratios. Beyond that that range, further accumulation might make capitalists as a group poorer rather than richer. Second, it might be easier to substitute between labor and modern capital goods, than between labor and agricultural land. Both these assumptions sound reasonable, altho I think they are both more problematic than they seem at first glance. But that's not the argument I want to have right now. The point I want to make now is that Piketty just takes it for granted that behind the smaller flow of money going to land owners in US circa 1800, there must have been a smaller physical flow of output coming off the marginal piece of land. Of course this isn't logically necessary -- the money-value of agricultural land will also depend on the legal rights associated with land ownership, the terms on which new land can be acquired, the ease with which land can be sold or borrowed against, etc. Presumably the same physical mix of land, tools and people would have led to a different share of money income being claimed as land rents if frontier land in the early United States had been owned by a few large landlords, instead of being freely distributed to white families by the government. But these types of explanations are not even considered. For Piketty, behind each flow of money there must be an identical flow of stuff.

The other strange thing is that, despite his insistence that money flows are fully explained by physical conditions of production, Piketty shows no interest in investigating those conditions. The numbers on the level and composition of money wealth in US are meticulously sourced and documented. The claims about physical production conditions, on the other hand, are entirely speculative. There is no shortage of material you could turn to if you wanted to ask whether whether land was really more abundant, in an economically meaningful sense, in the early US than in France or Britain, or if you wanted to know if adding an acre to an 1800-era American farm would increase its output proportionately less or more than adding an acre to a similar-sized British or French farm. But Piketty doesn't even gesture at this literature.

* * *

I draw two conclusions. First, it's hard to say anything sensible about the book until you realize it consists of two distinct, almost unrelated projects. There is the historical data on money wealth and money incomes. And then there is the whole rigamarole of "laws of capitalism." The book is mostly written as if the latter somehow distill or summarize the former, but they are really very loosely articulated. Let me give one more quick -- but important -- example. You might think that with all the huffing and puffing about r > g, the data would tell a story in which the share of wealth in national income rises in periods when r is relatively high and g is relatively low, and falls when g is high and r is low. But the data tell no such story.

The great fall in the capital share took place between 1913 and 1950, according to Piketty. But his own data show that this was the period of the highest returns to capital, and the lowest growth rates, in the whole 240 years the book covers. I've reproduced his graph of r in the UK below; the figures for other Western European countries look similar. Meanwhile, he gives an average growth rate for Western Europe over 1913-1950 of 1.4%, compared with 1.8% in the high-capital share 19th century, and 2.1% in the period of rising capital shares since 1970. This is exactly the opposite pattern that we would expect if r and g were the central actors in the story.

Of course Piketty has an answer for this too: The fall in the capital share in the first half of the 20th century is explained by the World Wars and the destruction of the old social order in Europe. No doubt -- but if factors like these dominate the historical trajectory of wealth and income, why not tell your story in terms of them, instead of a few dubious equations from the orthodox growth model? Unfortunately, discussion of the book has been almost entirely about the irrelevant formalism. I think that is why the conversation has been so noisy yet advanced so little. To return to the earlier metaphor, it's as if everyone is ignoring the iceberg and talking about a little igloo built on top of it.

My second conclusion is that the disconnect between the two different Pikettys shows, in a negative way, why what I've been calling the money view is so important. The historical data assembled in Capital in the 21st Century is a magnificent accomplishment and will be drawn on by economic historians for years to come. Many of the concrete observations he makes about this material are original and insightful. But all of this is lost when translated into Piketty's preferred theoretical framework. To make sense of the historical evolution of money payments and claims, we need an approach that takes those payments and claims as objects of study in themselves.


LATE UPDATE: A friend forwards the following (verbal) comment from Joe Stiglitz:

"There is a confusion in Piketty on valuation and physical stocks. In France, the main 'increase' in wealth is because of higher prices of land. Do we really think that France has become wealthier (using Piketty's physical understanding of wealth in his model) because while the manufacturing capital stock has declined, the Riviera has become more expensive?"