IN THE latest wave of criticism of
Thomas Piketty’s wonky blockbuster, “
Capital in the Twenty-First Century”,
Per Krusell at Stockholm University and Tony Smith at Yale University
argue that the book’s prediction of rapidly rising inequality is based
on extreme and implausible assumptions. In a
note,
Messrs Krusell and Smith claim that Mr Piketty’s proposed second
“fundamental law of capitalism” is supported neither by widely-accepted
macroeconomic theory nor by empirical evidence.
Mr Piketty, a
French economist, defines his second fundamental law of capitalism as β =
s/g, where β is the ratio of national capital to national income, s
indicates the savings rate net of depreciation and g denotes the growth
rate of the economy. For example, if the savings rate is 6% and the
economy grows by 2% every year, the country is predicted to, in the long
run, accumulate a stock of wealth which approaches 300% of GDP.
Employing
his law, Mr Piketty predicts that the future world capital/income ratio
will increase and approach 600% in less than fifty years. Since capital
tends to be unequally distributed, this implies higher inequality. This
forecast is based on two assumptions: that global growth will fall from
3% per year today to 1.5% in the second half of the century and that
the global savings rate will stabilise at 10%. The second assumption is
what troubles Messrs Krusell and Smith. While they do not dispute the
risk of falling growth, they take issue with the notion that the future
savings rate will be constant at around 10%. They write:
There
are no errors in the formula Piketty uses, and it is actually
consistent with the very earliest formulations of the neoclassical
growth model, but it is not consistent with the textbook model as it is
generally understood by macroeconomists...We look more closely
at...Piketty’s assumption of a constant (positive) net saving rate from
two perspectives: the textbook model with an exogenous gross saving rate
and a model in which the saving rate is chosen optimally. In both
settings the net savings rate can be derived as an explicit function of
g: as g changes, so ought the net saving rate.
Using
post-war data from the United States, Messrs Krusell and Smith plot the
net savings rate over time and show that it has fallen gradually toward
zero. In addition, as they predict, the authors find a positive
relationship between decadal averages of savings rates and growth rates.
They conclude that the belief that the net savings rate “will remain
constant and positive in the twenty-first century does not appear like a
good assumption at all”.
Ironically, however, Messrs Krusell and Smith make some strange assumptions of their own. As has been
pointed
out, their choice of a depreciation rate equal to 0.1 is
unrealistically high. It is also unclear why they focus so much
attention on a scenario with zero economic growth; it may be an
interesting theoretical exercise, but in terms of forecasting future
inequality it is doubtful whether anybody really believes that the
global economic growth on average will be zero over the next hundred or
so years.
A third point of criticism of Messrs Krusell and Smith's
analysis is the lack of cross-country data over time. The authors admit
that it is beyond the scope of their note to examine the hypothesis of a
positive relationship between savings rates and growth rates is
correct. Nevertheless, even if it would be demonstrated that no such
relationship exists, Mr Piketty still has to do a better job explaining
why he thinks it is plausible that the global net savings rate will
stabilise at about 10%. In many of the world’s largest economies, the
trend over the past decades has been falling net savings rates. If
history is to prove him correct, this trend will have to be reversed or
else be compensated by higher savings rates in today’s smaller
economies. A theory of how either or both of these will happen and why
that is plausible is in order.
The latest critique against the
French economist’s magnum opus notwithstanding, inequality may still
rise rapidly in the future. But rather than by the quotient of the net
savings rate over the growth rate, future inequality could be driven by
an increasingly unequal distribution of income. Both demographic shifts
and technological progress, for example, could favour the well-educated
over the less-skilled, causing a much greater concentration of economic
resources. Mr Piketty may therefore turn out to be right in predicting
increasing economic inequality, but it does not have to be because of
the implications of his second fundamental law of capitalism.