Failed Paradigms

From The American Interest

The problems of a small state college point to the weakness at the heart of liberal society—a weakness that undermines the strength of our republic at home and endangers world peace. And neither political party has the answers.

Piqued by Piketty?

“Money makes money. And the money that money makes makes more money.”

– Benjamin Franklin


Over the past 18 months there’s been a gushing and gnashing over the book by French economist Thomas Piketty, Capital in the Twenty-first Century. I have to admit I’m a bit late to the party and am just getting around to reading (perusing?) it. (I have a good excuse – an 18 mo. old baby.)

Seems most of the feedback has been delineated by political ideology – the left embraces Piketty’s work and the right dismisses it. Perhaps we can pursue a non-ideological tack to dissect Piketty’s take on capitalism.

Piketty has been rightly praised for the work he has led on the collection of historical wealth and income data, and he generously offers this data to the world for future study. Most of the controversy involves his particular interpretation of these historical statistics, claiming that inequalities have reached the same levels as the roaring ’20s a century earlier. Depending on one’s measures and comparisons, that might be argued as true. The devil is in the details.

Piketty makes broad claims that inequality is inherent to the internal dynamics of capitalist markets and that the interim period – 1930s-1970s – was a reversal due to the wealth destruction of the Great Depression and WWII. Then he explicates his “law” of capital that the rate of return on capital (r) will always exceed the rate of economic growth (g), leading to ever narrower concentrations of wealth among the owners of capital. But this is too broad a brush.

We need to unbundle the capitalist wealth creating process and the dynamics of distribution in order to understand why the data looks the way it does. How, when and why does r exceed g and what are the distributional consequences? Piketty so far has not provided satisfying answers.

First, he defines capital as the stock of all assets held by private individuals, corporations and governments that can be traded in the market no matter whether these assets are being productive or not. This includes land, real estate and intellectual property rights as well as collectibles such as art and jewelry. Thus, there is no distinction made between financial or physical capital or non-productive real assets and thus no explanation for why different asset classes might experience varying growth rates and what that means for wealth and incomes. The return on capital does not always exceed the growth rate and will often drop precipitously over the business or trade cycle, as well as due to the falling marginal rate of return on existing investment. (Certainly r was negative for a considerable period of time during the Great Depression, the 70s stagnation and our recent Great Recession.) With his broad brush, Piketty ignores these insightful details.

Financial assets, as claims on real assets (a form of derivative really), often fluctuate more widely than real assets. Real asset classes that are illiquid, such as art and real estate, often don’t trade, thus making true value difficult to ascertain. Let us explain why this matters (see Figure I.1 below from Piketty’s dataset): The two periods that Piketty claims represent his conclusion on inequality (red circles) were both marked by financial asset bubbles fomented by easy credit bubbles (green squares). In both cases, when the credit crunch inevitably came, these asset prices adjusted quite drastically and quickly, erasing much of the wealth accumulated during the bubble (look at the wealth shares of the 1% over time – it’s quite a roller coaster ride). The difference today is that we have harnessed public credit to maintain these inflated asset prices. Let me make the difference plain: in the panic of 1929 and the early ’30s stock brokers jumped out of windows to their untimely deaths; after the panic of Lehman’s collapse, they jumped out with Federal Reserve-issued parachutes and landed safely on their yachts and vineyards.

Income-USA-1910-2010Piketty’s graph does highlight a concern here. The massive crash in asset prices and capital incomes after 1940 was surely due to the destruction of WWII when high property values in Europe became worthless. The central banks of the world have done their utmost to prevent such a crash after 2008, but one can still manage a price correction to reassert pre-bubble values. Admittedly, this is difficult to do with debt and requires a lot of bankruptcy that needs to be managed. But instead we’ve reflated the bubble asset prices at the high end, and with them the high incomes derived from capital. Life is good when you’re the king (or the Fed chairperson).

Second, we should understand that housing is playing an outsized role in our recent widening of wealth inequality. Housing policy rewarded real estate investments over other investments during the long credit bubble that accompanied the maturation of the baby boom generation (green square on right). This gave the housing sector a double stimulus: rising demand plus a generous tax preference. When housing wealth is stripped from the current distribution of capital, wealth inequality appears much flatter (see Rognlie).

So, rather than some immutable law of capitalism, perhaps Piketty has identified an artifact of short-sighted policy, especially by central banks and government housing policy. In our recent financial market “correction,” these asset prices have not really corrected, as de-leveraging of private credit (mostly in the FIRE sector) has merely been assumed by public credits. The Fed has expanded its balance sheet by about $4.5 trillion and the Treasury has increased the total debt by almost $8 trillion. With all that liquidity sloshing around, the rich have gotten richer because of their ownership of capital assets, both real and financial, while economic growth and employment have stagnated because of de-leveraging and the uncertainty of price distortions keyed off a deliberately depressed interest rate. These monetary and fiscal policies have greatly aggravated inequality and created the more serious problem of allowing those with inflated financial assets to trade them for more permanent real assets, thus narrowing the control over these real asset classes. In the distant past this was called feudalism and we risk recreating such class distinctions.

Nevertheless, Piketty hits on some key truths about the workings of capitalism, none of which are really new but are worth reiterating. First, we call it CAPITAL-ism for a reason – it depends on the accumulation and productive deployment of capital in order to create wealth. To quote Ben Franklin: “Money makes money. And the money that money makes makes more money.”

For the same reason we don’t call it LABOR-ism, because capitalism is about successful risk-taking and our property rights legal system assigns risks and returns to a priori ownership claims. For too long we’ve understood the distributional mechanism of capitalism to be wage incomes, when an increasing share of that distribution is remitted through capital ownership claims on profits. Technology and globalization has only amplified this trend. In addition, a mature capitalist society with an aging demographic depends on an increasing share of rents earned by accumulated capital.

The growing disparity of wage incomes can be largely traced to incomes associated with financial capital, such as in the FIRE sector, and by winner-take-all, or superstar, markets in many professions such as entertainment and sports, but also among corporate managerial elites. In a free and just society this inequality needs to be addressed, but turning back to a laborist model of economic development would mean turning back the tides of trade and freedom.

Rather, we need to promote capital accumulation across the broadest stretch of the population. This simple graph of the relationship between physical capital per worker and income shows the symbiosis between these two factors of production – we merely need to cease dividing them into their antagonistic corners through misguided tax policy.

capital-income – from David Weil, Economic Growth.

In addition, we need policies that promote long-term risk-taking and risk management and de-emphasize short-term asset trading. A return to saving and prudent investment will require disciplinary constraints on credit policy, something we’ve lost with too much central bank discretion over monetary policy. The question is how will we attain that discipline with a fiat monetary regime that allows credit creation according to the policy whims of the central bank and the Treasury?

The answers to inequality are not simple and certainly more complex than Piketty’s retrograde and admittedly unworkable proposal of taxing capital for redistribution by the state. The leftist appeal of this argument readily embraces the idea that wealth in private hands is somehow more easily abused than wealth in the hands of politicians and bureaucrats. Tell that to the victims of statism across former Soviet societies. Instead, wealth should be enjoyed by the widest possible swath of the citizenry to be earned by the sweat of their brows and the liberated ingenuity of their imaginations. As I presented in an earlier post, Billie Holiday makes the most insightful observation when it comes to our capitalist society: “God Bless the Child that’s got his own.”

The Case for Obamacare

train wreckI couldn’t resist. The irony is just too rich. From the WSJ’s “Best of the Web” column:

Meet Brendan Mahoney, the young man who is saving ObamaCare. He’s 30 years old, a third-year law student at the University of Connecticut. He’s actually been insured for the past three years–in 2011 and 2012 through a $2,400-a-year school-sponsored health plan, and this year through “a high-deductible, low-premium plan that cost about $39 a month through a UnitedHealthcare subsidiary.” But he wanted to see what ObamaCare had to offer.

He tried logging in to the exchange’s website at 8:45 a.m. yesterday, which is impressive in itself. Most young people don’t get up that early. “He said the system could not verify his identity.” So he called the toll-free help line, whose operator also encountered computer trouble. “But then he logged on a second time, he said, and the system worked.”

“Once it got running, it was fast,” Mahoney tells the Courant. “It really made my day. It’s a lot like TurboTax.” He obtained insurance through ObamaCare. Now, he says, “if I get sick, I’ll definitely go to the doctor.” Even better, if he stays healthy, he won’t need to go to a doctor, and his premiums will support chronically ill policyholders on the wrong side of 40.

So, how much of a premium is strapping young Brendan Mahoney paying to help make ObamaCare work? Oops. The Courant reports that Mahoney “said that by filling out the application online, he discovered he was eligible for Medicaid. So, beginning next year, he won’t pay any premium at all.”

So the great success story of ObamaCare’s first day is the transformation of a future lawyer who was already paying for insurance into a welfare case.

Oh, this is not going to end well for us.

Why Ideology Matters in American Politics


Political polls in recent years have shown how little citizens approve of U.S. politics, with Congress receiving an approval rating as low as 16%, while the president’s approval-disapproval differential shows a 16-point deficit (41% strongly disapproving vs. 25% strongly approving). Most would agree this reflects a general dissatisfaction with national politics in America.

Ideology has taken the brunt of the blame for this, with the label ‘ideologue’ tossed around like a pejorative. But this would be a popular misconception promoted by the media, as are most of our political myths these days. Ideology is not really the problem, and may be the best solution to our partisan dysfunction.

Ideology, as promoted in the 21st century, is different than that of the 20,th which was defined by the clash of “isms”: principally liberalism vs. fascism, socialism, and communism. There have been other variants of lesser appeal, such as nationalism, collectivism, racism, and linguistic or ethnocentrism. With the collapse of the Soviet Union and the liberalization of China, ideological conflict has been decided in favor of liberalism, as manifested through democratic capitalism founded on the moral principles of liberty, equality, and justice.

Political parties use ideology to define themselves under the broadest of terms, but in America our ideologies have always been variations of liberalism. Those other “isms” of the far left and far right have never gained a foothold on our shores. After defeating the more malign extreme ideologies overseas in two world wars, our political parties at home split hairs over progressivism vs. conservatism, as defined by the economic class interests of capital vs. labor.

Sometime around 1968 our two major political parties began to redefine their “ideological identities” to fit those of their targeted voters. In effect, the question of moral principles became liberty, equality and justice: Yes, but for whom? The Democrats focused their efforts on minorities, unionists, feminists, and gays with policies such as affirmative action, welfare, collective bargaining for public unions, women’s and gay rights, while the Republicans focused on religious groups, finance, and business with culture wars, tax cuts, and deregulation.

This has created serious problems for the governance of a pluralist democracy based on constitutional principles. For example, our country’s past was cleaved by racial conflict, inciting a civil war and deeply affecting our politics to this day, a full century and a half later. (Many today mistakenly blame the history of racism for the political divisions we see now between the “red” region of the South and the periphery vs. the “blue” regions of the north and Pacific coast.) The true lesson of the transformation of the South is that the ideology of racism was defeated not by the grievances of the oppressed, but by the moral power of liberty, equality, and justice. White European Americans could not deny the moral justice of emancipation, liberty, and equal rights, as stated in the Constitution, but unrealized for almost two centuries.

Unfortunately, the problem we have today is that we have reverted to this “Southernization” of national politics that pits immutable identities against each other. A political party based on an ideology of identity is little different from one based on skin color. The result has been the fractionalization of national politics into a civil war of self-identified Democrats vs. self-identified Republicans. There is no route to negotiation and compromise under these terms – it’s a zero-sum game of win or lose. This is the nature of elections, but it cannot and has not yielded good governance. In a nutshell, this is why we can’t stand our politics.

Instead, we must return to the true nature of ideology based on ideas rather than identities. These ideas are present in our politics, but, when engaged, quickly revert to imposed identities. Our political discourse should not focus on rich or poor, black, white or brown, straight or gay, but on the moral principles that guide citizens in their personal and social behavior. These moral principles include liberty, equality, security, solidarity, justice, charity, civic responsibility and accountability—not for whom, but for all. Liberal Democrats and conservative Republicans differ in their emphases on these moral principles, but the larger point is that different ideas can converge on these principles over how society should be governed and ultimately how we govern ourselves. The continuum we need to negotiate travels from libertarianism at one end to statism at the other.

Electoral politics in a democracy is about dividing and conquering the opposition, but ultimately democracy is defined as “government by the people, for the people,” not “by the party, for the party,” or “by the elites, for the elites.” It’s time to redefine our politics according to moral ideology based on first principles. It would be helpful to push public discourse in that direction.