Home / Opinion / Blogs /  An Austrian view on Piketty

Thomas Piketty’s Capital in the Twenty-First Century has taken the intellectual world by storm. The French economist attempts—through a vast amount of historical data and a couple of fundamental laws of capitalism—to provide a formal framework to show the underlying forces that cause extreme disparities in wealth accumulation under capitalism.

Piketty observes that since the end of World War II, the value of capital stock of major economies has increased considerably compared with their national incomes. This is shown by the value of capital in Europe (Britain, France and Germany), for instance, which was over six times the size of yearly national income in 2010 compared with only 2-3 times after the war. In a way, Piketty’s conception of the economy’s production structure is similar to the Austrian view on the matter. At first, Piketty studies the split of national income between capital and labour, but later goes beyond the distribution of national income—which at best represents a minor part of total spending in a modern economy—to consider spending across the production structure.

Its significance was noted by Friedrich Hayek in Prices and Production. “The amount of money spent on producers’ goods during any period of time may be far greater than the amount spent for consumers’ goods during the same period," Hayek said. “It has been computed, indeed, that in the United States, payments for consumers’ goods amount only to about one-twelfth of the payments made for producers’ goods of all kinds." Strictly speaking, while national income is not the same as spending on consumers’ goods—for instance, unlike the latter the former takes into account spending on intermediate finished goods—Piketty’s distinction between national income and capital stock suggests his understanding of the time dimension of the production process.

Making an important point, Piketty notes, what in the long run causes extreme accumulation of capital is the phenomenon of the rate of return on capital being higher than the rate of growth of national income. In other words, each year the capital stock of the economy absorbs a part of the national income (in the form of capital share of national income), which turns out to be higher than the growth of national income, thus leading to a shrinking share for labour. Increasing capital stock, according to Piketty, could affect its marginal productivity leading to a lower return on capital. However, this would still not halt the steady absorption of national income into the capital stock in the absence of sufficient growth to countervail the effect of huge accumulated capital. In fact, PIketty notes that historically, the rate of return on capital has not decreased enough to countervail the effect of accumulated capital (page 216).

Why Piketty uses growth rate in real terms to make this point is not clear. After all, only market prices can provide the best measure of wealth. This is especially so, when with respect to measuring the value of capital, Piketty himself notes, “All forms of wealth are evaluated in terms of market prices at a given point in time. This introduces an element of arbitrariness (markets are often capricious), but it is the only method we have for calculating the national capital stock (page 149)."

In Piketty’s framework, apart from low growth of national income, higher savings is another crucial factor that could further tilt the balance of wealth distribution in favour of capital. This should be obvious since higher savings decreases national income (in nominal terms) and further adds to the capital stock of the economy (pages 173-183). And as if to confirm his Marxist leanings, Piketty points out, “We run up against a logical contradiction very close to what Marx described. If (growth rate) is close to zero, the long-term capital/income ratio tends toward infinity. And if (capital to income ratio) is extremely large, then the return on capital must get smaller and smaller and closer and closer to zero, or else capital’s share of income will ultimately devour all of national income (page 228)."

Piketty’s errors

From an Austrian perspective, the market represents a rational social order. Increased accumulation of capital stock represents neither a conspiracy to expropriate wealth from labour, nor an insurmountable law that dooms capitalism, but merely a reflection of lower time preference of individuals. When individuals decide to save more, spending on producers’ good increases, which is reflected in turn through a higher value of capital stock. Savings, in turn, are a pre-requisite to sustaining modern living standards (of not only capitalists, but also labourers—who can now consume from a larger economic pie)—which call for a longer production structure that promotes higher productivity.

The process of lengthening of the production structure was explained, most famously, by Hayek in a 1929 article titled The ‘Paradox’ of Savings, where the Austrian economist refutes the under-consumption theory of economic downturn proposed by William Foster and Waddill Catchings (later revived by John Maynard Keynes).

The article is worth a read, as Hayek refutes a dangerous argument currently in vogue: decreasing labour share of income would lead to lower aggregate demand and economic downturn. Sadly, the theory was later unfairly discredited by the mainstream following Paul Samuelson’s demonstration of the possibility of re-switching between production techniques, which was about capital intensity in a particular line of production as against Hayek’s focus on the distribution of resources amongst competing lines of production.

The difference in savings rate leading to larger accumulation of capital stock is noted by Piketty himself, “Japan: with a savings rate close to 15% a year and a growth rate barely above 2%, it is hardly surprising that Japan has over the long run accumulated a capital stock worth six to seven years of national income […] Similarly, it is not surprising that the United States, which saves much less than Japan and is growing faster, has a significantly lower capital/income ratio (page. 175)." He further notes, “Looking beyond the particular circumstances of this or that country, however, the results are overall quite consistent: it is possible to explain the main features of private capital accumulation in the rich countries between 1970 and 2010 in terms of the quantity of savings between those two dates (page 175)."

In this context, Piketty’s comment on asset prices is worth noting, “The last factor explaining the increase in the capital/income ratio over the past few decades is the historic rebound of asset prices [...] in order to understand the depth of the mid-twentieth-century low [in capital/income ratio], we need to add the fact that the price of real estate and stocks fell to historically low levels in the aftermath of World War II for any number of reasons (page 187)." Piketty for some reason seems to believe “the historic rebound of asset prices" explains an increasing capital to income ratio, while the causal link runs exactly the opposite way. It is higher savings (or forced savings in the case of bubbles fuelled by central banks) that causes higher asset prices and an increasing capital to income ratio.

Meanwhile, Piketty’s fear of extremely high capital accumulation leading to lower returns on capital due to decreasing marginal productivity of capital is interesting. In fact, he harks back to Karl Marx, “for Marx, the central mechanism by which “the bourgeoisie digs its own grave" corresponded to what I referred to in the Introduction as “the principle of infinite accumulation": capitalists accumulate ever increasing quantities of capital, which ultimately leads inexorably to a falling rate of profit (i.e., return on capital) and eventually to their own downfall (page. 227)."

But in this, Piketty merely repeats the mistake of various proponents of the productivity theory of interest. Unlike common belief and as counter-intuitive as it may sound, interest is not the remuneration for capital’s productivity, but merely a reflection of savers’ time preference. As the pure time preference theorists—most notably, American economist Frank Fetter, and Austrian economist Ludwig von Mises—explain, the interest rate in the loan market is merely a manifestation of the discount on future cash flow. Savers (or capitalists) dictate the return on capital, not the other way round. This is no different from how consumer demand alone dictates the price of goods—a proposition cost theorists of value failed to comprehend.

Lastly, much has been made of the split of national income between labour and capital. However, the fundamental functional distribution of income boils down to land and labour—as capital represents but an intermediate product from combining land and labour. And under competitive bidding in markets, the split of income between labour and land depends on the relative scarcity of these factors. Apart from the folly of lump-sum classification of land and labour—given the heterogeneity of these factors—a lower remuneration for labour often sends alarm bells ringing among even otherwise sane economists.

This is unwarranted, for prices signal the relative scarcity of factors, thus spurring decisions of various kinds aimed at mitigating it. British economist John Habakkuk, for instance, pointed out how the US developed labour-saving innovations to counteract the effect of high wages, as labour was scarce relative to land (in a land-abundant country). Japan, on the other hand, chose land-saving innovations as the country represented a case where land was scarce compared to labour. Taxes to offset higher prices (be it on land or labour)—by nullifying the role of price system in reflecting underlying scarcities—would simply serve no useful purpose while killing productivity.

Piketty may have revived interest in the neo-Marxist economic tradition. But, much like his predecessor, he is plainly wrong. Given the favourable reviews the book has received, one can only hope the measures he recommends in the last part of his book—drawing from his own faulty economics—do not see the light of the day.

Natural Order will run every Monday, with a libertarian take on the world of economics and finance.

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less
Recommended For You
Get alerts on WhatsApp
Set Preferences My ReadsWatchlistFeedbackRedeem a Gift CardLogout