Very good rebuttal on Picketty and socialism

[yadayada]

In the comments of that peter schiff article. Might interest some people here. The article itself was very mediocre at best, but this comment was excellent.

 

It seems that capitalism will enhance automation and productivity, which will be good for everyone in the end. And socialism is envy, that will hurt the 1% and the 99% in the end. Probably the 99% more then the 1%. And the general public is generally in favor of it because they do not fully understand it's implications in the long run. If they knew they would not want a government this large, regulating and arranging as much stuff as they do now.

 

Of course Mr Schiff is right that Picketty is a load of horsefeathers, but in the international sport of taking whacks at him I find a distinct lack of aim. Yes capitalism makes everyone better off, yes seeking greater equality by cutting off the heads of the successful is an idiotic as well as an immoral idea. But crimenny, just destroy the man's completely innumerate math first.

 

Stipulate that the average rate of return on capital is higher than the average rate of economic growth, and ask if anything whatever follows for inequality. The answer is a resounding no. You cannot deduce a *distributional* consequence from an *average*. An average consequence, you might deduce. But the average rate of return on capital tells me literally nothing about the distribution of returns on capital. An average is a single point in the middle of the weight of a distribution. The distribution is a plethora of millions of actual outcomes for specific cases. When you are trying to derive a distribution-effect outcome, you need the entire *distribution* of returns on capital as your input, *not* one point.

 

The rate of return on capital might average 5% a year because every scrap of capital in existence returned exactly 5% a year, and you'd have one distributional consequence - except the premise does not obtain, so we don't actually see that distributional consequence. Or the rate of return might average 5% a year because 99% of all capital was lost instantly without any return, and the other 1% won a lottery and returned just enough to raise the overall average to plus 5% a year after covering all the losses of the losers. Anyone want to pretend that the distributional consequences of those two would be the same?

 

The returns of investing in US stocks in the 20th century were quite good, and even in real after tax terms come to positive several percent per year. Bully. But the returns of investing in Czarist bonds in the 20th century were 100% loss, and the French public lost $3 trillion in present value in that asset class. In 1900, there was no particular reason to think that the latter was a riskier asset class than the former. So US stock investors got wealthier in that century, and French investors in Russian debt did not (from those investments at least). Nobody got the average. Bill Gates got rich from the success of Microsoft; nobody got rich off the failure of Word Perfect - there are natural lotteries in the marketplace, where one solution will reap the rewards of all the rival efforts that it replaces.

 

So capital returning r does not mean capitalists enjoy a return of r. And it certainly doesn't mean they can enjoy a return of r without running very material risks and encountering wide dispersion of returns, across investors and across time periods and all the rest of it.

 

The Italian economist Wilfred Pareto invented the power law distribution because he was studying income statistics and the exponentially damped normals that previous generations of statisticians told him to use were clearly just completely wrong about everything that happens with income. Income is power law distributed - it follows "80-20" rules in which the top 1/5 account for 4/5th of the weight, as a rough illustration - not narrow normal distributions were almost everyone gets the average or close to the average. This has been true for as long as statistics have been kept, in every human society and under every political, economic, or monetary regime.

 

Normal distributions arise whenever random chance interacts with a fixed, constant probability of occurrence. The normal distribution is the limit as the number of independent trials increases of binomial chance - coin flipping writ large. We would not get equality of outcomes even if everyone's abilities and chances were precisely the same; luck alone would give us normals.

 

But skill gives us power laws instead. If you assign each participant a random success probability over a wide range, then have each of them make repeated tries, the success cases will not be distributed normally. Those with a higher prior success probability who are also on the lucky side will account for a very large share of the successes, others with high prior probability and average luck plus those with good luck and still decent prior probability will account for the next slice, and so on. At the low enough of small prior probability one will find few if any successes and their combined weight will not move the needle on overall successes. Sharp peak distributions result - by mathematical law.

 

Having dealt with the math, it is next time to deal with the history. Look around you at the large fortunes in existence today. How many of them were the result of modest sums lent out at interest in the ancient past, just compounding down to today untouched? None of them. Instead we find *recent entrepreneurship*, in the largest cases in successful *public* companies (meaning their gains were widely shared with millions of other people, from services renders to millions of people). For middling fortunes we find recent entrepreneurship is smaller and private enterprises, and the highest paid learned professions (successful doctors late in their careers e.g.).

 

But, someone will say, Picketty has a chart that shows the top 10% in the year 1970 owned... Who were they? None of his charts tracks the same people as they or their descendants wander through the categories. Again it is the trick of bad distributional thinking brought in when he wants it, and left out of the question entirely, by mere silence not argument, when it goes against his thesis. The 10% line in one year and one country is not the same as it is in another, and above all the people over that line are not the same people. Some invested in Czarist bonds or Word Perfect - or just retired from being a doctor - and dropped out of the category. Others invested in US stocks or Microsoft, or built a practice up over the intervening decade. But Picketty tries to pretend they are the same people with money on deposit just adding interest.

 

The reality in the 20th century is that even the pre-tax return on just deposits left at interest was zero in real terms. Leave aside being greater than g, that sort of r was barely positive. You could have borrowed at the prevailing short term interest rate in 1900, discounted your interest costs at the prevailing business tax rates throughout as a business expense, and roll over the whole sum clear down to 2000, and you would have *gained* in real value terms *as the borrower*, not the lender.

 

r is only positive for those who actually ran risks, in other words, and only the successful among investors got a return as high as that average. Unsuccessful risk takers lost their capital, and those who took no risks did not get any return on their capital at all. They lent its use to other men in return for staying even, at best, against the headwinds of taxes and inflation.

 

Finally there is the fallacy of double counting the capital income of those who do achieve a return of r. If it is supposedly compounding away to outstripping g, then they are reinvesting all of it, and spending none of it. Which means they gave away the full use of that capital to other men, and in return drew flat nothing from the produce of the rest of the society. If on the other hand they are supposedly living on the income of their capital without working, then they are *consuming* the returns of their capital, *not* saving them. The same dollar of capital income cannot be in both places at once. Suppose g is 3 and r is 5 (generous indeed on the latter score, when all the low risk stuff is returning more like 0 to 1); then someone can only keep up with economic growth if they live on an income of 2% of their capital. And they do not, in that case, increase economic inequality - they only stay even.

 

The demographic reality is, instead, that those with high incomes save over lifetimes to modestly endow their descendants; that only a very small number of the skillful and lucky can do more than that, balanced by the risk takers who failed; that most fortunes that are used to support consumption off the income from capital are dissipated in the process, not concentrated or grown further. They are further dispersed by the natural growth of families, which spread the inherited benefit over more and more people in later generations. This is why the present cohort of the rich is made up of recent entrepreneurs, not the sons of medieval land barons.

 

In all of it, Picketty has committed the same mathematical sin of treating the entire weight of a distribution as being concentrated on the single value of its average. When engaged in a discussion of distributional effects, this is simply unforgivable.

[merkhet]

I'm not sure I would count the Rockefellers as being "recent" entrepreneurs.

 

This is why the present cohort of the rich is made up of recent entrepreneurs, not the sons of medieval land barons.

 

There's something to that "all generalizations are false [including this one]" quote.

[yadayada]

only 6% of the wealthy (north of 500k$) got their money from inheritances. According to a survey by PNC wealth management. Shouldn't this be more by now? I guess the posters argument is that three things will happen to a inheritance.

 

It will be invested, which is good. It will wither away , so inequality goes away, or it will be consumed. Also good for the economy.

[merkhet]

More than $500K is wealthy, but I doubt it's what most people are talking about when they talk about the wealthy. I'd be curious about the north of $100 million set.

 

Also, think about the following. Assume 6% inheritances. Now assume a completely new cohort of recent entrepreneurs. Prior to them, that 6% was 100% of the wealthy. Now it's 6%. Does this prove anything?

 

Not necessarily. Why? Because the other 94% haven't died yet. Two things we don't know:

 

(1) What happened to past inheritances.

(2) What will happen to the families of the currently wealthy.

[yadayada]

I guess you are right. But still the point that that is bad seems to stand. They either spend it, it will be destroyed or it will be invested and help other people.

 

A larger supply of capital will lower the cost of capital over time. In the middle ages you had mostly loan sharks to go to because there was not much supply of capital. Which meant low mobility. So with a very large 1%, they will either spend it or invest it. Or it slowly rots away through inflation (least likely probably).

 

And not to forget that part of it is given away. Some of the richest people have given it away and accomplished amazing things. Governments all over the world do a very poor job at a lot of things. Rich people giving money away should be more effective then having it go through the bureacratic system of the government.

 

Another thing is, you do not hear people up in arms about the massive amount of tax money that is being wasted by governments. This is not other people's earned money sitting in some account, this is actually the people's money partially being pissed away.

[merkhet]

I wonder if people ever think about the public and private divide in terms of size.

 

People say all the time that the government is bureaucratic and wasteful and attribute that to the fact that it's the government. Institutionalization and bureaucracy might be an issue of size rather than the nature of the entity.

 

Also, your answer seems to presuppose that having a wealthy group is better than not having one. That may or may not be the case. Spending, destroying and investing wealth exists independent of the distribution of wealth.

[rkbabang]

If you assume an average of 2 kids per generation.  The rich guy has 2 kids, 4 grand kids, 8 great grand kids, 16 great great grand kids, 32 great^4 grand kids, etc....  Then a fortune would have to be absolutely immense to enable more than a generation or 2 to live off of it without productively adding to it.**  If they do not productively add to it, then it will be gone in a historically speaking short amount of time. If they do productively add to it, then that will be good for society.

 

**The Rockefeller fortune was truly enormous, $336B in 2007 dollars according to Wikipedia, which is why they are a notable exception, but even that fortune will be gone in time.

 

[coc]

The Rockefellers are a good example of wealth not really "sticking" over time. When Standard Oil was split up, Rockefeller owned about 25% of the outstanding. If you simply carried that through until today, the figure would have to be well over $250 billion (If you add XOM, parts of BP, COP, CVX, etc. back together.) Then you had his immense non-oil fortune, I don't know the figure but I'm guessing it would be worth many, many billions today as well at standard rates of return.

 

But the Rockefeller clan isn't worth anywhere near $300 billion. Most of it was given away or spent over time in an immense philanthropic effort, the same way the Gates fortune and the Buffett fortune will dissipate in a similar time period.

 

I don't know how this all adds up but Piketty's assumptions strike me as pretty unusual. Besides philanthropy, there are major discontinuties that tend to destroy wealth pretty fast. The Rockefeller money is an example of a business that has held up extremely well over the years -- probably the most successful large company ever. And even that fortune, as I mentioned, is mostly gone (compared to what it would have been). Where are the Vanderbilt, Carnegie, Gould, etc etc fortunes now? They're rounding errors as a % of the wealth of the United States.

 

And that's just the in the US, which is the "Standard Oil" of large countries. Think of all of the fortunes lost to war, competitive destruction, hyperinflation, etc. in other countries.

 

I'm nowhere near an expert on any of this, so take me with a grain of salt. But Piketty makes me extremely skeptical. I'd think, if he was correct, there would be multi-trillion dollar dynastic fortunes from a long time ago. And there really aren't. The majority of private wealth seems to be less than 100 years old. (Again, to my untrained brain.) And I suspect 100 years from now, it'll be a different group. r>g takes you into extreme mathematical territory over enough time. I don't know.

[randomep]

Well said. At the risk of being repetitive, let me summarize:

 

Picketty is wrong on so many levels. But Bill Gross made a similar point in his letter on "the death of equities"

 

http://www.reuters.com/article/2012/07/31/us-investing-gross-pimco-idUSBRE86U15720120731

 

And your article points out the faults with both. We humans waste A LOT capital for discretionary things:

- helping the poor (ok ok maybe this isn't exactly a waste)

- helping preserve nature

- partying

- fighting wars

- taking drugs

 

And relatively few people actually save and grow capital. And growing capital isn't easy, lots of people try and lose their shirts. So the world must reward those who can take the risk and are good at allocating capital. Without the reward of 10% investment growth the GDP cannot grow at 3% or whatever number Picketty uses. We already gave marx his chance to implement his theories, that's enough!

 

 

[VersaillesinNY]

Today's rich families in Florence, Italy, were rich 700 years ago

 

http://www.vox.com/2016/5/18/11691818/barone-mocetti-florence

[KCLarkin]

But the returns of investing in Czarist bonds in the 20th century were 100% loss, and the French public lost $3 trillion in present value in that asset class. In 1900, there was no particular reason to think that the latter was a riskier asset class than the former. So US stock investors got wealthier in that century, and French investors in Russian debt did not (from those investments at least).

 

This is perhaps the most un-intentionaly stupid thing ever written. Yes, capital can't forever become concentrated into a few hands. But the usual way to correct this natural accumulation is revolution, war, theft, and assassination.

 

What happened to the Russian Czars?

 

As a capitalist, I think the conclusion from Picketty is not that socialism is bad (or good). But that moderate socialism might be preferable to the guillotine and the bayonet.

[VersaillesinNY]

Yes, Your Parents’ Status Does Influence Your Earning Power

 

https://www.bloomberg.com/news/articles/2017-06-28/yes-your-parents-status-does-influence-your-earning-power

 

You cannot strengthen the weak by weakening the strong. You cannot help small men by tearing down big men. You cannot help the poor by destroying the rich. You cannot lift the wage earner by pulling down the wage payer. You cannot keep out of trouble by spending more than your income. You cannot further the brotherhood of man by inciting class hatreds. You cannot establish security on borrowed money. You cannot build character and courage by taking away a man's initiative and independence. You cannot help men permanently by doing for them what they could and should do for themselves. Abraham Lincoln

[scorpioncapital]

And yet the former communist countries are the most free and capitalist while the western developed nations are the most controlling and socialist these  days. Just look at marginal tax rates Including capital taxes , 40 percent plus in developed "non socialists" west and 10 to 15 percent in the east. I have not been able to see a difference in services to justify this difference. Even health insurance you can just buy a policy for 2000 a year and yet we are told 50 percent taxes are needed for the services we receive ! I rather take user fees + insurance.

 

The west is cooked . I see nothing but slow or negative growth and a massive dose of inflation, a double tax to pay for the massive borrowing which cannot be unwound.

[tede02]

The trouble with socialism is it seems gradually expand and you can never peel it back without a crisis.  It reminds me a lot of union benefits that get fat during good times.  When things go south, no one is willing to give anything up until either the companies go broke, pension funds are exhausted, etc. 

 

I think its just human nature. 

 

I hear relatives and friends bashing socialism regularly.  Then you start talking about peeling back specific socialistic programs (like Social Security, Medicare, Medicaid, the public school system, state parks, national parks, law enforcement, roads & bridges, and on and on) and they go silent.  It demonstrates how challenging the problem is. 

 

My dad loves to ask the rhetorical question, "Can we govern ourselves?"  I think its an open question but in the more narrow issue of managing our own financial affairs (as nations), I'm definitely pessimistic. 

 

 

[Jurgis]

And yet the former communist countries are the most free and capitalist while the western developed nations are the most controlling and socialist these  days.

 

Yeah. Lithuania by now lost about 1/3 of its population due to emigration. You'd think those people would wanna stay in the "free and capitalist" instead of leaving for the "controlling and socialist".

 

Wanna "free and capitalist" country that needs people? Just go there. Have fun. Tell us how it works out for you.

 

8)

[JSArbitrage]

only 6% of the wealthy (north of 500k$) got their money from inheritances. According to a survey by PNC wealth management. Shouldn't this be more by now? I guess the posters argument is that three things will happen to a inheritance.

 

It will be invested, which is good. It will wither away , so inequality goes away, or it will be consumed. Also good for the economy.

 

I think crafting unearned wealth inequality as inheritance is a bit misleading.  For example, one could say that Bill Gates is self-made; he received no significant inheritance and went into an industry completely different than that of his father (attorney.)  But one could also argue that his parents have a huge impact on his trajectory.  His parents even paid for a prestigious, expensive private school that had a computer in the 70's (which was insane at the time.)  Bill's father even wrote a book on parenting. 

 

As for myself, I sometimes think about how much of "me" was baked in many generations ago.  I had parents that were upper middle-class, purposely moved across town to get me into the best public school system in my city, always came to my sports games, spelling bees, etc.  Their parents were educated immigrants from Germany who could claim to have come to the US with nothing in their pockets (true) but were also quite educated for their day in Germany (also true.) 

 

When I think of wealthy inequality, I don't think of the Rockefellers.  I think about all the children today that have a really strong headwind while I had a strong tailwind.

[abitofvalue]

When I think of wealthy inequality, I don't think of the Rockefellers.  I think about all the children today that have a really strong headwind while I had a strong tailwind.

 

+1

 

 

[randomep]

only 6% of the wealthy (north of 500k$) got their money from inheritances. According to a survey by PNC wealth management. Shouldn't this be more by now? I guess the posters argument is that three things will happen to a inheritance.

 

It will be invested, which is good. It will wither away , so inequality goes away, or it will be consumed. Also good for the economy.

 

I think crafting unearned wealth inequality as inheritance is a bit misleading.  For example, one could say that Bill Gates is self-made; he received no significant inheritance and went into an industry completely different than that of his father (attorney.)  But one could also argue that his parents have a huge impact on his trajectory.  His parents even paid for a prestigious, expensive private school that had a computer in the 70's (which was insane at the time.)  Bill's father even wrote a book on parenting. 

 

As for myself, I sometimes think about how much of "me" was baked in many generations ago.  I had parents that were upper middle-class, purposely moved across town to get me into the best public school system in my city, always came to my sports games, spelling bees, etc.  Their parents were educated immigrants from Germany who could claim to have come to the US with nothing in their pockets (true) but were also quite educated for their day in Germany (also true.) 

 

When I think of wealthy inequality, I don't think of the Rockefellers.  I think about all the children today that have a really strong headwind while I had a strong tailwind.

 

I agree with this post completely!  It isn't monetary advantage that sets people apart. It is the pride of your identity that sets people apart.  The implication that money somehow gained in the 1800's can have an effect on the wealth distribution today is just insulting to everything we do, why the heck should I even try to invest, save money, go to college if I am pre-disposed to be poor like my ancestors from their 3rd world country.

 

Our society creates financial windfall to those who do not have smarts and financial savvy all the time. Just think of how much money goes to professional sports. The biggest expense in pro sports is labour costs.  If all that money concentrated on a few can be used like Picketty says, then we would have many many more african america billionaires today. I read 60-75% of NBA and NFL players go broke a few years after retirement.  It is ridiculous how some NBA players can blow $100M in career earnings.  If the athlete's way of thinking towards money is indicative of their community or their identity group no amount of socialism can change the wealth distribution for these people. Sure some in the ghettos can become billionaires always but socialism won't change where the rich come from.

 

[RichardGibbons]

Yeah, I think you're right about the headwinds versus the tailwinds.  I think you can get pretty far simply by reducing the headwinds dramatically with better education.

 

http://www.huffingtonpost.ca/entry/social-immobility-climbin_n_501788

 

The other concept that's useful, and I think Scalzi has written about, is financial resilience to handle random bad events.  e.g. If you're middle class, and your car breaks down, you get it fixed, and maybe take temporary hit to your credit card, but nothing insurmountable.  If you're poor, and your car breaks down, you might not be able to get it fixed, and so you might not be able to get to your job, so you might lose your job.  Essentially, parental wealth (middle class+)  gives you a greater buffer against random bad luck.

[Ross812]

When I think of wealthy inequality, I don't think of the Rockefellers.  I think about all the children today that have a really strong headwind while I had a strong tailwind.

 

I agree with your last statement. What I take issue with though to a certain extent is the kind of wealth in the US that is concentrated toward. the 1%, 0.1% and 0.01%. After WWII until the Regan Administration, each quintile of wealth in the US grew together benefiting equally from the expansion in the Country's GDP growth. Trickle down was introduced by Reagan as a stimulus to get the economy going in 80 and it worked. The trickle down "stimulus" was never withdrawn and was expanded during later administrations.

 

In the last 35 to 40 years, GDP has grown by roughly 60% on a per capita basis. If it were shared equally, people at all income levels should have seen an increase in income of around the per capita GDP growth. In reality, the bottom 3 quintiles have seen about 10% income growth, the 4th quintile (the start of the middle to upper middle class) has seen 35% growth, and the upper quintile has seen 70% growth. When we break down the 5th quintile we see the 80-94% have seen their incomes increase by about 50% and the upper 6% are doing about 100% better. The top 1%, .1%, and 0.01% have seen 200%, 400%, and 550% growth respectively.

 

What worries me is we have started to see social movements (occupy) and political candidates (sanders) that are shining a light on income inequality and true to the polarized nature of politics in this country, there will be an overreaction. The overreaction of doubling the taxes on the top 20% will be so disruptive to the economy that the increase in tax money will all be spent creating social programs to steady the economy and we end up with a socialist system.

 

An alternative scenario would be politicians decide to gradually raise taxes (ala the Fed and interest rates, winding down the stimulus) while still providing freedom to give money to charity and have a generous inheritance exception. A gradual increase would be a return to the 1970's tax brackets over 15 to 20 years. The increase in income can go toward reducing debt, and increasing education. The aim shouldn't be to make all the classes equivalent, but to maintain a capitalist system where all income classes participate in GDP growth.