After Reading Piketty’s CAPITAL

Istvan Gorog   

June 2014, Eureka, CA

I posted my “Notes on the Economy: Jobs, Incomes, and What the Future May Hold” contemporaneously with the American publication of Thomas Piketty’s “Capital in the Twenty-First Century”. Here I comment on our similarities and differences, as well as append my earlier thoughts based on what I learned from reading Piketty.


Contents

• Introduction
• Overview of similarities and differences
• Education and unemployment
• Public debt
• Intellectual capital
• More on inequality
• Conclusion
• Notes

Introduction

In April of this year I posted my “Notes on the Economy: Jobs, Incomes, and What the Future May Hold”.  Also in April Harvard University Press released the English version of Thomas Piketty’s “Capital in the Twenty-First Century”.  Piketty’s book is a 700 page major scholastic achievement, a detailed study of wealth and income inequality, based on the detailed analysis of historical economic records. My Notes are a brief summary of my observations supported by easily available data. Nevertheless our overlap is sufficiently strong to compel me to write this comparison of my modest work and his bestselling masterpiece. Principally, my interest here is to summarize where his data supports my findings, where my Notes supplement his work, and where our emphases differ. Briefly: we do not disagree, we simply focus on different aspects of the same problem, and offer complementary solutions that together will be needed to save American capitalism and establish a just society in the 21^st Century.

I believe it is important to emphasize that we both believe that capitalistic democratic society is the best social system known to date. While as I wrote in my earlier Notes,  some may perceive some of my views as socialistic, and others have charged that Piketty is a Marxist, we both seek to repair the growing flaws of capitalism to avoid its demise through social discord between the haves and the have-nots that ultimately could lead to destructive violence.

Overview of similarities and differences

We both recognize a significant inequality where the upper brackets’ shares both in terms of wealth and income are at historical highs and are still growing. Piketty addresses this issue globally, focuses on its evolution over history. It is this growing inequality that he believes needs remedy. I look only at the USA, using some data from abroad only as guiding reference. I focus principally on the growing unemployment resulting from technological advances. In my view these advances now more and more substitute robotic machinery, thus capital, for labor. Furthermore, I argue that virtually no job or profession is immune from this substitution of human activity by intelligent machines that can move, are dexterous, can see and may have also other sensory capabilities, obey voice command, and are easily programmable. They will be mass produced, affordable, and ubiquitous. I foresee them in factories, offices, homes, and public places; they make things, answer questions, deliver goods, and provide personal assistance. I believe that we can produce enough food, goods, shelter, transportation, and energy from renewable sources to provide for all our needs, but with our economy as it is structured today, in the 21^st Century we will not be able to provide fulltime jobs for all to earn enough to pay for all their needs. There simply is not sufficient need for labor in our economy; thus there are not enough jobs today, and in the future there will be still fewer. The solution to this quandary is Piketty’s social state with more progressive taxes on income than we have today and a new general wealth tax on wealth.

I also believe that it is better for all to be employed than for some to work and others to be unemployed; therefore the legal working hours need to be adjusted with the aim to achieve full employment with reduced working hours. Also, contrary to much of the current political wisdom, for the same reason the retirement age may need to be reduced rather than increased. Piketty’s social state, paid for by progressive taxes, could address these needs.

Education and unemployment

Even though education is not an absolute protection against unemployment, its significance in employability cannot be overemphasized. As I discuss it in my Notes, there is a direct correlation between attained education level and employment. The “official” unemployment rate (US BLS U-3 measure) in 2013 for people with less than high school diploma level was 11%, for those with high school diploma was 7.5%, while for people with Bachelor’s degree or higher level was 3.7%. The “total” unemployment rate (US BLS U-6 measure that includes all who wish to work full time but can’t find such employment and either work part time or have given up looking for work) is about twice that of the official rate: 12.3% vs. 6.3% in April 2014 for the USA. (No BLS U-6 data is available by educational segmentation.) Thus assuming a constant total-to-official unemployment rate ratio for all education levels, over 20% of the population without high school diplomas  and over 15% of those with high school diplomas but without additional education is unable to find fulltime employment. The foregoing is likely to be an under-estimate; less educated social groups are more likely to be discouraged and give up looking for satisfactory employment than are the better educated, more successful groups. Furthermore, based on personal observations I estimate that in fact the majority of the younger people (under about 35 years) with only high school diploma or less education are unemployed or underemployed. More than 40% of the US population has high school only or less education; thus their employability status is a major social and political issue. Piketty views access to education everybody’s need and right in an equitable society and thus the state must provide it at public expense, similar to how it is done in much of continental Europe.

Public debt

Public debt is a major concern of many Americans and it is much discussed in the media; frequently there appears to be some confusion about who owes what to whom. Neither Piketty nor I consider it a top priority. Before discussing it, I wish to clarify certain aspects of it. First I wish to emphasize that there are two kinds of national debt that are not always clearly differentiated and thus are frequent sources of confusion and misconception in public discussions. There is public debt and there is external debt. Some of the public debt is external debt and some of the external debt is public debt, but the two are not the same. The public debt, also known as sovereign debt, is what the government owes, what it borrowed to do what it is supposed to do: provide for the defense, education, health, and welfare of the people, as specified by the laws and provided for in the budgets; both the budgets and laws have prior approval by Congress. The external debt is what the US government, institutions, businesses, and individuals collectively borrowed abroad and thus owe to foreign governments, institutions, businesses, and individuals. Thus in principle, we could have no public debt and still have foreign debt, or no foreign debt and still have public debt; in practice we have both.

The US public debt on May 31, 2014 was $17.5 Trillion, out of which $5 Trillion was intragovernmental, whereby the government borrows for its current operational needs funds that it currently collects, but will need to pay out only later. The principal source of intragovernmental borrowing is Social Security. The public debt net of intragovernmental borrowing, thus the debt held by the public, is $12.5 Trillion, or 74% of the GDP. (In 2013 the US GDP was $17.1 Trillion). However, the debt held by The Federal Reserve is included in this figure of public debt. The Fed’s share of this is $2.4 Trillion. Thus netting out the Fed holding, the remaining debt held by the public is $10.1 Trillion, or 59% of the GDP.  (To summarize the confusing terminology: we have public debt that includes intragovernmental debt; the debt held by the public is the public debt net of intragovernmental borrowing; the debt held by the public includes the debt owed to The Federal Reserve; the debt held by the general public – which may include foreigners and foreign governments – is debt held by the public net of The Fed holdings.)

The external debt of the USA as of December 31, 2013 was $16.5 Trillion, of which $5.9 Trillion, or 36% of the GDP, was government debt. The US also has external financial assets and the difference between the external debt and the external financial assets is the net international investment position (NIP); at the end of 2013 the NIP of the USA was negative $4.6 Trillion, i.e. foreigners owned American assets in excess of foreign assets owned by Americans worth about 27% of the GDP. According to Piketty, the total private and public capital in the US is about 450% of the GDP, thus the US NIP is about 6% of the total US capital.

It is also important to recognize that $13.5 Trillion out of the total US external debt of $16.5 Trillion, or over 80%, was borrowed in US dollars. Thus in principle the Federal Reserve could wipe out much of the external debt by simply printing more dollars. Clearly there would be significant damage to the US prestige and economy as a consequence of such an action; nevertheless it is an option.

To put the above numbers into a Global perspective, the global external debt (the sum of all external debts of all countries at the end of 2013 was $73 Trillion while the GWP (Global World Product, i.e. the sum of the GDPs of all countries) was $74 Trillion at official exchange rates and $87 Trillion at purchasing power parity (PPP). Thus the US external debt as percent of the GDP is in line with the global figure. Obviously the global NIP, the sum of the NIPs of all countries, is zero. Since the US NIP is negative, we conclude that foreigners feel more secure owning American assets than do Americans owning foreign assets.

Having established the basic quantitative parameters of or national debt, I wish to address some key conceptual issues related to public debt. Here I will follow Piketty’s reasoning that I adopt henceforth as also mine. When the taxes collected are insufficient to pay for Government expenditures, public debt is accrued as the Government finances its expenditures by borrowing. In other words, one way of looking at public debt is that it a substitute for taxes. Another way is to view it as regressive taxation: the rich collect rent (interest) from the Government by lending to it and all tax payers share in paying for this rent (and one way or another, ultimately also will need to pay back the principal). – The third view, much cited in certain circles is that it is a way to pass on the cost of current generation’s profligacy to future generations, is not very credible, since in the past two centuries this never happened, even though government debts in the USA, and in all developed countries, continuously existed during this period, at times at significantly higher levels relative to GDP than is the case now in the USA. -- Public debts were managed (old outstanding ones virtually eliminated) by growth of the economy (USA through its history), inflation (most everywhere in the 20^th century), and forgiveness (post WWII Germany).

Historically the wealthy like public debt as means to derive a relatively safe income from accumulated capital. They do not like inflation since it reduces the real value of the rent collected, as well as of the principal. By the same token, the wealthy like deflation since it increases the real value of the interest collected, as well as of the principal. Today most economists agree that deflation is dangerous; it stifles growth and leads to recession. The generally held belief by experts both within and outside of government is that a moderate inflation of about 2% per year is desirable.

So how are we going to manage our debt?  Can we outgrow it? Not likely. Historically, in addition to productivity growth, the growth of the US economy was aided by territorial and population growth. Going forward GDP growth will only come from productivity and population growths.  Let’s use a specific time frame: what can we expect in 36 years, by 2050? As Piketty emphasizes, the real inflation adjusted GDP per capita growth historically in America over any extended period has never exceeded 2%, and 1.5% maybe a realistic forecast (see Table 2.5 in Piketty’s “Capital…”). According to the US Census forecast, by 2050 the US population will be about 400 million vs. 320 million now; thus the population growth rate is forecast to be about 0.6% per year. The combined effects of per capita productivity growth and population growth are expected to result in a real GDP growth by 2050 of about a factor of 2, i.e. we can expect the GDP of 2050 to be about $34 Trillion in 2014 dollars. Thus today’s publicly held debt of $10.1 Trillion, net of the Fed holdings, will still be 30% of the GDP; the total public debt of today, including the Fed holdings and intragovernmental borrowing, would in 2050 still amount to 50% of the GDP. Since we cannot outgrow it, the remaining options to manage our public debt are taxation, inflation, and default. Outright default is extremely unlikely. Inflation, especially one induced by the Fed, is a form of default; again it is an unlikely US debt reduction measure. Thus the likely solution is increased taxation. Piketty advocates an increase of the top marginal income tax rate to 80% and the introduction of a wealth tax of a few percent per year. While the political will to adopt these measures in America is lacking today, increased taxation is a necessity and the wealthy are not likely to escape paying their share. Whether increased taxation will come according to the formula Piketty suggests, or in some other manner, is not clear to me. But I am certain that it will come, because it has to come.

Currently we have public debt because as a country we needed to pay for things that were needed, and we were unwilling (politically unable) to raise our taxes, and there were (are) people willing to lend us. Our public need for public funds will only increase and not decrease.

Intellectual capital

I see a world rapidly emerging where smart machines do most of the work and much of the need for traditional labor disappears. To install and operate the smart machines, society needs two kinds of capital: physical and intellectual capital. Here I would argue that the traditional term “human capital” for the acquired non-tradeable but rentable human skills is not adequately clear in the 21^st Century. All of us people are born human, but going forward our sheer human competence has no economic value; it is our learned skills that society needs for its growth and operation. Therefore I prefer the term intellectual capital over human capital.  Owners of capital collect “rent” on the capital deployed. The rent taken by owners of physical capital is the interest and royalties earned; the rent taken on intellectual capital is in the form of wages and professional fees earned (Note 1). Physical capital is transferrable (sold, given away, inherited, and even stolen), intellectual capital is not transferrable. Thus intellectual property (IP), be it patents, copyrights, or designs, is in this sense physical capital. It is interesting to note that while intellectual capital is non-tradable and cannot be inherited, there is increasing evidence that social mobility does not increase with the increasing emphasis on intellectual capital. It appears that individuals born into families who possess physical and/or intellectual capital will more likely acquire intellectual capital than do less fortunately born individuals. To acquire physical capital, an individual may inherit it. To acquire intellectual capital, an individual needs training, which in turn also requires both physical and intellectual capital investments: physical to cover the living expenses and intellectual to impart the knowledge. The fortunate have access to both early on in the homes in which they grow up. The significance of access to intellectual capital during childhood may be greater than in later life. Intellectual capital appears to be similar to physical capital in a sense that a seed investment is needed so that that when it is well managed it may grow significantly. Without a starting seed no amount of compound interest can lead to wealth. Similarly without a starting interest in knowledge acquired in childhood, no matter how much access to education may be available, no significant level of intellectual capital can one acquire. It is of further interest to recognize that more and more advanced  teaching is taking place via remotely accessible electronic means, whereby one highly trained individual may impart his/her knowledge to thousands or even millions of  students. Thus in advanced training the relative need for physical capital over intellectual capital is increasing.

In any case, recognizing the significance of intellectual capital and the growing insignificance of traditional unskilled labor, Piketty’s social state will need to pay increasingly for education and welfare. The money to pay for these increasing expenditures will need to come from those who possess capital, be it physical or intellectual.

Here I wish to separate the unjustified supersalaries from the justifiable compensations derived from intellectual capital. Earnings derived from intellectual capital put many professional in the upper decile of total income; some even make it into the upper centile, earning hundreds of thousands of dollars per year). The supersalaries of top tier corporate managers (possibly  millions, or even tens of millions per year, are not justifiable by their contribution to the economy, not by their competitive value. As Piketty argues, supersalaries are the result of  crony behavior on self-serving corporate compensation committees. Thus, while both intellectual capital and supersalaries contribute to inequality, earnings derived from intellectual capital are the result of useful contributions to the modern economy; supersalaries are derived from cronyism.

Physical capital has two major principal components: real estate and financial assets. As cited above, that the total US wealth, i.e. physical capital, is about 4.5 times the GDP, thus it is $77 Trillion. At 5% return on investment, US wealth earns about $4 Trillion per year. I am about also interested in estimating the magnitude and associated earnings of intellectual capital possessed by professionals in the USA. For the purposes of my estimate, in this group I included engineers, scientists, physicians, lawyers, architects, and accountants. I estimate that there are a total of about 9 million people in this group, with about two-thirds in the engineers and scientist category (Note 2). Then, using a published figure of $1.1 million for the average intellectual capital value owned by professionals (Note 3), I estimate the total US intellectual capital as $10 Trillion. Owners of intellectual capital also tend to accrue physical capital by systematically saving and investing from current earnings, such savings may take the form purchasing a home and/or investing in financial assets for retirement purposes. As the result of such savings and accruals, the total physical capital owned by professionals is likely at least to match, but even more likely to exceed the total intellectual capital owned by them (Note 4).

More on inequality

Now I wish to return to the question of inequality. Everybody who looks at the widely available statistics agrees that we have significant inequality. In my “Notes on the Economy…” my basic thesis is that 1) a new type of fundamental inequality is of growing significance: technological change forces more and more people out of the productive and growing economy (Note 5); and that therefore 2) in a democratic just society the fortunate, whose share in the benefits produced by this economy is growing, must take care of those of those who became marginalized. Furthermore I argue that as machines replace people, the role of capital inevitably increases. Piketty provides detailed analysis of historical data and he concludes that when the rate of return on capital exceeds the growth rate of the economy, capital’s share in the GDP increases and to rebalance the resulting inequality appropriate tax policies need to be adopted.  Furthermore he shows that throughout history capitalism has not been simply operating according to some divine law of the free markets, but was much affected and controlled by wars, depressions, and political acts. He argues that inequality is now dangerously growing and he places (at least partially) the blame for the 2008 Financial Crisis, and for the Great Recession in 2008-9 that followed it, on this inequality.

The recovery from the Great recession is not proceeding as many would wish and expect. In June 2014, about five years after the recession, we have 2.1% per year GDP growth and the US unemployment is at 6.3%, while at the start of the recession GDP growth was about 3% and unemployment was 5.0% (Note 6). To make the unemployment number worse, we need to recognize that the labor force participation  rate dropped from 66.4% in January 2007 to 62.8% in May 2004 (Note 7). Thus, even though now fewer people are looking for jobs than before the Great Recession, still fewer can find one. As I cited earlier, according to Piketty, the GDP per capita growth rate over any extended period never exceeded 2%, and going forward it will more likely be about 1.5%. Since now the US population is growing at about 0.6% per year, practically zero, the real GDP growth must come from productivity growth. Thus 2.1% GDP growth rate, especially with increased unemployment, is rather good by historical standards. This may indicate that the economy is in fact still catching up for ground lost during the recession, or that in fact we may have already fully recovered from the great recession, but we do not like what a recovery in the new economy looks like.

Decreasing employment participation and increasing unemployment rates are well aligned with my thesis that jobs are disappearing permanently due to technology changes; or stating the obvious more explicitly in a different way: in the new economy technology advances eliminate more jobs than new opportunities resulting from new technologies create new jobs. We must face up to this fact and act accordingly. For the benefit of all, the new societal need for sharing must be recognized and new rules to establish and maintain the needed sharing must be legislated and implemented.

Conclusion

Several conservative and libertarian attacks on Piketty’s work have been published, notably in The Economist, The Financial Times, and The Wall Street Journal. Some claim that there is no growing inequality; others call him the new Marxist. I disagree with these attacks. Paul Krugman twelve years ago raised the issue of increasing inequality, and he recently pointed out that some of these attacks are “politically motivated efforts to deny the obvious” and also are comparing apples and oranges in order to discredit Piketty’s work (Note 8). It is notable that earlier bestselling books (Note 9), one by Paul Krugman and another by Joseph Stiglitz, both Nobel laureate American economists, addressing the same issue of inequality, both books shorter and less filled with quantitative data and thus more readable by the general public, did not receive the same level of public attention as did Piketty’s. Maybe the times are changing?

There is one fundamental issue on which I disagree with Piketty and the other above cited economists. They all emphasize political action to stimulate the economy, to assist people to move from jobs being lost to jobs being created. They seem to feel that the balance of the job market as we knew it in the 20^th Century can be reestablished with appropriate political actions. I disagree. As I stated above, I believe that we are faced with a fundamental structural change, where inevitably in the 21^st Century technology will eliminate more jobs than create new ones. We must develop new social and political thinking to address this fundamental issue (Note 10).

One may indeed ask whether Piketty’s ideas, and mine too, are in fact socialistic. Here again I wish to state most emphatically that I am an ardent believer in capitalism and I believe so is Piketty. I strongly believe that supply and demand must be mitigated by a competitive market. In the 20^th Century we witnessed the failures and miseries of centrally planned economies, most notably in Stalin’s Soviet Union and in Mao’s China. At the same time the competitive market must be subject to laws and regulations. Too big to fail is unacceptable: why should society pay for the blunders of excessively compensated superrich managers because their organizations cannot be allowed to collapse? This is clearly wrong. Also environmental issues, renewable energy, and public safety need to be addressed by appropriate regulations. Furthermore, taxation should be used to provide equitably for all. Those who harvest the benefits of the modern economy must provide for those who in fact are being rejected by the same forces that allow the fortunate to harvest the benefits. Inequality must be reduced and democratic control over capital reestablished.

Notes

Note 1 Future returns of capital can be computed, or estimated based on past experience, in various ways. For physical capital the simplest method is to use is to calculate the compound interest over a fixed period, more sophisticated methods may use simulation calculations that employ random sampling of historical data. For returns on intellectual capital, various methods have also been developed based on the investment, i.e. the cost of education, and the anticipated excess earnings attributable to the intellectual capital acquired through the education. According to such a calculation, a UC Berkeley engineering degree in 2013 costs, after financial aid, about $70,000 and the graduate engineer over 20 years will have earned $1.1 million more than a cohort who never went to college (The Economist April 5^th 2014).Thus one can assign a dollar value of $1.1 million as an estimate for the average intellectual capital value owned by the graduate engineer.  For comparison, at 5% compounded interest, after 20 years a $70,000 investment will have earned about $0.1 million.

Note 2 The total engineering and scientific manpower estimate is given by The Congressional Research Service as 6.2 million people (CRS report R43061, February 19, 2014). For other professional manpower estimates, see United States Department of Labor, Bureau of Labor Statistics, Occupational Outlook Handbook (http://www.bls.gov/ooh/home.htm). 

Note 3 Combining the data sources cited in Note 2 above, physicians represent less than 10% of all US professionals. The average cost of education and average earnings of all other professions is about the same, thus I use the value of $1.1 million from Note 1 as a crude estimate for the dollar value of the average intellectual capital per professional.

Note 4 If one saves $10,000 every year, an amount most mid-career professionals can afford, and invests it at a real net of inflation rate of return of 3%, after 20 years the resulting physical capital value is $2.6 million; then 9 million professionals will own physical capital of $23 Trillion total value, which is 30% of the total US wealth of $77 Trillion. – This is likely a significant overestimate, since even in the most oversimplified model of such a group not everyone in the group can be expected to have saved uniformly  for 20 years. If we assume that the number of group members is constant over the years, that for all participants the group participation ends after 20 years of participation, and that every year the same constant number joined (i.e. membership is evenly distributed over the years of participation), then group average accrual would be about $1.2 million per person, and the group’s total physical capital accrual would be about $10 trillion or 13% of the total US wealth.

Note 5 In my Earlier “Notes on the Economy…” I focused first on manufacturing automation and then discussed how not only manufacturing, but also most service activities are likely to be taken over by smart machines. Lest one thinks that artists are safe from losing their jobs to machines, now opera orchestras may face replacement with “the digital sound of sampled instruments”, see “A Digital Orchestra for Opera?”, NY Times, Thursday, June 12, 2014 p.A1.

Note 6 See: “A Scarred Economy”, NY Times Thursday, June 12, 2014, p. B1. For GDP growth data, see: US Department of Labor Bureau of Labor Statistics, National Income and Product Accounts Tables, Table 1.1.1. Percent Change From Preceding Period in Real Gross Domestic Product. For the three year period preceding the Great Recession, years 2004-2006, averaging the Bureau of Labor Statistics quarterly data indicates about 3% real GDP growth rate per year.

Note 7 US Department of Labor Bureau of Labor Statistics, Economic Releases, Databases, Tables & Calculators by Subject (http://data.bls.gov/timeseries/LNS11300000)

Note 8 Paul Krugman: “On Inequality Denial”, NY Times, Monday, June 2, 2014, p. A17.

Note 9 Paul Krugman: “The Conscience of a Liberal”2007; Joseph E. Stiglitz: “The Price of Inequality”2012

Note 10 Some skills and professions will continue to be in demand, offered by owners of intellectual capital; at the same time the number of unemployables, those without intellectual capital, will inevitably grow. -- In my view the primary problem with the superrich is the superpower they wield in setting the political agenda. The problem of inequality is more broadly based: on the fortunate side are the owners of intellectual and physical capital; onto the unfortunate side go more and more unemployables; and the middle is progressively disappearing. In my view not only do we need to reduce excessive concentration of wealth and power at the very top, we also need to increase more broadly the sharing in the benefits of our productive economy across society with all who become structurally marginalized. Who will have to pay for it, i.e. to share their benefits? According to a recent CBO report on incomes (http://www.cbo.gov/sites/default/files/cbofiles/attachments/10-25-HouseholdIncome.pdf), the top 1%  earners take 21 % and the top 20% earners take 55% of all income.  (70% of the one-percent-group are managers and professionals from medicine, law, and finance; a group whose earnings clearly are derived from their intellectual capital.) Wealth is even more concentrated at the top than is income: the wealthiest 0.1% owns more than 20% and the upper 10% owns about 75% of the total wealth of the nation (E. Saez and G. Zucman, 2014 slide presentation, http://gabriel-zucman.eu/files/SaezZucman2014Slides.pdf). --  Increasing welfare rolls are inevitable, but every effort should be made to combine welfare  subsidies and new employment opportunities. To this end we need to reduce working ours, make education at all levels accessible to all, and make public investments to provide incentives to create new jobs where the new economy on its own shows at best limited growth. (Note that Google’s 2014 financial estimates forecast $40 Billion revenue and 50 thousand employees; this indicates excellent productivity of $800k per skilled employee, but does not describe an engine for broadly based job creation. In May 2014 there were 135 million employed Americans [http://www.bls.gov/news.release/empsit.t05.htm] who will produce  a GDP of $17 Trillion, or $126k per employed person.) --The principal areas to address with new public incentive investments are: renewable energy, infrastructure, environmental cleanup and protection. Maybe a new new-economy can be thus created, but even then the employment prospects of the unskilled and skill-mismatched are dim and their support by the social state will be required.