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Thoughts On Piketty's Capitalism

I always jump around in reading books and I am doing that with Piketty's Capitalism in the 21st Century. I will not write a review until I finish the book but I already have a few thoughts.

Acknowledging the difficulties in defining "capital", Piketty nevertheless tries to measure it and to make various calculations. He demonstrates reasonably well that there has been a trend toward a greater disparity in the income levels of the top 1% (centile) and the top 10% in comparison with everyone else. He concludes that high income households will save more than everyone else. Over time, their investments will result in an increase in the ratio of "capital" to GDP. This, he argues, will mean that more national income will be used to provide a return on capital over time and less will be used to generate wages. This, in turn, will widen wealth gaps and lead to the emergence of a "rentier" class and a focus on inheritance as the major avenue to wealth. He frequently refers to accounts of the 19th century drawn from Balzac, Austen and other writers and suggests a reversion to a depressing period of class stratification and stagnation. The wealthy will exert disproportionate political influence and distort democracy producing a society we may not even recognize. Much like the counterfactual trip taken by the protagonist in "It's a Wonderful Life" visiting a world in which he had never been born, we will travel back to the poorhouses of the Dickens era and the exploitation described by Upton Sinclair.

His premise is largely based on a pessimistic estimate of future GDP growth - although the last few years have established a trajectory which gives some credibility to his assumptions. His data concerning income disparity appears consistent with other observers and is reasonably well grounded in reliable statistical sources. Wealth concentration is notoriously greater than income concentration so that his assumption that the iron law of compounding will produce ever larger fortunes owned by those wealthy enough to reinvest rather than spend the income generated by their "capital" is superficially plausible.

While his thesis is provocative and should set off a vigorous debate, I take exception to his basic thesis for several reasons.

1. Inheritance - His assumption is that wealthy people will leave most of their wealth to their children. Even making that assumption, however, the pace of wealth concentration will still depend a great deal on family size, whether wealthy people marry other wealthy people, charitable contributions and taxes. At the ultra-high end of the wealth scale, there has always been a tendency in the United States for enormous amounts of money to be given away. Piketty mentions the fact that private universities in the US have endowments totaling $400 billion (in 2010 - doubtlessly much higher now) but he doesn't focus on where this money came from. The enormous non-profit sector of our economy is a testament to the proclivity of the wealthy to give away their money. Of course, the examples of Gates and Buffet loom large in our current situation but one need only to reflect on why universities are named "Stanford", "Duke", "Vanderbilt", and "Cornell" to be aware of the important role charitable contributions have played in the development of our excellent private university system. The family size and choice of spouse issues will probably not lead to much diffusion of wealth and the tax issue is, of course, up for debate.

2. Slow Growth - I find it hard to imagine a world in which there is an explosion in the amount of invested capital but growth stays at low levels. It is not hard to think of areas in which capital investment would increase jobs, improve living standards and increase GDP. In the energy area we have enormous opportunities to deploy technologies whose "first cost" is higher than alternatives but whose "life cycle cost" is much lower due to reduction in energy consumption. Presumably, the gushing forth of rivers of capital looking for a home would help solve this problem. Of course, more money would be available for R&D, startups, and business expansion. Almost inevitably, the pace of technological change and therefore productivity growth would be accelerated. The combination of a huge increase in capital and slow growth is hard to imagine .......... unless we assume macroeconomic mismanagement.

3. Macroeconomic Policy - This is an area Piketty neglects. The real problem with an income distribution dumping huge amounts of money on the top centile is that consumer spending will decline as more income is saved and, perhaps even worse, consumer spending will become very volatile because wealthy people engage in more "discretionary" spending which can be cut back suddenly in response to market jitters. This will result in steeper recessions and will mean that financial panics will immediately lead to sharp fall off in demand. If our government is dominated by dunderheads who feel compelled to "balance the budget" at all costs and under all circumstances, then a trip back to the 1930's is on our near term itinerary. However, if Keynesian countercyclical deficit spending is utilized and the government essentially prints more money and hands it out for people to spend unless and until inflation becomes a problem, then all will be well. Put another way, in recessions we should definitely increase transfer payments to those out of work; the smart way to do it is by printing more money but, if the only way we can get the necessary money is to grab it from the "rich", that is probably what will happen.

Piketty appears to harbor a latent hostility to the affluent. In that regard, French history has created a very different dynamic than we experience here. France spent a long time battling over the existential monarchy/empire/democracy debate between 1789 and 1870 and then faced deep divisions leading up to WW2 and culminating in the Vichy Era. Many wealthy people and business leaders "collaborated" in one way or another - often out of necessity (the best customers for industrial products were often the various brances of the German military). After the War, this may have led those involved to be discredited. In the United States, the only real parallel is the occupation of the South between 1862 and 1876 and the emergence of "carpetbaggers" and "scalawags" who allegedly profited by cooperating with an army of occupation. In reaction to this, we got a wave of anti-business populism in the South and an enormous allegiance to William Jennings Bryan.

When Piketty thinks of the 1870 - 1914 period, he thinks of a stratified society throttled by privileged snobs and scarred by the exploitation of labor. When I think of the period, I think of robust economic growth, the emergence of entirely new businesses, all sorts of "rags to riches" stories, and an increasing standard of living. Immigrants arrived and became film producers, retailers, industrialists and, often in a single generation, turned themselves into a new elite. Of course, the reason immigrants came to the United States was that it offered much, much greater opportunities than did Europe. Looking forward, it is vital that we continue to be "The Land of Opportunity".

If we employ macroeconomic policies designed to pick up the slack in demand that may be created when the top centile gets scared and cuts back its spending we will probably be fine. If we don't, Piketty's model may play out and lead to a very ugly future.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.