In Douglas Adams famous non-fiction series on galactic economic history, “The Hitchhiker’s Guide to the Galaxy”, we are presented with a description of the tragedy of the planet Frogstar B.
On Frogstar B, for a time shoe production increased faster than the rate of overall economic growth. As a result, with time, shoe production became a larger and larger fraction of the economy, until finally the Shoe Event Horizon was hit, at which point nothing but shoes could be manufactured, and lacking any other goods or services, their civilization collapsed.
Thomas Piketty’s “Capital in the Twenty-First Century” describes a similar tragedy that lies inevitably in our future, the point at which the only economic activity left is investment, all money is held by a tiny minority of wealthy people, and our civilization permanently ends.
Will we be wise enough to learn from the people of Frogstar B, and place a heavy tax on capital before our doom is reached?
I hope not, because of course Douglas Adams was writing comedy, not an economic history. Sadly, Piketty appears not to be a parodist, and presents the claim, in all seriousness, that something like a Shoe Event Horizon, in this case the Investment Event Horizon, could actually happen.
Normally, I would ignore such a book, but numerous commentators (all of whom, by strange coincidence, were already enthralled by the idea of expansions state power) have responded to Piketty’s call for heavy wealth and income taxation with rapturous reviews, driving Piketty’s work to the center of much of our current political discussion.
It is therefore, sadly, our duty to seriously to consider his arguments and the effects of his proposed remedies…
It is, of course, certainly the case that for limited periods of time all sorts of industries grow faster than the overall rate for the entire economy.
Mobile phones, for example, have been produced in increasing numbers for some time now, but I see few books on the market worried about the future in which our starving children, fed only on mobile phone casings, go naked but for mobile phones glued together into crude garments.
We see little hand-wringing about this because the proposition is so patently ridiculous — even a small child could tell you that this tragedy or the Shoe Event Horizon could not happen.
People demand some product or service in increasing amounts as a share of the economy only for brief periods. Economics teaches us that every marginal unit of any good is valued less. A man with no mobile phone might want one, but a man with two might find a third uninteresting regardless of the price, and certainly no one but a mobile phone dealer will have a use for fifty. People eventually want to buy other things, and the market for mobile phones, shoes, or anything else will stop growing long before it consumes the entire economy.
Piketty, however, seems to have forgotten this.
Piketty’s argument amounts to this:
1) The rate of return on investments is higher than the growth of the entire economy.
2) Therefore, if we do nothing, wealthy people who have more money to invest will eventually own almost everything.
3) Therefore, we need high income taxes and wealth taxes to prevent people from investing too much.
We may call (2) the Investment Event Horizon, the point at which all money is held by rich people, and all economic activity consists of investing. (Piketty would doubtless call this an unfair caricature, but I don’t think it is.)
Note also that, although it is never stated, a central assumption made is that (1) will remain true without limits, regardless of how much investment capital is present in the economy.
Others have noted, correctly I think, that Piketty’s heavily touted research in his book is of poor quality — the numbers he gives are often simply incorrect — but I would like to stipulate them for a moment, because the claims he makes on their basis would be ridiculous even if they were correct.
Let us suppose that Piketty is approximately right, and that at some points in history, perhaps even for very long stretches, the rate of return on investment has been higher than the growth rate of the overall economy.
The rate of return on investment is not an arbitrary number. It is a price discovered in the market. It comes about because of a supply curve for investment capital and a demand curve for investment capital.
The supply curve is the result of a large number of people trading off their time preference for spending now versus their desire to have more things later. They could spend their money now on vacations or fancier food, or they could save it, invest it, and hopefully have more to spend tomorrow. (We say “hopefully” because all investment in a truly free market entails the risk of loss.) The higher the rate of return, the more capital will be supplied.
The demand curve results from the mass of people who want investment capital so they can grow their businesses. They know that they have factory production machines they could build, airplanes they could construct, office towers and apartment buildings to erect, and other capital goods, if only they had the money with which to do it.
At some point, the two curves cross, resulting in a price. As I noted, this is not at some arbitrary point. The more capital you have in the economy, ceteris paribus, the lower the rate of return. If a larger and larger amount of capital is chasing the same number of businesses that want investments, eventually the rate will go down.
(Indeed, the Pikettian tragedy is, on its face, ridiculous — consider simply that in this terminal state the whole economy is the liquid capital for practical purposes, and it cannot grow faster than itself.)
Looked at another way: the reason rates are generally relatively high is that there’s loads to invest in but relatively little liquid capital available — if we add capital without limit, how would high rates of return be sustained?
Indeed, a high rate of return is a way that the system conveys information to potential savers and investors, telling us that the economy could grow faster if only people invested more in capital improvements. As more investment capital appears, of course, the rate will drop.
And here we come to the central problem. In essence, Piketty is confusing a signal that we have too little capital investment for evidence that capital investment must be prevented — an astonishing inversion!
Of course, we live in a society where state policy already heavily discourages savings, which are the source of capital investment. In the United States, the Social Security Ponzi scheme absorbs 12.4% of an ordinary worker’s income, thus reducing the amount they can save by a quite significant amount, and the same system tells the worker that they will be provided for in retirement even if they don’t save, reducing the necessity for saving. The Federal Reserve is currently in the midst of an orgy of money printing (dubbed “Quantitative Easing” by their staff euphemists), the proceeds of which are used to synthetically drive down long term interest rates, which also discourages savings. (There’s much more, of course, but these are two representative policies.)
However, it is not sufficient, according to Piketty, to discourage savings in this piecemeal manner. He insists that we must make it our deliberate state policy to punish investment and raise people’s time preference — that is, to encourage the wealthy to spend now rather than investing. I wish I was being metaphorical here, but this is literally what he demands.
Say you are a high salary earner, and you are going to earn some fixed amount in salary over a lifetime regardless of the decisions you make about savings. Say that you could choose to
a) save as much of the money as you can, where it would not only earn income for you but also be employed making capital improvements that increase overall productivity, and then leave the money to your heirs,
or
b) blow the money on champagne and caviar and expensive vacations, saving only the minimum you can to avoid discomfort.
Piketty will punish you for (a) and laud you for (b) — (a) will get you subjected to the Pikettian wealth tax, (b) will not. The Pikettian wealth tax is precisely an attempt to increase time preference, to get people to blow their money now rather than invest it and have more of it later. The motive is precisely that he sees rate of return on investment as too high, and is precisely to discourage people from building up the infrastructure that makes our society wealthy.
Now let us consider the consequences of encouraging people to blow their money now instead of keeping it around for later.
It is not by accident that we are wealthier than people who lived hundreds of years ago. Over time, people have worked hard and have saved the surplus over their current needs. This allowed them to invest in capital goods, such as better and better factory equipment, transportation equipment and the like, and we have put these things to use improving labor productivity, to the point where even in the last few decades our society has become dramatically richer.
When I was a child, even middle class families darned the holes in their socks, while today, even the poorest members of society simply throw socks that develop holes away, because the ratio of the value of a sock to an hour of labor has plunged so far that it is no longer worth your time to repair them.
Piketty, however, would like to discourage the sort of steady accumulation of investments that have made everyone so much better off with time. He does not wish to punish people for being wastrels, rather he wishes to punish them for not being wastrels.
This is the most corrosive possible idea, and I cannot see how it would fail to seriously harm the world’s poor, who, having little surplus income of their own, depend on the investments made by those with the capacity to save. Without that accumulated capital, there can be no cheap clothing, no cheap food, no cheap medicine, since all these things depend critically on increasing capital accumulation, not on punishing it.
If I might be so bold, he is, in short, asking that we make the entire world look like his native France, a society where nice vacations and fine living have become a priority for working professionals over savings, and where entrepreneurship is both looked down on in society and punished by the tax code. Wealth taxes and regulation have long since caused France’s educated population to conclude that government jobs are the safest refuge, and that a month in the countryside now beats saving money that will simply be seized by the state or inflated away later.
The result in France has been decades of essentially zero economic growth there and increasing desperation for the poor — and Piketty would seemingly want the rest of the world to adopt this model, in the name of “reducing inequality”.