Friday, 30 May 2014

Piketty, the 0.1% debate and the backdoor return of class warfare

Recently economists got very excited by a book on wealth inequality (Piketty, 2014), which reminded me of how economics is still mostly an ideological debate and how far it is from being the queen of social sciences.

We see again the old left wing anti-capitalism rhetoric and its denial by the traditional adulation of the rich by the usual ass-kissing right wing. Economics can claim to be the science of many things, but apparently it is unable to be a science of common sense.

If economists relied more on common sense, they would immediately realize that the rise in inequality is hardly news. There has been plenty of studies showing that. Meanwhile, the focus on the share of the top 0.1%, apart from creating an “identifiable” common enemy, tried to create a stereotype equivalent to the XIX century top hat capitalist depicted by Marxists.

Remember that the later began by focusing on the 1%, but probably this group was too large to provide the necessary stereotype. Note also that the debate relies largely on the Gini coefficient and ignored the different weightings that society may put on inter-group income transfers using the metric suggested long ago by Atkinson.

Yet the greatest failure is on understanding why inequality is rising, and the reason may be quite plainly related to the failure to correct a well-known feature of capitalism.

Capitalism is the most efficient economic system ever devised by humankind that replaced a largely hereditary class system (nobility, clergy and serfs) based on predatory (conquest) economics by a system mostly based on social mobility through free enterprise and trade.

Yet, its central feature, the free accumulation of private property has two limitations. On one hand some ventures require large amounts of capital which are beyond individual means and require institutions (such as governments and institutional investors), and on the other hand the law of compound interest would allow such long-living institutions to ultimately own the entire capital stock and self-destroy capitalism itself. As we have shown in this post, the solution to this feature is easily achievable through reasonable levels of progressive taxes and the taxation of inheritances.

We add here that the survival of capitalism should not rely on artificially curbing the return on capital (Piketty’s r/g) or opportunistically expropriate the rich from time to time as some on the left advocate. There may be some reasonable curbing of executive compensation in listed companies where shareholders are basically powerless, but that is a different governance matter.

Let us exemplify with one of the richest man in the world. Would it make sense to have limited Warren Buffett’s wealth? If we had done so, he would not have created so many jobs and profits through his smart investments and society would be poorer without his $300 billion company. However, he is a very wise man and has decided on his wisdom to donate most of his fortune to charity.

Some will dispute whether that is the best use of his wealth. Some would prefer that he had given his money for research, environment, sports, culture or whatever, while others may say that the government should decide, not him.

How the inheritance money should be spent is an interesting question to debate but not relevant to decide whether to like or dislike capitalism or to bring back through the backdoor a destructive class warfare as advocated by Marx.

In conclusion, common sense suggests that governments should exercise moderation on taxing inheritances and give the taxpayers enough say on where governments will spend their wealth. We do not need to go back to the old divide.

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