A (Long) Note on Piketty

by Don Boudreaux on May 5, 2014

in Balance of Payments, Inequality, Myths and Fallacies, Trade

Wonky

Aaron the Aaron does not like my allegation that scholars such as Gary Becker, Armen Alchian, and Ronald Coase had a deeper appreciation of the economic forces at work in society than does Thomas Piketty.  Mr. the Aaron challenges me to “give just one instance” in support of my claim.

In my review of Capital in the Twenty-First Century, which will come out in Barron’s likely sometime in June, I’ll offer many more than one such instance.  But to humor the mysterious (and increasingly belligerent) Mr. the Aaron, I mention one such instance here.  It occurs on pages 297-298 of Piketty’s book; Piketty here is writing about the increase in income inequality in the United States since 1980.

Note, too, that this internal transfer between social groups (on the order of fifteen points of US national income) is nearly four time larger than the impressive trade deficit the United States ran in the 2000s (on the order of four points of national income).  This comparison is interesting because the enormous trade deficit, which has its counterpart in Chinese, Japanese, and German trade surpluses, has often been described as one of the key contributors to the “global imbalances” that destabilized the US and global finance system in the years leading up to the crisis of 2008.  That is quite possible, but it is important to be aware of the fact that the United States’ internal imbalances are four times larger than its global imbalances.

Where to begin?

First, a trade deficit is defined as being a direct result of a series of exchanges between two conventionally identified groups of people: domestic citizens and foreigners.  Specifically, the home country runs a trade deficit during some time period if, during that time period, foreigners sell a greater value of their exports to domestic citizens than domestic citizens sell of their exports to foreigners.  In contrast, changes in the ‘distribution’ of income are not the direct result of any such exchanges between the relevant groups of people (‘rich’ and ‘not-rich’).  To analogize a rising trade deficit to rising income inequality is to suggest that the rising incomes of rich people are the direct result of sales of goods and services by rich people to not-rich people.

Such transactions can and do occur, but the analogy remains too weak to be anything other than confusing.  No one argues that ‘the rich’ are getting richer and the ‘not-rich’ poorer chiefly because ‘the not-rich’ keep buying more and more goods and services from ‘the rich.’  As Piketty himself elsewhere in his book recognizes, the wealth and incomes of ‘the rich’ can rise – both absolutely and relative to the wealth and incomes of the not-rich – by means other than ‘the rich’ selling more to ‘the not-rich’ than ‘the not-rich’ sell to ‘the rich.’  This comparison by Piketty of rising trade deficits to rising income inequality is like a comparison of orangutans to oranges: the two have virtually nothing relevant in common.

Second, ‘the rich’ and ‘the not-rich’ are not identifiable individuals across time in the same concrete way that ‘foreigners’ and ‘domestic citizens’ are identifiable individuals.  Even if there were something necessarily unbalancing about an increasing share of national income “transferred” to (say) the top decile of income-earning Americans – and also something necessarily unbalancing about trade deficits – the analogy remains unrevealing and unhelpful.  The reason is that there’s far more fluidity through time by individuals across income groups than there is across political borders.  Americans do not regularly become citizens of France and citizens of France to not regularly become Americans.

A third and more serious error is Piketty’s acceptance of the notion that a trade deficit necessarily involves a “transfer” of wealth from domestic citizens to foreigners.*  As regular Cafe patrons know, this notion is mistaken.  It springs from a fundamental misunderstanding of trade and of the meaning of international-economic accounts.  Simple hypothetical: Americans buy $50,000,000 of furniture from Ikea in Sweden; Ikea then uses all of this $50 million, not to purchase U.S. exports, but instead to finance the building of a retail store in Newark, NJ.  As a result, America’s trade deficit rises by $50 million.  Yet where’s the imbalance?  Where’s the increased risk of economic calamity or collapse because of this series of transactions?  Americans in the first instance got furniture at prices they found attractive; Ikea then created $50,000,000 worth of new capital in America (its new retail store in Newark); Americans then enjoy more retailing options, greater competition among furniture retailers, and a new source of jobs.  And, by the way, Americans incur no additional debt as a result of this series of transactions and the resulting higher U.S. trade deficit.

If Piketty truly understood the market processes that generate trade deficits, he’d understand that a high and rising trade deficit can very well be good news for citizens of the ‘deficit’ country.  Yet any such optimistic understanding of trade deficits is clearly not in Piketty’s mind.  Although I still have a few more pages of Piketty’s book left to read, I’ve read enough to be quite certain that he does not believe that high and rising income inequality can be good news for ‘the not-rich.’

I can guess why Piketty tossed into his book this inappropriate comparison of a trade deficit to income inequality.  The reason (I’m guessing) is that Piketty accepts the mistaken notion that high and rising trade deficits necessarily represent some ‘imbalance’ in an economy that must eventually generate its own ‘correction.  Piketty argues that high and rising economic inequalities between different groups of people create an imbalance that requires correction.  He likely is trying to appeal to the same mistaken sense that people have that high and rising trade deficits are necessarily a bad development that require ‘correction.’

I do not believe that Piketty is correct about either the sources or the consequences of economic inequality.  But even if all that Piketty says about the sources and consequences of economic inequality is true, his analogizing it to high and rising trade deficits shows, at the very least, that he doesn’t adequately understand the market processes that generate trade deficits.  Yet if he doesn’t adequately understand the market processes that generate trade deficits – if he sees in trade deficits necessarily some ominous imbalance that spells doom if left uncorrected, or if he sees evidence that foreigners necessarily are getting richer at the expense of domestic citizens – then perhaps M. Piketty doesn’t adequately understand the market processes that generate economic inequalities.

….

* I mention here only in a footnote that Piketty is also mistaken to describe rising income inequality as being the result of an “internal transfer between social groups.”  That Piketty uses the term “transfer” here reveals his inadequate appreciation of the fact that wealth must constantly be produced.  Despite some occasional obiter dicta to the contrary, Piketty views wealth production as largely independent of human agency.  For Piketty, wealth might grow over time, but it does so largely exogenously – so that the greater the amount of wealth that is grabbed by, or transferred to, Jones, the less wealth there is available for Smith.

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