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More Problems With Piketty

In my most recent column in the Pittsburgh Tribune-Review, I highlight yet other problems with Thomas Piketty’s narrative of inequality.  In particular, here I focus on some aspects of Piketty’s faulty understanding of the economics of executive compensation as well as of the market for corporate control.  A slice (link added):

Here’s an even deeper mystery: If current patterns of executive compensation serve no purpose except to enrich unproductive corporate oligarchs, what explains the rising market value of the capital that Piketty believes to be the central driver of increasing wealth inequality? Piketty doesn’t ask this question because, for him, wealth perpetuates itself. It grows automatically.

In reality, of course, wealth doesn’t grow automatically. Although Piketty is blind to this fact, wealth must first be created and then carefully, skillfully and continually nurtured if it is to grow. Therefore, if Piketty’s peculiar “theory” of executive compensation were correct, corporate boards’ inattention to the productivity of their management teams would cause the market value of corporations to plummet. Capitalists and the masses both would sink ever more deeply into poverty.

Fortunately, neither the rich nor the rest of us are suffering any such lamentable impoverishment.

Had Piketty examined more carefully the empirical literature on executive compensation, he would have discovered that this compensation is indeed tied closely to managerial productivity. As University of Chicago professor Steven Kaplan reported last year in Foreign Affairs, when he and co-author Joshua Rauh analyzed 1,700 firms they “found that compensation was highly related to performance: the companies that paid their CEOs the most saw their stocks do the best, and those that paid the least saw their stocks do the worst.”

I’m grateful to University of Chicago law professor Todd Henderson for reminding me several weeks ago of the work by Kaplan and Rauh.

In November 2011, Russ talked with Kaplan at EconTalk.