Wednesday, April 23, 2014

Tyler Cowen Skewers Thomas Piketty

Tyler Cowen has taken to the pages of Foreign Affairs to review the Amazon #1 best seller Capital in the Twenty-First Century by Thomas Piketty.

Cowen does a very decent job in the review of touching on many problems with Piketty's book, though one has to be a careful reader of the review, since Cowen sprinkles praise on Piketty throughout. It does take a while to catch on to Cowen's game, but at a point it becomes clear that every time  Cowen writes that the book is important, he is about ready to unload on Piketty.

Here are a couple of examples:
Every now and then, the field of economics produces an important book; this is one of them...

Piketty derives much of his analysis from a close examination of an important but generally overlooked driver of economic inequality: in contemporary market economies, the rate of return on investment frequently outstrips the overall growth rate, an imbalance that Piketty renders as r > g....

Piketty expertly narrates the story of how that gap has played a major role in economic history since the dawn of the modern era...

Yet there are flaws in this tale. Although r > g is an elegant and compelling explanation for the persistence and growth of inequality, Piketty is not completely clear on what he means by the rate of return on capital. As Piketty readily admits, there is no single rate of return that everyone enjoys. Sitting on short-term U.S. Treasury bills does not yield much: a bit over one percent historically in inflation-adjusted terms and, at the moment, negative real returns. Equity investments such as stocks, on the other hand, have a historical rate of return of about seven percent. In other words, it is risk taking -- a concept mostly missing from this book -- that pays off.

That fact complicates Piketty’s argument.

and this

 Piketty’s focus on the capital-to-income ratio is novel and worthwhile. But his book does not convincingly establish that the ratio is important or revealing enough to serve as the key to understanding significant social change. 

The most curious paragraph in Cowen's review is the last. After doing a decent job of destroying Piketty's book, including his interventionist proposals, Cowen ends by making a a number of  interventionist policy recommendations, himself. He writes:
A more sensible and practicable policy agenda for reducing inequality would include calls for establishing more sovereign wealth funds, which Piketty discusses but does not embrace; for limiting the tax deductions that noncharitable nonprofits can claim; for deregulating urban development and loosening zoning laws, which would encourage more housing construction and make it easier and cheaper to live in cities such as San Francisco and, yes, Paris; for offering more opportunity grants for young people; and for improving education. Creating more value in an economy would do more than wealth redistribution to combat the harmful effects of inequality.

The first problem with this is that after trashing Picketty throughout the review for his attempts at promoting equality, Cowen here buys into the idea of reducing inequality as a worthy policy goal. Murray Rothbard warned about this:
In no area has the Left been granted justice and morality as extensively and almost universally as in its espousal of massive equality. It is rare indeed in the United States to find anyone, especially any intellectual, challenging the beauty and goodness of the egalitarian ideal. So committed is everyone to this ideal that "impracticality" — that is, the weakening of economic incentives — has been virtually the only criticism against even the most bizarre egalitarian programs.

From there, Cowen, in that final paragraph, goes on to suggest great meddling of different kinds, just more to his taste, such as the establishment of sovereign wealth funds. Cowen's forms of meddling, of course, distort the economy, just as Picketty's policies do. And so, in the end, we learn that while Cowen, when he is inclined to do so, can shoot down meddling policy proposals, he, at the same time, can be an advocate of meddling policy proposals that tend to be looked upon more positively inside the Beltway.


  1. -- Piketty is not completely clear on what he means by the rate of return on capital. --

    Of course not, because Piketty automatically regards *capital* as a single isomorphic whole and not as a structure with different types of capital, in order to give his r > g any semblance of coherence.

    -- Piketty is not completely clear on what he means by the rate of return on capital. --

    I don't think so. I see it as a sham. There's no economic reason to think that such an aggregate metric as "growth rate" has any meaning or that comparing it with the return on investment means something. It does, however, serve to surreptitiously make an envy-based argument by showing how much the capitalist is sucking from the overall economy, as the "r > g" ipso facto implies a zero-sum game.

    1. Below are highlights from a Bloomberg Story detailing the recent surge of leveraged recaps by the big LBO operators. These maneuvers amount to piling more debt on already heavily leveraged companies, but not to fund Capex or new products, technology or process improvements that might give these debt mules an outside chance of survival over time.

      No, the freshly borrowed cash from a leveraged recap often does not even leave the closing conference room—it just gets recycled out as a dividend to the LBO sponsors who otherwise hold a tiny sliver of equity at the bottom of the capital structure. This is financial strip-mining pure and simple—-and is a by-product of the Fed’s insane repression of interest rates.

      The ultra-junk paper which funds these leveraged recaps is bought for one reason alone: money managers are desperate for yield and as the cycle nears its peak, they simply close their eyes and buy bonds that have an overwhelming chance of default. They then comfort themselves with a wholly specious financial figure called the current default rate which presently happens to be running under 2%. It was also running under 2% in 2007 and in 1999 and in 1990!

      Each time the Fed sponsored financial bubble eventually burst. Then junk bond prices cratered, yields soared and default rates reached double digits levels. In fact, we are now on the cusp of the fourth junk bond crash since 1989. Needless to say, these now well-choreographed cycles of boom and bust would not occur on the free market.
      PE Firms’ Dividend ‘Epidemic’ Intensifies Junk-Debt Alarm

      Borrowers including Madison Dearborn Partners LLC’s mobile-phone insurer Asurion LLC obtained almost $21 billion in junk-rated loans this year to enrich their owners, the most in seven years, according to Standard & Poor’s Capital IQ LCD. Some of the least-creditworthy companies are even selling notes that may pay interest with more debt, which BMC Software Inc. did for its $750 million payout to a group led by Bain Capital LLC.
      With defaults by the neediest U.S. borrowers approaching record lows, buyout firms are taking advantage of the Federal Reserve’s (FDTR) easy-money policies to extract payouts by piling more junk debt onto the companies they own.

  2. Thus Cowen once again proves the aptness of his blog's name (marginal in the non-technical sense of being "barely within a lower standard or limit of quality"). His prescriptions are marginally better than Piketty's.

  3. How is this Piketty? 7? What a moron!

  4. Cowen : we are both interventionists but my intervionism is better than your interventionism