The media buzz over Thomas Piketty’s Capital in the Twenty-First Century is dying down, replaced by media buzz about a musician marrying an heiress and Stress Test by Timothy Geithner, the equivalent silliness for the rest of us. The chatter from ill-prepared journalists and pundits is being replaced by more substantive discussions from people who have actually read the book and comprehended what they were reading. One such reader is Yves Smith at Naked Capitalism, here, and here.

Piketty’s argument is that as long as the rate of return to capital exceeds the rate of growth in the economy, there will be an increase in inequality. He produces a vast amount of data on these numbers, based on the information provided by a number of different sources from different countries at different times. Then he gives us a series of graphs which show the history of this relationship, expressed by the ratio of capital to income. Some of the graphs show the ratio of private capital to total national income, and some show the ratio of total capital (including that held by the country less the debt of the country) to the total national income. The graphs help us to see that when the rate of return to private capital is greater than the amount of growth in the country, inequality of wealth increases, and when the rate of return to capital is less than the rate of growth, inequality decreases.

There are assumptions and definitions behind these graphs. One is that growth has two parts: increase in population, demographic growth; and increase in output per capita, productivity growth. P. 72. Others are harder to find and describe, because they are buried in the development of the data. This is the basis for the criticism done by the Financial Times, followed by instant analysis from others, here, and here, and here for example. For what it’s worth, I’m in the so-what category; the issues raised in the Financial Times don’t seriously affect the results as far as I can tell, and most of the results in the book are explicitly described as estimates and approximations. See the charts in the last link. I think we should expect to see a lot of work on how to clean up data for use in studies like Piketty’s.

Piketty thinks that the historical rule is that the rate of return to capital exceeds the rate of growth, so that massive wealth inequality is the usual state of things, interrupted only by cataclysmic disruptions, like world wars and world-wide depressions, and by massive legislative and social changes that reduce the rate of return to capital. He points to the historic fact that the rate of return to capital has been 4-5% for centuries, as far back as we have reasonably accurate records. This fact is difficult to explain.

Smith’s criticism is this:

If a rising capital ratio is inevitable (as his history empirically suggests), and capital markets work the way the neoclassical models says they do, then taxes are the only tool available.

But in interviews I’ve read, he defends himself by saying he’s talked about market imperfections and political institutions in the book. But making many broad general comments is not analysis. His central assertion depends on faith in a general equilibrium model.

As a result, she says, taxes may not be the only solution. Other possibilities would include “financial regulations, anti-trust campaigns, and public financing of politics that could minimize their power and privilege.” Other people think stronger unions would be a solution.

Well, I’m not so sure. It’s certainly true that one reason for the high return to capital is the political power of the wealthy, which gives them the ability to insure the existence of market imperfections. The history of economic growth in the US is rich in market imperfection, including every kind of fraud imaginable and many we haven’t heard about yet, monopoly, extortion, black markets, labor exploitation, wage theft, abuse of the patent system, general destruction of government as an idea, and so on, the list is endless. Why do critics think it would be easier to remove these market imperfections and strengthen the power of the non-rich to get a higher return for their labor than to impose very high taxes on the rich? If their political power is great enough to create conditions for them to maximize their returns, it is certainly great enough to defeat any combination of us rabble.

Further, she argues that in the long run, the rate of return to capital cannot exceed the rate of growth in the economy. That’s more or less true, and Piketty doesn’t deny it. He makes one strong point, that the rates of return to the largest fortunes are significantly higher than the return to smaller fortunes, using college endowments as his example. And just note that for small savers, the rate of return is effectively 0 right now, and is always lower than the return to the rich.

But the larger point is that in the last 200 years, only cataclysmic disruptions have interrupted the rate of return to capital. Taxation of excessive wealth is obviously a better solution.