James K. Galbraith

Shortly after Thomas Piketty’s Capital in the Twenty-First Century became available in English, Jamie Galbraith published a review in Dissent, Kapital for the Twenty-First Century. Galbraith says that the book is a good review of facts, but a bad guide to policy and “not the accomplished work of high theory” that it’s title suggests.

In the first section, Galbraith discusses the definition of capital used by Piketty: any form of asset that can be bought and sold in a society. Galbraith contrasts that with the definition of capital used in neoclassical economics, the dominant form in the US, which is that capital is physical stuff which is paired with labor and used to produce goods and services. This definition enables economists to make up production functions, equations linking wages and profits to the marginal products of labor and capital. Galbraith claims: “The new vision thus raised the uses of machinery over the social role of its owners and legitimated profit as the just return to an indispensable contribution.”

You will recall these ideas about marginal product and marginal utility from Econ 101: companies hire until the marginal contribution from the last worker is effectively zero, because that maximizes profits. This Wikipedia entry shows how easily this stuff turns into equations. US economists love this stuff. Galbraith explains that once we shift to this form, we want to figure out a way to measure things, including capital. Galbraith explains that this is where Piketty fails. He doesn’t value capital correctly.

First, he conflates physical capital equipment with all forms of money-valued wealth, including land and housing, whether that wealth is in productive use or not. He excludes only what neoclassical economists call “human capital,” presumably because it can’t be bought and sold. Then he estimates the market value of that wealth. His measure of capital is not physical but financial.

Galbraith finds this confusing. Maybe it is if you think the entire structure of the book depends on the use of marginal productivity and marginal utility and other marginal stuff, which US economists all do. I don’t think Piketty relies on marginal anything.

Too much capital kills the return on capital: whatever the rules and institutions that structure the capital-labor split may be, it is natural to expect that the marginal productivity of capital decreases as the stock of capital increases. P. 215.

That’s a very mild statement, that seems to reflect what everyone knows. If you are eating ice cream, the first bite is wonderful, and each successive bite is a bit less wonderful. I’m not sure I really taste anything in the sixth bite. But then he adds that capital is extremely adaptable to different uses:

Indeed, the observed historical evolutions suggest that it is always possible – up to a certain point, at least – to find new and useful things to do with capital: for example new ways of building and equipping houses (think of solar panels on rooftops or digital lighting controls”, ever more sophisticated robots and other electronic devices, and medical technologies requiring larger and larger capital investments.”. P. 221

In other words, it might be true that adding another machine or another worker in one business might be less profitable than the previous machine or worker was. However, there are plenty of wonderful new ways to use capital that will do better than adding a machine or worker in that business. There are whole worlds of technology for investment, whole worlds of new ideas, and whole worlds of new ways to exist in the world. The optimism is almost catching.

In another section, he discusses the possibility that enormous US executive salaries are due to the wonderfulness of managers. They earn all the money because their marginal contribution to the profits of the enterprise is very high, due to their marvelous to behold qualities. He shows how stupid that argument is. P. 333. Indeed, a recent study shows concretely that high pay doesn’t correlate with the financial results achieved by the firm. You might recall that the heads of all the failed banks and brokerage firms were making tens of millions of dollars right up to the moment of collapse, and then, of course, they claimed it wasn’t their fault, they didn’t know what was going on in their own businesses.

Marginal theories are not central to Piketty’s analysis of the data. He doesn’t think they explain anything. He thinks capital isn’t subject to marginal limitations in grand scheme of things; instead there are plenty of unimaginable new ways to use capital for productive purposes. I would add that there are also plenty of new ways to extract wealth from the 99%, through reducing public support for education, privatizing roads and airports, allowing monopolies and oligopolies to extract rents (think cable companies and wireless companies) refusing to allow the poor to use the banking system and forcing them into payday loans, check-cashing services and so on. Piketty isn’t using any of this marginal theory to form a model. Instead, he examines it to see if it explains the facts he has unearthed. This is a completely different project than the one criticized by Galbraith.

In Section 3, Galbraith says that the interesting thing about Piketty’s definition of capital is that it allows us to talk about power. “Private financial valuation measures power, including political power even if the holder plays no active economic role. Absentee landlords and the Koch Brothers have power of this type.” He saysPiketty blurs the distinction between socially useful wealth, that is, wealth used in the productive sector, and wealth taken by the rentier. It’s true that Piketty doesn’t rant on about the political power of the richest among us, but he makes it clear that he thinks inordinate wealth erodes democracy and meritocracy. Indeed, he discusses social utility in several places throughout the book, including the epigram at the beginning of the Introduction.

Galbraith claims, as all critics do, that Piketty’s proposals of a tax on wealth is not really possible. He then offers the standard Liberal Democratic answer:

If the heart of the problem is a rate of return on private assets that is too high, the better solution is to lower that rate of return. How? Raise minimum wages! That lowers the return on capital that relies on low-wage labor. Support unions! Tax corporate profits and personal capital gains, including dividends! Lower the interest rate actually required of businesses! Do this by creating new public and cooperative lenders to replace today’s zombie mega-banks. And if one is concerned about the monopoly rights granted by law and trade agreements to Big Pharma, Big Media, lawyers, doctors, and so forth, there is always the possibility (as Dean Baker reminds us) of introducing more competition.

Why is this any less utopian than Piketty’s suggestion? Galbraith doesn’t explain that. He doesn’t explain how the entrenched political and ideological power arrayed against a tax on capital would be any less potent when arrayed against unions, changes in the financial sector, higher taxes on corporate profits, minimum wages and monopolies. It isn’t that these aren’t good things, and it isn’t that I don’t support them, and that they don’t have a great deal of support already. What they don’t do is attack wealth directly. Until that attack is launched and begins to show success, the rest of the program will be dead in the water.