Like-minded thinkers: Thomas Robert Malthus (13 February 1766 — 29 December 1834), English cleric, scholar, and economist; and Thomas Piketty (7 May 1971 — ), French economist
Photo Credits: Wikimedia Commons / John Linnell (1792-1882), and Wikimedia Commons / Gobierno de Chile

Discussing blogging recently  with a couple of high school interns brought to mind the French economist Thomas Piketty, and how much his ideas on income inequality have been seized upon by the political Left to justify further state intervention into the economy. Inevitably, the conversation also brought thoughts of the eighteenth century economist whose thinking Piketty is, consciously or unconsciously, emulating: Thomas Malthus and his Iron Law of Wages.

Thomas Piketty and His Ideas

I keep hearing Piketty’s name  raised in defense of the idea capitalism is rigged to distribute the economy’s output inequitably in favor of the rich. For this reason I would like to draw notice to the similarity between Piketty’s thinking and Malthus’, and why they are both ultimately wrong.

Piketty’s main thesis is that as capitalism has historically developed, the returns on investments, especially stocks and other capital investments, have increased faster than the growth of the GDP in most nations. As explicated in his 2013 book Capital in the Twenty-First Century, the result has been a growing concentration of wealth, with this inequitable distribution of wealth and income triggering social and economic instability. A primary part of his argument is that economic inequality is not an accident but a central feature of capitalism. If the rate of economic growth is low, then he argues wealth accumulates more rapidly through investments than from labor. In such a situation those who hold stocks and other forms of capital ownership such as real estate will garner out-sized shares of the national income. Holders of capital will naturally invest it to maximize their gains.

In Piketty’s opinion, the process can be reversed only if the wealth, not merely the income, of the very wealthy is taxed away by government. His own proposal is a global wealth tax of up to 2%, together with a progressive income tax with a top marginal rate of 80%. Then, government can redistribute the wealth through a multitude of mechanisms, such as a universal basic income welfare program.

Before we take a look at some of the criticisms of Piketty’s view of reality, let us examine the similarities of Piketty’s views on income and wealth inequality with Malthus’ Iron Law of Wages.

Malthus, Ricardo, and The Iron Law of Wages

Although the Iron Law of Wages  is often credited to Thomas Malthus, the historical record is that Malthus and his friend David Ricardo mutually worked out the basic mechanism in interaction. There are some, such as the economist John Kenneth Galbraith, who give Ricardo the greater credit due to

his more developed ideas about wages and other factors of production. The phrase “Iron Law of Wages” was never uttered by Malthus or Ricardo, but was first used somewhat later in the mid-nineteenth century by the German socialist Ferdinand Lassalle.

Ricardo developed what he called his “corn model” to predict changes in the output produced by the various factors of production, as well as changes in those factors themselves: wages, profits, interest, and rents (Reference [E1], chapter 4). In his model, workers were just another factor of production, to whom their employers had no interest in paying more than subsistence wages. If the employers paid more, workers would just have more children, producing an increasing supply of new workers. The increased supply would then drive the price of labor, wages, downward. The tragic Iron Law of Wages was that in the long run workers would receive enough wages to sustain their lives, no more.

Now, the Iron Law of Wages is significantly harsher and more brutal in its implications than Piketty’s income model, but if you think about it, they are both based on substantially the same idea. The owners of capital, the means for producing wealth, are driven by market forces to give the minimum wage possible to their employees. This maximizes the returns of the owners while minimizing the income of the common folk, driving an increasing inequality in wealth between the masses of ordinary people and the very rich.

Yet, when we look around at the economically developed world today, the masses quite evidently do not live on subsistence wages (even though it might feel that way to many!). Something has gone very wrong with the Iron Law of Wages. Could that same something or somethings be invalidating Piketty’s model?

Where Piketty, Ricardo, and Malthus Go Wrong: Why There Is and Must Be Inequality In Income and Wealth If There Is To Be Economic Growth

Looking at the claim following the colon  in the sectional title above, you might think I am conceding the argument to Piketty and his fellow socialists. Bear with me. Piketty says the increasing economic inequality is irreversibly driven by capitalism. However, what we can see around us argues that economic inequality is limited by market forces, and can become severe only with the interference of the state. In what follows, I will attempt to justify this claim.

Thomas Piketty’s work has been criticized by some for mathematical errors, caused by not taking factors such as depreciation of capital into account. However, there have been a plethora of other criticisms, some even coming from non-neoclassical economists such as the eminent Keynesian economist Larry Summers. I particularly like Summers’ criticism, which has to do with the diminishing returns of investment in a highly-developed economy close to equilibrium. Let us consider a few of these criticisms.

1. Labor as a scarce economic commodity:  Interestingly enough, David Ricardo himself identified an important market force that would keep the Iron Law of Wages from working at all, so long as investments, increasing technology, or some other factor caused economic growth to continue. Skilled labor itself is a scarce economic commodity, and companies will bid up wages to attract skilled labor away from other companies. This same factor creates a limit to income inequality arising from profits from capital investment.
   
   In addition, most modern industrialized countries have gone through the demographic transition from high birth and death rates to low birth and death rates. In such societies, no longer needing large numbers of children to provide a kind of “social security” in old age, an income increase does not translate automatically into an increase of procreation and a larger supply of labor. This fact limits both Piketty’s income inequality and the Iron Law of Wages.
   
   
2. Diminishing Returns of Investment:  Large returns for new investment occur only in a dynamic, robustly growing economy. In slowing economies with low economic growth, such as Piketty postulates, the incentive to invest more capital decreases as returns on investment fall. If owners of capital do not enjoy capital gains, their tendency is to dissipate their wealth. The historical record is that 70% of rich families lose their wealth by the second generation, and 90% by the third. In addition, a  study by sociologists Thomas Hirschl of Cornell University and Mark Rank of Washington University has shown that Americans on average reside in many different income brackets during different parts of their lives. For example 70% of the population will be within the top 20th income percentile for at least one year; 53% will be within the top 10th percentile of income; and 11.1% will be in the much-discussed 1% for at least one year of their lives. It would seem the fabled 1% is a moving target, and is fabled indeed. This clearly places a limit on Piketty’s mechanism for income inequality.
   
   
3. Wealth is not necessarily the same as capital goods:  Piketty is concerned primarily with wealth in the form of capital goods that constitute the means of production. The German economist Stefan Homburg has criticized Piketty for equating wealth with capital, as wealth also includes land and other natural resources. [Homburg, Stefan (2015). “Critical remarks on Piketty’s Capital in the Twenty-first Century“. Applied Economics. 47 (14): 1401–1406. doi:10.1080/00036846.2014.997927.] Homburg argues that much of the increase in wealth over time cited by Piketty comes not from an increase in capital goods, but from rising valuations for land. The Keynesian economist Joseph Stiglitz agrees with this point of view, saying that “a large fraction of the increase in wealth is an increase in the value of land, not in the amount of capital goods.” 
   
   
4. Wealth inequality is not the most important issue:  A different kind of criticism from Martin Wolf and his colleague Clive Crook is that wealth inequality is not necessarily a bad thing, but certainly not the most important issue about which we should be concerned. Concerning this, Crook wrote:
   
   

   Piketty’s terror at rising inequality is an important data point for the reader. It has perhaps influenced his judgment and his tendentious reading of his own evidence. It could also explain why the book has been greeted with such erotic intensity: It meets the need for a work of deep research and scholarly respectability which affirms that inequality, as Cassidy remarked, is “a defining issue of our era.”
   
   Maybe. But nobody should think it’s the only issue. For Piketty, it is. Aside from its other flaws, “Capital in the 21st Century” invites readers to believe not just that inequality is important but that nothing else matters.

These are just a few of the most important criticisms. Expanding on the very last point, we should observe that a degree of wealth inequality is absolutely essential for economic growth, whether the economy be capitalist, socialist, or communist. The need for inequality stems from a requirement for an unconsumed surplus (i.e. savings) to be used for investments. Without investments, economic growth can not materialize. In the case of socialist and communist states, the surplus is absorbed by the state, which performs the necessary investments. In the case of capitalist countries, most of the wealth of the very rich goes into the needed investments.

I have argued in The Actual U.S. Distribution of Wealth Today that the rich have demonstrated a particular aptitude for allocating economic resources for the benefit of the economy. The proof is they have actually made profits on their investments. The capital they have under their control is used by investment for the benefit of society, not primarily for their indolent consumption. The record of socialist and communist governments (see the posts Historical Lessons on Economics and Politics, More Historical Lessons From Europe, and Lessons From The Developing World) is not nearly so good.

The ideas of Thomas Piketty are filled with errors. Not the least of these is that we do not need income inequality for our economic well-being, which we most certainly do to some degree. In the improbable case a free-market economy approaches an equilibrium where GDP neither grows nor contracts over a long period of time, we can expect the market mechanisms in the second of the criticisms of Piketty in the list above to equilibrate wealth among the population.

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