Thursday, May 1, 2014

Capitalism and inequality

Does capitalism increase or diminish economic inequality? Alternatively, is capitalism neutral, neither increasing nor diminishing economic inequality? I know of no economist who argues for the neutrality of capitalism. Karl Marx famously argued that capitalism inexorably increases the disparity between the wealthy and everyone else. More recently, Nobel Prize winning economist Simon Kuznets has argued the opposite, that capitalism diminishes inequality. Who is right?

Thomas Piketty, in his new book, Capital in the Twenty-first Century (tr. Arthur Goldhammer), offers a theory of capitalism intended to resolve that debate definitively. Piketty, who lives and works in Paris, established his reputation as an economist through exhaustive historical studies that demonstrated present levels of economic inequality in the United States resemble those of the Gilded Age, the period of the robber barons that ended with WWII.

Piketty's analysis hinges upon his contention that the rate of return on capital owned by the wealthy generally exceeds the rate of economic growth, which he captures in the formula r > g. Data from the last decade certainly supports his analysis. Many poor and middle class people possess little capital, i.e., they have no investments or savings apart from any equity they may have in their home. Many among the poor and middle class who do have some capital invest that capital in various types of bank or money market accounts, all of which now pay a negative real rate of return (the nominal rate of return is less than the rate of inflation). These people accumulate additional wealth—or perhaps hold their own—only as they are able to save part of their current income.

The wealthy, in contrast, invest substantial amounts of capital in assets that have significantly increased in value even during the last decade's general economic malaise. They achieve positive results by having more capital to invest, using professional money managers to access investment vehicles not generally available, foreign investments, accepting more risk, a tax code biased in their favor, etc. For the wealthy, their rate of return (r) has exceeded the economic growth rate (g). Economic inequality has indisputably increased and it seems likely to continue doing so.

On the one hand, I'm not ready to abandon capitalism. Capitalism, more than any other economic system, promotes economic growth by providing individuals an incentive to take risks and to innovate. While reflecting on Piketty's assessment of capitalism, I read an opinion piece by Matt Ridley in the Wall Street Journal, "The World's Resources Aren't Running Out" (April 25, 2014). Ridley is a former academic, an ecologist, and a member of the British House of Lords. He argues that pessimism about limited resources and the inevitable destruction of the planet's ability to support life resemble earlier, similar claims, such as those of early nineteenth century economist David Ricardo. Human innovation and behavioral changes (e.g., agricultural improvements, birth control, and declining birth rates) altered the assumptions on which Ricardo had based his predictions. Ridley contends that this is likely to occur again, pointing, for example, to the discovery of vast new supplies of natural gas, consumption of which is far less damaging to the atmosphere than is consumption of petroleum.

On the other hand, Piketty's case for the increase in economic inequality is persuasive. Like me, conservative New York Times' columnist David Brooks accepts that pessimistic assessment. ("The Piketty Phenomenon," April 24, 2014) Piketty's admittedly unrealistic ukase is to establish a global tax on the wealthy, which Brooks rightly dismisses. Brooks, to my surprise, advocates a tough inheritance tax and measures that will encourage saving, investment, and innovation. I agree—cf. Ethical Musings' Some thoughts about inheritances. Unlike Brooks, I'm also convinced of the need to situate capitalism within a regulatory structure that will prevent abuses. Without adequate regulation, capitalism easily leads to monopolies (think, for example, of the Standard Oil Trust or disk operating systems), unsafe products (remember the meat packing scandals of the early twentieth century, vehicles manufacturers know are unsafe, etc.), and exploitation of workers (why unions gained traction).

While a utopian community of shared assets appears congruent with Christian ethics, early Christian experiments in socialism failed. More recent experiments based on Marx's economic theories produced disastrous results. Capitalism is clearly the preferable economic system. The challenge, from the perspective of Christian ethics, is to structure through law, regulation, and taxes capitalism in a way that promotes innovation, economic productivity, and care for creation while ensuring an adequate social safety net and preventing excessive economic inequality. The Christian scriptures and tradition support each of those criteria. What the Christian scriptures and tradition do not provide are specifics, which are historically contingent rather than absolutes.

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