Wednesday, January 27, 2016

Voting is not a privilege; It is a right – And not a very important one.

First, let me dispose of some issues irrelevant to my subject here. This blog is not about the question of whether or not voter IDs are a good thing, or whether or not a reform of the voting system is desirable and fair. I don’t care so much about this, because I don’t think voting is all that important. But, hey, yes, let’s by all means make sure that voting is accessible to all adult citizens on an equal and transparent basis. Let’s get rid of the dirty tricks, etc.

“Liberals” reading my stuff sometimes see their own issues as my targets, without paying attention to what I am really saying. They allow their presumptions about me to dictate what they think I must be saying. I suppose, given the proximity and media-prominence of the impending election this is understandable, if regrettable. And, indeed, this blog was, in part, inspired by the usual sentiments regarding voting.

For example, It is not correct to claim that voting is a privilege. It is not a privilege. It is a right. And so is the right not to vote. There is surely nothing admirable about voting for the sake of voting when none of the alternatives are desirable to you – especially if they are all equally undesirable. And exercising your right not to vote, to sit on your hands, at least makes a statement to this effect.  So we should stop mouthing this judgmental platitude.

We might be less prone to do so if we realized that in actual fact the right to vote is much, much less important than certain other rights, and not realizing this has resulted in a perversion of our values when it comes to judging domestic and foreign policy. What I aim to establish here is that we accord much too much respect and importance to the establishment of political-democracy and much too little to economic-democracy. The context is primarily foreign policy – the values and principles we try to spread around the word.
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Nothing I say here is original. In fact, it is somewhat chutzpahdick of me to even trot it out again. It is painfully familiar to many – certainly most economists, political scientists, political philosophers, and similar folks. So I beg their forgiveness. It is not, however, familiar to most people. Somewhere along the way in the last one hundred years or so the idea of political-democracy, the right to vote for those who form the government, at various levels, became identified with the very essence of freedom. This is the conventional wisdom today. And it is to the vast majority for whom this appears to be the case that this blog is directed. It is a challenge to the conventional wisdom, an invitation to engage in, perhaps difficult, reflection to consider my claim that what you believe on this is wrong, dangerously wrong.

It is dangerously wrong because this is only one side of the coin. Along with the veneration of the right to vote has come the denigration of the right to trade, to protection of one’s property, the right to spend one’s money as one sees fit, in short, economic-democracy.

Right about now I am in danger of losing a portion of my audience. Seeing these terms about economic freedom, some will conclude that this is a familiar and irrelevant rant from an economic conservative with ridiculous and insensitive claims about the importance of economic freedom. Sad to say these days it takes only a little discomfort with views expressed to provoke people to turn off. I hope you resist this impulse.

Think about it. What really matters most to the majority of the world’s population living in poor or modest economic circumstances under arbitrary and mostly brutal dictatorships? The right to vote for a limited slate of candidates once every now again, or the right to trade, move, spend, read, speak, freely? Of course, you say, the latter, but the former is necessary for the achievement of the latter. No it is not., Not only is it not necessary, it is not sufficient either. The right to vote is not a cause of economic or personal freedom. It is, if related at all, a result, a not-so important result. In other words, if you really care about personal freedom for most people in the world you should be emphasizing the liberalization of the economy – most importantly – the freeing of trade, the opening of closed markets. It is quite simply the attainment of a high degree of economic freedom that is responsible for the achievement of prosperity and the personal freedom that comes with it. Prosperity is impossible without economic freedom. If you don’t believe that find me a counterexample.

A graphic and vital example of this is how the simple process of exchange enriches in so many ways. At its most basic, trade is a positive-sum game in which both parties gain. I give up something I value less for something I values more, so I experience an increase in value. And the person who sells to me gives up something he values less for something he values more (things he can buy with the money I give him). Value goes up for him. By the simple act of exchange for mutual advantage, value is created. Unlike the amount of mass-energy in the world, value can be both increased and decreased. In fact, value can be increased without limit. We call that economic growth. And it begins with simple exchange.

But, exchange, trade, is much more than just that. The process of trade is conducive to many other profound benefits over time. It is provocative of innovation in production, it is provocative of artistic innovation; because of increases in productivity, wealth, value, it is responsible for the spread of literacy (people do not have the time to learn to read or to read when they are devoting all their time to surviving), and of individual reflection that brings one to the realization of what freedom is and how it is to be achieved and maintained. Only then does the right to vote matter much at all. Without a commitment to the fundamental values and institutions that support the achievement of a modicum of prosperity, the  right to vote is not much use at all. To encourage people to think that if they have to right to vote for a government who promises to make them rich they will be free, is the height of irresponsibility when you know that all that said government will do is try to make itself rich at their expense. The responsible thing to do is to help people gain the realization that prosperity comes from the bottom-up in the right circumstances and the best that governments can do is allow it to develop.

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It is simpler than it might seem. Everything flows from basic property-rights. In fact, correctly understood, property-rights encompass all individual rights and individual rights are the basis of freedom. It starts with self-ownership (property-rights over oneself) – individual autonomy. No one should be able to own anyone else. Can we agree on that? Then, by extension (says John Locke) we can assert a right of ownership over that which we create or come by voluntarily trough trade or gift. It is property-rights all the way up.

And this works if and only if such property-rights are sufficiently secure. Ambiguity surrounds human affairs and judgement in ownership disputes is called for. Such judgement must be seen to be fair, equal and universal. In other words, we need abstract rules (laws, customs, norms, etc.) that apply to everyone equally – that is, everyone, the president as much as the peasant (at least in sufficient measure). Rules needs to be apart from the rulers who enforce them. Such a society is said to be governed by ‘the rule of law’ and not by the rule of men (humans).  Where do these rules-laws come from? That is another matter of course, about which volumes have been written. Suffice it to say that they are the stuff of long-term social evolution and consitutionalization. If we are to maintain the kind of freedom we are talking about here they cannot be arbitrary and they cannot be ephemeral. They must be durable, respected in the abstract, not subject to opportunistic tinkering.

To summarize, property-rights under the rule of law is the ticket to freedom, real freedom. That is economic freedom, and it extends to all manner of individual rights, including freedom of speech and expression generally. Don’t touch me and don’t touch my stuff without my permission – applicable to everybody equally. If we care about freedom and about world poverty we should be doing what we can to bring about these social institutions. Not easy, maybe not even possible in most places. But starting with freedom to trade is a viable strategy. Help people to help themselves and they will realize the ingredients of freedom in time.

One other thing. Political freedom without economic freedom is useless – actually a dangerous diversion. If there is no private ownership of resources, or if the latter is not secure, then political freedom is an  illusion at best. No one can marshal the necessary resources to be a viable opposition without private property guarantees. Witness Russia - one sad and prominent example of many.

So when president Kennedy said that the Vietnam intervention was “to make the world safe for democracy” he was way off target, unless he meant economic-democracy, aka, economic freedom. The people of Vietnam today have a much greater measure of economic freedom than they did then, but not so much of political-democracy. And they are much better off. A result of opening up of trade and investment and migration, not a result of war.

And when president Bush proclaimed that an aim of the Iraq adventure was to bring democracy to Iraq, he was equally off target. The proclaimed aim of the Iraq intervention was ‘nation building’. You cannot build a nation by securing for people the right to vote. When they have achieved a measure of freedom the right to vote won’t matter that much. Why did president Bush not embrace the aim of economic freedom? Why does no president put this front and center? Because it is not political expedient to do so. Because political-democracy is venerated and economic-democracy is denigrated. Political-democracy is a false god. It is time to depose this false god.

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This cannot be done solely with an understanding of the importance economic-democracy. One needs, in addition, a sober understanding of the problems that attach to political-democracy in its various forms.

Quite simply, the political vote is a blunt, inefficient instrument for getting what you want as an individual. It is a 0-1 choice for a proposition given to you. More often than not, that proposition is a candidate, the embodiment of a bundle of promises, some of which matter to you some of which do not, and on some of which your candidate has the right ideas (or so he/she says) while on the others he/she is wrong (on your terms).  There is no sense in which you get anything significant of all of what you want to be happy by exercising your vote. Your vote does not even matter. And even if it did, you exercise it once every long period for the confounded package as a whole, not for any of its constituent parts.

What emerges from the political process that we refer to as representative democracy – the political-democracy of our foreign policy pronouncements – is a dictatorship of minority special interests. Politicians are political entrepreneurs who buy votes by promising special favors to economically powerful people who reward them in various ways, legal and extra-legal.  Those who marshal enough power in this way get to dictate to the rest of us about things over which we have no control. The more things are subject to choice by politics, the less choice there really is.
                                                                             
You do not get the yellow tie you want by voting. You do not get the house you want by voting, or the car, or the food you like to eat, or the books you like to read, or most of what makes your life comfortable and meaningful. The dollar vote is a much more flexible instrument than the political vote. Increasing the ability of people to vote with their dollars will ultimately increase the dollars they have to vote with. That is what we should be doing. That is what we should be emphasizing.

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One final word on “inequality”. It’s all the rage right now. Doesn’t the system characterized by economic freedom that I am talking about produce large and unacceptable inequalities between people? The answer to that is not so simple. First, it refers to economic inequality. Equality before the law, equality of individual property-rights, etc. are part of the system. What some refer to as economic inequality are simply the different outcomes of different choices. Presumably there is nothing unfair about that. I will share a secret with you. Academic employment does not pay as much as some other things I might have done. I chose this, was free to choose it, and I earn less as a result. Guess what? I am happier than I would have been earning more in a job I liked less. That is a large part of it.

Yes, but what about really poor people? They don’t have many options at all. True. Their problem is not inequality though. It is poverty. It is not clear that economic freedom does produce more inequality in a meaningful sense. It does produce more diversity of outcomes. Some measures of inequality count this as more inequality. If so, then it is part of the package and not a bad thing. In really poor countries there is inequality of a different kind. There is typically a small proportion of the population, the political elite, that is fabulously wealthy, and the rest of the mass of the population who are all equally, miserably poor. Now that kind of inequality is something to get energized about.

As for us, we can achieve that kind of inequality-equality in the U.S. if we want. We just have to decide whether we prefer to be unequally rich or equally poor.

Equality of outcome is another false god. The ridiculous concentration of the wealth at the very top, notwithstanding the Oxfams of this world’s preoccupation with it, inequality is not the problem; poverty is. And poverty worldwide though still a problem, is at an all-time low.

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Our economic policies, our foreign policies, our social policies, all are bankrupt. But we will not be able to change them until we change the terms of discourse at the very top. 

Sunday, January 10, 2016

Our Debt to Spinoza

I have just finished reading Irvin Yalom's The Spinoza Problem.
I am not inclined to review the book, save to say that while I found it very interesting and learnt a lot from it, I also found it contrived, pretentious and anachronistic. The author is a well-known psychiatrist and much of the substance of the book indulges his psychiatric predilections in an ultimately unconvincing way. Still, the interested reader will definitely learn a lot about Spinoza and about the monster Alfred Rosenberg, the ideologue of the Third Reich, who seems to have had an interest in Spinoza. So reading this book provoked thoughts about Spinoza, his ideas and the time and context in which he lived by contrast with our own time and context. And it is this that I want to deal with here. 
Living in Amsterdam in 1656, Baruch (Benedict) Spinoza was brutally excommunicated by a committee of Jewish leaders and forbidden any kind of interaction with members of that community. For him, one of the greatest philosophers of the Western tradition, indeed perhaps the first 'modern' thinker, it was a disaster. He was caught between his love for his community and his inability/refusal to dissemble about his true beliefs. He was cast into a social wilderness, forever sad and lonely – but not completely so, for he lived the rest of his short life in the stimulating company of like-minded thinkers. But his life as a Jew was over.
Today large numbers of Jews (who knows how many?) hold views that in large part agree with those held by Spinoza and they do not lie about them (not to suggest that they comprehend the profundity of his work). They live comfortably within Jewish communities and participate in communal affairs in many ways according to their choice, according, one supposes, to whatever they feel comfortable with and enjoy doing. Secular Jews have come to revere Spinoza, the Jew, - a prominent street in Israel is named after him.
Meantime these secular Jews are the targets of diverse religious Jewish outreach groups who, far from excommunicating them - which would carry no practical consequences for them - seek to attract them to their congregations; never questioning their beliefs or their right to have them and write and speak about them.
The Amsterdam Jewish leaders got their power from tradition, but, moreso, from the government of the Netherlands. The government that welcomed Jewish refugees from the hell of the Spanish and Portuguese Inquisitions into Holland, was a government that was, in part, driven by religious (Calvinist) laws. They placed conditions upon the tolerance of the Jews and gave their leaders the power to enforce those conditions - among which was the punishment of heresy - indeed the leaders had an obligation to punish it. The Dutch would tolerate Jews, within limits, but not atheists or Catholics. So Spinoza had to be banned. The survival of the Jewish community was seen to depend on it.
Today the survival of these religious-orthodox outreach groups depends on their ability to attract adherents, including non-believers, upon whom they must be careful not to make too many demands. The difference? They have no power and obligation to compel. Religion and state are separate and religious beliefs are seen as personal matters.
It is hard to overestimate the importance of this development - the 'secularization' of society - a development recommended by Spinoza whose thinking contributed mightily to it. Without it the transition from a zero-sum to a positive-sum society might have been impossible.
Is it not this that holds back much of the Islamic world today?


Saturday, October 17, 2015

A free people under siege

I returned yesterday from a wonderful week in Israel where I participated in the fourth biannual Friedberg Economics Institute seminar (my second) at Neve Illan, just outside of Jerusalem.
My friend and colleague Richard Ebeling asked me the following questions. My answers appear below.  
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Since you've been in Israel during part of this new series of violent acts, I was wondering about any thoughts, observations, interpretations you might have of these events.
·         How are Israelis you talked to or saw reacting to this? What do they think (or fear) this may or may not lead to?
·         Do they consider these types of events a never-ending and recurring nightmare,  or is there any  belief (hope) that there is any "light at the end of the tunnel"?
·         Are there any rational, reasonable Palestinians, or is this near unanimous collective madness?
·         Is this making Israelis "hardened" against any deals and compromises with the Palestinians, is there sentiment that negotiations need to be restarted sooner rather than later?
All good questions. My impressions, purely personal, based on my very limited interaction with a small number of people.

Israel is a country under siege without a siege mentality. Soldiers everywhere, but where the civilian ends and the soldier begins is barely discernable. The equivalent of the Pentagon is in downtown Tel Aviv. There is an ongoing conscious effort to try and 'normalize' the life of a soldier as much as is possible. Some people I know in the military wear their uniforms for work only and are critical of the settlements and wary of the threat of Haredi political domination.

As to the stabbings, Israelis try to live their lives unperturbed, watchful but determined. No, they are not at all hardened to the prospect of peace but do not believe in current circumstances that this is a real prospect. Except for the radicals [some of the Haredi and the settler-types] all Israelis desperately want peace. Yes, they see it as a part of a never-ending series of violent strategies to destabilize and ultimately destroy Israel - not a cycle of violence because they do not see these and similar acts as bona fide responses to provocation as suggested routinely in the world media. They are not responses, they are politically orchestrated acts of violence. It would not make any difference if Israel reformed the severity of the checkpoint procedures tomorrow.

They don't see it as a nightmare, horrible as it is, because they have seen worse before and Israel day-to-day is a vibrant incredibly free society. Take your pick of multiple, candid talk shows on any subject, vigorous business activity, construction everywhere, highways, night clubs, shopping malls, technology, art, music, literature, sports, …

Definitely there are many reasonable Palestinians. It is surprising there are not more - there are formidable cultural pressures pushing for uniformity. Polls show that most Palestinians and Israeli Arabs want peace to enable them to get on with their lives and build better futures. And there are forces making for internal tensions. For example, Israeli Arabs who live and work in east Jerusalem get four to five times the pay available on the West Bank, so they are secretly not in favor of unification with the West Bank, and they don't want West Bank Arabs coming into east Jerusalem for obvious reasons. Israeli Arabs are fully integrated into the economy, though sadly not into the broader society. And the Arab members of the Knesset are incredibly hostile to Israel – some moreso than others. None of them condemns the current violence. In this they part company with many of their constituents. It is something of a sad mystery as to why Israeli Arabs continue to elect representatives hostile to coexistence while themselves (many of them) hoping for it.

The on-going, endemic biggest problem is the current Palestinian leadership - status quo bias – directly descendant from Yasser Arafat. Any effective deviation is brutally squashed.

I would describe the current mood as a mixture of realism and hope for the unlikely.

Thursday, October 1, 2015

Once upon a time in the land of Machinea

Once upon a time in the land of Machinea there was a problem The economy was powered by machines produced by different factories and rented by producers. There were those machines that were distinguished by being a bit wider than their substitutes, the W’s. There were those that were distinguished by being a bit bigger than their substitutes, the B’s. And there was a third kind that was atypical, the A’s. Each kind of machine was produced by a number of factories. The largest number were the W’s, then the B’s then the A’s. The machines were difficult to construct and thus there was significant variation in their efficiency – by which is meant their productivity and reliability. Statistically speaking it known that an A was likely to be more efficient than a W or a B, and a W more efficient than a B. As a result, since all they knew about the machines was their type and average efficiency producers were reluctant to hire them at the same rate as the W’s. And since it was frowned upon (and in some place illegal) to pay a lower rent to a B than a W, the likelihood of a B being rented was significantly less than the of a W being rented. The problem that the policy makers wanted to solve was that the rate at which B’s were hired, rented, was too low for their liking. The B factories were struggling to survive.

The proffered solution was to strongly incentivize the machine renters to hire more B’s, that is, to hire more than they would have given their expectations of their efficiency. The reasoning underlying this solution is that the low productivity of the B’s is endogenous, it is a result their low rental earnings feeding back into the budgets of the B factories, which, then, in turn, struggle to produce efficient machines. By intervening in this way, a judicious public policy could break the vicious cycle producing self-sustaining B inferiority. So, they instituted a policy of mandatory affirmative B rental requirements. Each producer had to produce a report showing that his B-rentals were at or above the proportion of B-machines in the market.

Though it seemed like a good idea, albeit at the cost of some inefficiency imposed on the producers and their customers, there were unintended consequences. The managers in the B factories realizing that the likelihood of renting their machines was now higher, regardless of their efficiency, faced a reduced incentive to produced efficient machines, and the quality of the machines actually went down, even as they produced more machines. This raised the hiring mandate under the policy and further reduced the incentive for quality production. So, the policy was actually counter productive and accentuated the negative cycle of B inferiority. The B factories now became wholly dependent on the government to enforce the affirmative rental of their machines.

A minority of policy makers and advisors pondered alternative policies. Perhaps the initial problem lay in a structural defect in many, though not all, of the B factories. These defects were endemic and though not irremediable would require substantial changes in the incentives faced by the B-producers. They suggested policies that would allow B’s to compete by offering lower rental rates, and the scrapping of all policies that deterred the B-producers from making painful but necessary changes.


There were other more wide-ranging policy change suggestions like those that pertain to the inadequate training that B-producers received in their training schools, but these are beyond the scope of this brief. 

Tuesday, September 29, 2015

Happy birthday Ludwig von Mises - Economist Extraordinaire

Ludwig von Mises would be 134 today. The grandson of an East-European (Galicia) cum Austrian rabbi in a rabbinic dynastic family which became prominently involved in finance and was ennobled by Austro-Hungarian emperor. He studied economics at the University of Vienna with teachers from the original Austrian School of Economics founded by Carl Menger. He was always swimming against the stream of political short-sightedness in a turbulent age. He was advisor to the minister of finance in Austria in the inter-war period and helped Austria avoid the ravages of hyperinflation. He was economist to the Chamber of Commerce in Austria and, though always controversial, was quite influential.

With rise of the Nazis, he was personally targeted as they advanced into Austria with the signing of the Anschluss – he was a Jew and a prominent liberal (in the true European sense). He fled literally hours before they arrived for him. After a few years in Switzerland, during which time he wrote his famous Nationale Ekonomie, he was persuaded to leave for the United States (people feared that the Nazis would invade Switzerland). He lived the rest of his life in New York. He remained a visiting professor at NYU for that time. In both New York and Vienna he had weekly seminars. In Vienna these were attended by many of the most prominent scholars of the time. His junior colleague Friedrich Hayek had gone to London in the 1930’s and won the Nobel prize in 1974. Mises died at the age of 93 in 1973. During his years in America he wrote profusely – in English – including the English version of his Nationale Ekonomie, Human Action.

When the Nazis arrived at his apartment in Vienna they packed up his voluminous library, including some of his work and work-in-progress, and put it in storage. Years later my friend and colleague Richard Ebeling, who had married Anna who is Russian, discovered Mises’s library in Moscow – the Russians had shipped it back from Vienna. Richard has now compiled, translated and published three volumes of Mises’s hitherto unknown early papers, which provide a precious account of the economics of the interwar years.

It is hard to overstate the magnitude of Mises’s intellect and his achievements. He was one of the greatest economists ever, and maybe the greatest. For him economic knowledge was indispensable to the understanding of civilization and economic ignorance was more than regrettable, it was positively dangerous, a matter of the life and death of civilization.

"The body of economic knowledge is an essential element in the structure of human civilization; it is the foundation upon which modern industrialism and all the moral, intellectual, technological, and therapeutical achievements of the last centuries have been built. It rests with men whether they will make the proper use of the rich treasure with which this knowledge provides them or whether they will leave it unused. But if they fail to take the best advantage of it and disregard its teachings and warnings, they will not annul economics; they will stamp out society and the human race." (Human Action)




Sunday, September 6, 2015

Against the over-examined life

Reportedly Socrates tells us the unexamined life is not worth living. Aside from the drastic and uncompromising tone, one can easily understand the sentiment, and it has been widely endorsed. Critical self-reflection is to be admired. 

Ok, I agree, sort of. And so does Jewish tradition. Jews are exhorted once a year to take stock of their lives; for ten days to turn their attention to unflinching self-examination, to face up to their own mortality and to rededicate themselves to resist destructive temptations and follow the right path, ending the period with a 24 hour long fast - which makes me appreciate the abundance of nutrition in my life. I will play. 

It occurs to me, however, that many of my cerebral friends and colleagues are in a continual, almost obsessive, state of close self-examination (I include myself). There is an unavoidable element of self-absorption (narcissism) involved. Accordingly I would like to put in a plug against the ‘over-examined life’. There is something to be said for living the way most people do, one day at a time, in the moment, and not to get too hung upon analyzing each and every minute. What would Aristotle say? With this, as with all things, everything in moderation.

Friday, July 31, 2015

Totalitarian Chassidism - my impressions of this book.

Reading this, recently published, book. It is not for everybody. Not likely to be interesting for non-Jewish people, or for those with no interest in Jewish socio-religious matters. For me it is captivating - a page turner. I find myself alternating between sympathy and disgust. It is one man's perspective - declared a heretic and forced to leave the Skverer Chassidic community - a very puritanical community. (His parents were baalei teshuva Chassidim, who lived 'on the edge' of the Skverer community, and he was born into it.) 

I am intrigued and interested in how others with more knowledge than I react to it. Is it accurate of the Skverers? How different are the Satmars and other groups? Or the non-Chassidic groups (at one point he is very dismissive of what he sees as the Litvisha culture). And as far as I have read in the book, Chabad is sort of beyond the pale for all, or most, of these Chassidic groups - totally corrupted and contaminated by goyishe culture, true?

My reflex impression is of a community caught in and struggling to preserve its tribal (clan) mores and rituals that evolved over many years as a response to persistent existentially threatening persecution. And the overall preservation strategy includes ingenious types of insulation strategies - like regarding all those who disagree as 'mentally ill'. It is a horrifyingly totalitarian society in which the most minute and intimate details of personal life are strictly scripted and departures severely punished by shaming. 


And yet, in spite of that the overall approach is remarkably civilized insofar as it is essentially non-violent and, at times, compassionate and loving. It is a model for an earlier more violent age in which it was superior in its treatment of women and dissidents. Today it is just the opposite.

A moving and revealing exploration of Hasidic life, and one man's struggles with faith, family, and communityShulem Deen was raised to believe that questions are dangerous. As a member of the Skverers, one of the most insular Hasidic sects in...

Wednesday, May 20, 2015

Minimum wages, the discussion continues

Ivry Man encounters Dr, Know at their customary meeting place, and raises the issue of the minimum wage in California. They had previously discussed minimum wages here.

IM:
Did you see that Los Angeles has increased its minimum wage to $15. It seems soon the whole of California will follow. Isn’t this wonderful?
DK:
Yes, wonderful. Tell me, why only $15? Why did they not increase it to $20 or $25 or, indeed, $100?
IM:
Of please Dr. Know. That would be stupid. At those prices businesses could not afford to hire all the workers. That is just common sense.
DK:
But at $15 they can? How do you know this?
IM:
I am sure the law-makers must have researched it thoroughly to come up with the right wage level.
DK:
Why on earth my good man would you believe that?

Thursday, May 7, 2015

The Preacher's Dilemma



[helpful FB conversation with Mario Rizzo is gratefully acknowledged.]

In case you missed it, Pope Francis has been offering strong opinions on a number of very different contemporary issues and pseudo-issues, among which are how to respond to the threat of global warming and what to do about the gender pay-gap. Apart from the merits of his arguments, one may wonder how he can think himself competent to “(a) evaluate the science (Imagine that! The Church that attacked Galileo is to evaluate science!) (b) decide what an efficient/efficacious response would be (c) decide the tradeoff between economic growth in the developing world and the use of fossil fuels.” (Mario Rizzo, FB post).

Yet this is so typical. I think of it as 'the preacher's dilemma'. Vestiges of the pre-modern world. The religious leader, like the 'high priest' of old, used to be a powerful, even magical, figure. In a perplexing world of mysterious and dangerous forces, from nature and from other human societies, the religious leader provided a blanket of structure to 'explain' and comfort. The will of the gods was an explanation for both the moral and the scientific questions - there was no Humean divide, between facts and values. It was all part of the laws of the universe known fully only to the gods.

The ubiquity of religious belief in the post-modern world indicates that humans have not quite gotten over this. Incredibly they still look to their religious leaders for guidance on everything - including lots of stuff that these leaders have no knowledge of or business having an opinion about. But, their (the religious leaders') livelihood depends on them having such opinions. Hence the dilemma.

The situation calls on them to engage in a pretense of knowledge. This is not necessarily a charade. The successful religious leader in the modern world  (priest, rabbi, mullah) must possess the conviction that he/she is, indeed, competent to speak on these diverse matters. But having the conviction does not make it so. And it strains the most basic of virtues that a religious leader is assumed to have, humility.

The truth is that religion struggles for relevance in the modern world – especially in the developed countries. This is less true for fundamentalists who retain the pre-modern belief in the infallibility of the revealed word. But they are, certainly in the developed world, a small minority. A growing number of the world’s population either cleaves to no organized religion or else practices a kind of religion that is very different from its fundamentalist predecessors, appearances to the contrary notwithstanding. The advent to two related phenomena has drastically reformed religion as practiced by many, namely, secularism and pluralism. Secularism, the separation of religious authority from the authority of the state, has meant the loss of the power to compel uniformity of religious practice and belief. And this has led to pluralism, the mushrooming of many different religious doctrines that compete for adherents.

In modern free societies, religious doctrines can be questioned, debated, satirized, without fear of state persecution. So religious practice becomes just one part of one’s identity, and is a matter of personal preference, of choice. One is free to exit. In such an environment, religion arguably plays more of a ‘tribal-like’ role in which familiar rituals, literature, music, idioms, shared histories, etc. provide valued support and comfort, both routinely, and, especially, in times of celebration and grief. The charismatic religious leader can no longer appeal without qualification to the infallible word as a source for his pronouncements and exhortations. These congregations do not believe in simple revelation any more. Instead, he must strive, and mightily he does, to establish the continued relevance of inherited religious teachings. For some communities, some of these teachings will just not fly any more, and so, there is a lot of picking and choosing going on – trying to separate the ever nutritious wheat from the decayed chaff.

As I listen to my rabbis I feel a mixture of empathy and irritation. On the one hand I understand their need appear able to offer valuable insight and advice on all matters – psychology, public policy, foreign affairs, environmental policy and, in my case most alarmingly, economics (all fields in which professional specializations exist and indeed are the hallmark of competence). On the other hand, what they say alarms me for its boldness, ignorance and chutzpah. As Donald Rumsfeld might say, they do not know what they do not know – and apparently do not want to know. With some notable and gratifying exceptions, the few opportunities for frank, mutually respectful discussion with them have not been successful. I have not been let in. The façade has proven impenetrable – in most cases I think unintentionally.

I am not sure how much this matters to my fellow congregants. Those who stay presumably don’t care that much. But many do leave for want of credible inspiration from their leaders – in search of  alternatives. There is a ‘market process’ going on driven by ‘product differentiation’. Like all market processes its future course is unpredictable.




Thursday, April 16, 2015

They're baaack.

It is hard for some of us to believe this, but the Neo-Ricardians (NCs) are still with us. In fact there seems to be something of a resurgence. They are still claiming that the phenomenon of reswitching renders the very concept of 'capital' as a factor of produciton meaningless and, that this, therefore, shatters the *entire* foundation of neoclassical economics. How frustrating it is! Not that these ridiculous ideas will not die, but that a whole new generation has now to be taught how wrong and dangerous they are.
The NCs are wrong in a number of ways. 1. they erect a metaphysics of a world in equilibrium and engage in comparative statics - never addressing the question of how actual economies actually work and move from one 'equilibrium' to another. 2. they confuse the price of capital services with the price of borrowing (any kind of service) and call it the rate of interest instead of the rental rate on capital. 3. they never address the fact that billions of people use capital accounting every day and seem to think that capital is a real thing. I could go on.
But perhaps the 'largest' of their errors is to claim that, while the factor of production capital is non-existent, labor is real - in fact what we think is capital is actually (HT Karl Marx) indirect labor. In fact, it is the other way round. It's all capital. All productive services - from human bodies or from machines or buildings or land - are valuable only because they are 'knowledgeable' - they 'know how' to do things that we value - they are 'embodied knowledge' (HT Howard Baetjer Jr.). The simplest and most plausible way to think of factors of production is to think of them as different types of capital - human and physical.

Tuesday, March 24, 2015

Memo to Frank Underwood


Memo to Frank Underwood


Your plan to cut entitlements by $500 billion and use the money to ‘create’ jobs won’t work. 
Why not use it to cut payroll taxes across the board instead?


By Peter Lewin


The consensus verdict on season 3 of Netflix’s House of Cards will arrive in due course. I will leave it to the literary critics to do their thing. Is it art? Is it commentary? Did it hit the target? I am not sure it matters what they say. What matters most to Netflix is how many people watched it and what the prospects are for season 4.
If Frank Underwood is all about getting votes and the power that comes with it, the Netflix writers are about gaining viewers and all that that implies. Think about it. These motivations are not all that different. The viewers are the voters in another guise – or at least they share the same concerns. And more important they share the same presumptions about how to address those concerns.
So it’s a fair bet that the writers are aiming at the concerns and presumptions of the viewers, who are voters in the real world. In other words, what we see in the script acted out on the screen, is a reflection of what the writers think are the concerns of the American public and the presumptions that underlie them. The writers may be wrong or they may be right. And even if they are wrong, if many of the viewers do not identify with the highlighted issues and/or the suggested solutions, it may still make for good entertainment – indeed that is why I continued to watch, even though I was pretty irritated not only by the moral depravity of that world, but also by the grossly false assumptions that its characters hold. I am not sure, however, that I will stay the course for another season. I came away thinking that the script revealed more about the writers than about their intended audience.
For starters consider the central strategic project that runs through season 3, Frank’s inspired America-Works program (AW). AW serves a number of interesting purposes and it plugs into a number of current issues. It serves to separate the protagonist from his fellow politicians and to fine-tune the tension between them. And it provides him the weapon to outflank his rivals as he appeals for votes. To work, it has to be something that the viewers, and the voters, in the story and in reality, will understand. So it must be connected to the issues they actually face in the real world.
At the top of that list of current issues is unemployment, prominent on the current political agenda as we in America struggle haltingly to escape from the lingering recession. The notion of “ten million jobs” needing to be created is very familiar. Then there is the question of “presidential prerogative” and the “separation of powers” of the different branches of government – as in the president decides to do something with money Congress has appropriated for something else – sound familiar? Is this a criticism or a backslap for President Obama’s wild and independent agenda? Take your pick. Certainly, there is the hint of admiration for Frank Underwood’s energetic initiative in working around a pathetically ossified Congress. He is a man of action able to “get things done” when no one else can.
And then, when the hurricane hits (literally), the program falters (though it still serves Frank’s purpose) and the money goes away. What a pity, if only he could have gotten away with it, all those people would have had jobs. And now they are stuck again without work and pay!
Really? Who believes this? Have we really thrown out an appreciation of the necessity for the Congress to check the power of the president to act independently? And, more important, do we really believe that it is government, and government alone, that creates jobs? There is a name for this kind of thinking. It’s called crude Keynesian economics and it was discredited back in the 1970’s and 1980’s before Obama and company decided to recycle it.
Yet, somehow, nobody in Frank Underwood’s world questions his presumptions, not his Democratic political opponents nor anyone from the other side of the aisle, no-one. The writers see no need to have anyone question the presumptions underlying the AW initiative. Nobody points out that the diverted money was going to be spent somewhere else and would no doubt have ‘created’ jobs there. Nobody wonders how AW managers know what jobs to create and whether these are in any way ‘sustainable’. Nobody wonders how the FEMA money was raised in the first place – by taxes that reduce private incomes and private expenditures. Nobody suggests to Frank Underwood that a tax-cut of that magnitude might lead to enough private spending to create jobs where they are most needed in the private sector. No of course not. We all know that these ideas are so yesterday.
Newsflash, there are some Americans, maybe a few, maybe not so few, and certainly some in Congress, who still believe them. So why are they not in the script? I think I know why. Keep reading.
Consider the hurricane. Playing off of Katrina, right? AW gets derailed because in the absence of the FEMA money hundreds (or more) lives will be lost. Really? Don’t the writers know that this is an unintended cruel joke, that the performance of FEMA in the actual Katrina event was worse than miserable, and actually counterproductive, that, plausibly, FEMA’s bungling may actually have caused more casualties than it prevented? And clearly they don’t know that the most effective efforts at relief and revival came from the private heroic efforts of the local communities themselves and, incredibly significantly, from the likes of private companies like Walmart, Home Depot, and others. How inconvenient a truth this is as Heather Dunbar dramatically excoriates Walmart for the low wages it pays its workers. Yet, again, nobody points any of this out. Nobody in the show challenges these presumptions.
And herein lies the explanation. The show is shot-through with what we may call the “accepted assumptions” that set of assumptions that define the current left-liberal way of thinking to the exclusion of any other. Thinking differently is simply impossible for those whose thinking is constrained this way – it never occurs to them to ask what to others seem obvious questions. It is acceptable to hate Walmart and not acceptable to suggest that Walmart is actually a hero. It is natural for them to identify salvation with well-intentioned government programs (even at the hands of the morally bankrupt Frank Underwood) and unthinkable to imagine that better results may occur spontaneously if only we allowed people to go about the business of making as much money as they can. Terms like John Kenneth Galbraith’s “conventional wisdom” or what Conservatives call “political correctness” come to mind. It is an all-pervasive feature of season 3 and, in the end, serves to corrupt the entire structure of the series. The shark is jumped with the writers’ decision to make this season about gender-inequality, the depravity of masculinity and the nobility of femininity. The whole season is really a build-up to Claire’s dramatic, courageous, empowering, and ennobling grand exit – her decision to leave Frank and his depraved male-dominated world, and, in so doing, reinvent herself to become a moral human being, re-born. And this is something the perceptive soulful writer Tom Gates knew all along about Claire.
Even the sub-plot of the Russian-American conflict, with the men needlessly and stupidly confronting each other while pushing soldiers around the world’s chess board, serves to channel Claire’s unlikely conversion. When she finally sees a target that serves her own particular ambitions (UN ambassador) she finds it impossible to act without the manipulating heavy hand of her husband, who helps her in this only as long as it serves his agenda. The nature of their relationship is, to be sure, ambiguous. They serve each other’s needs. Mutual respect and mutual reliance, a hint of real love. Now she suddenly comes to the realization that she is married to a monster? “We are murderers Frank.” Oh dear I have been a bad girl. If only I had not let this nasty man dominate me to serve his wicked ambition. Do you buy this?
Forgive my cynicism. We know from previous seasons that Claire Underwood is a relentlessly driven narcissist who is an accomplice to more than one murder and a slew of other nefarious acts. Prior to this season she displays only dispensable empathy and can be relied on to do what is necessary to advance her and her husband’s agenda.
What drives this is the issue of gender equality – which fits nicely into the accepted assumptions. The writers push it beyond any reasonable bounds. Heather Dunbar, the feminist role model, declares “all aspects of sexism should be illegal.” The presidential debate scene is maybe the most effective scene in season 3. What is it ultimately about? Sexism and the betrayal of Jackie Sharp (a woman) by Frank (a man, the man). Heather Dunbar is a noble woman, who offers Jackie nothing save integrity and authenticity. Meanwhile Jackie, this egotistical, self-serving politico has been getting in touch with her feminine side – discovering the virtues of family and love. So naturally she comes to the realization that the right thing to do is to unite with her “sister” against the man. And Remy Danton? Who would have thought that he would find his conscience. Did it help that he got to connect with the plight of some of the less fortunate? Accepted assumptions wherever you look. The West Wing wins out against Frank Underwood.
And then there is Doug Stamper, perhaps the most interesting character in the story. There is no redemption for him, but at least he is believable.
In short, there is an implicit narrative running throughout season 3 that embodies the writers’ vision and pretty much reflects the narrow presumptions of the Washington elite and the ideological intellectuals who inform them. And like all popular art, it serves not only to reflect but also to inform.

Saturday, March 7, 2015

Israel and Palestine: The real asymmetry

We hear a lot about the asymmetry between Israel and Palestine. David and Goliath. Ironically, in this view, Israel is Goliath – powerful, threatening and oppressive - while Palestine is David, powerless, victimized but defiant. But, this is not the real asymmetry.

Binyamin Netanyahu faces vigorous and unrestrained opposition in Israel, as do all political leaders in Israel. There are hundreds of thousands of Israeli citizens who believe that Israel can and should adopt policies more conducive to peace with the Palestinians and even with Iran. They are vocal and politically active. Over his high-profile speech to the U.S. Congress, Netanyahu faced opposition from 180 prominent military and intelligence leaders (here). These people are all still alive, there is no threat to their persons, their livelihoods or their loved-ones.

How do matters stand in Palestinian society? Where are the hundreds of thousands of people agitating for peace there? Where is just one such person? I believe that they are there. But we don’t see them. They cannot exhort their people to reach-out to the Israelis in friendship without endangering themselves and the ones they love. That is the key difference between the two peoples. That is the real asymmetry. The Palestinians are twice oppressed: once by the Israelis who perceive them as an existential threat and even moreso by their own leaders who deny them basic freedom of expression and dissent, not to mention basic economic freedoms to produce and buy what they choose.

What is interesting to me it how little attention this gets from intelligent observers of the situation. Of what use is it to vilify Israel for its treatment of the Palestinians without pointing to the more fundamental pathologies within Palestinian society? No Israeli politician could long stand against a clear popular call for peace from a solid Palestinian peace movement – that would certainly team up with its Israeli counterpart (in fact, though muted, there are multiple such initiatives). Those who really care about the Palestinians should be targeting their corrupt politicians who would be made obsolete by the establishment of peace and normality with the Israelis. They should be agitating over the lack of civil rights.

I am not naïve. I understand that given current conditions there is no way to meaningfully ‘democratize’ Palestinian society. The leaders are entrenched and will brook no opposition. Any hint of deviation in the direction of greater acceptance and accommodation of Israel (there have been a few) is immediately and firmly quashed. But without such democratization there can be no real peace. 

Thursday, February 19, 2015

Climate change - a quick follow up.

Add this to my previous musings on this question.

HT: Steve Horwitz: Steve suggests we ask the climate alarmists the following question. But don't expect they will give you and answer any time soon.

What would it take for your belief in "climate change" to be falsified?

Do they even have an answer? Is it a null set? Where is the burden of proof?

Thursday, January 29, 2015

Some Puzzles About Brian Arthur’s Views on Complexity


I just finished reading this important paper by Brian Arthur (‘Complexity-economics: A Different Framework for Economic Thought’). I noted my irritation earlier on Facebook that he has no reference to Hayek or any of the Austrians, and wondered how one could write about complexity in economics without mentioning, indeed examining, Hayek’s work. Now that I have read the paper I have a better appreciation of it and think that it is quite well done and is a valuable contribution. Of particular note is the penultimate section, ‘Discussion’ which contains Arthur’s analysis of the place of complexity-economics within economics generally. He provides both methodological and historical perspective. Here is my quick paraphrase of part of that section, focusing on what I find noteworthy.

According to Arthur, complexity-economics is about open-ended systems that are in the continual process of forming and in which the arrival of novelty is on-going. This means that the methods of traditional quantitative economics, concerned mainly with allocation of ends to means in a closed system, and amenable to mathemization, are inapplicable. Other methods have to be found. In particular, time in complexity-economics is real-time as we experience it and not linear, reversible time as expressed in traditional economics. Complexity must deal for example with events that are essentially non-repeatable.

So, while the familiar Marginalist economics (what Austrians call the “pure logic of choice”) has a role to play in economic education it is only one aspect of a much bigger picture, one only now beginning to fully emerge.  In an important way, complexity-economics is close to old-fashioned political economy. There is a synergy between them. “Complexity-economics allows us to explore the world of formation theoretically and systematically; political economy allows us to explore it intuitively and empirically” (17).

So far so good. Quite encouraging. And he does include a passing shout-out to Hayek as a political economist, though no reference. Austrians will see much to agree with albeit they will wonder if Arthur came to all this (the ‘literary’ side of things) never having read Hayek, or Lavoie, etc. He speaks of “nonequilibrium” not “disequilibrium”. Never mind. But then he turns to “policy implications”. And as satisfying and reassuring as the discussion so far has been it now becomes incredibly irritating and bewildering. To wit:

“Certainly, complexity teaches us that markets left to themselves possess a tendency to bubbles and crashes, induce a multiplicity of local attractor states, propagate events through financial networks, and generate a sequence of technological solutions and challenges, and this opens a role for policies of regulating excess, nudging towards favored outcomes, and judiciously fostering conditions for innovation. Colander and Kupers (2012) express this succinctly as getting meta conditions right. (18, italics added)”

So the principle lesson he draws from his perceptive, and expert, understanding of complexity is that “markets left to themselves” exhibit bubbles and crashes that open the way for benevolent regulation? How can this be right? No mention of the amazing self-regulating properties of the market. Where is the ‘invisible hand’? No mention of “complex adaptive systems” or converging network effects, never mind “spontaneous order”. Now maybe I am being picky, but in a contemplative piece on the place and significance of complexity-economics surely the first and foremost of characteristics to note are the convergent and homeostatic properties of many complex social systems. Am I wrong in thinking that this is a big part of the complexity literature? But they are nowhere to be found in this paper.

It gets worse. He goes on to blame an inability to see the benefits of and necessity for regulation on equilibrium economics. (And here we all thought that the neoclassical perfect general equilibrium edifice lent itself to the advocacy of central planning a la Oskar Lange. Does Arthur even know about that?)

“I believe we can make a stronger statement. The failures of economics in the practical world are largely due to seeing the economy in equilibrium. If we look at the economic crises of the last 25 years—the debacle that followed the freeing of markets in Russia in 1990, the extensive gaming of California’s energy market after the lifting of regulations in 2000, the collapse of Iceland’s banks in 2008, the ongoing Euro crisis, the Wall Street meltdown of 2008—all these were caused in no small part by the exploitation of the system by a few well-positioned players, or by markets that careened out of control (Arthur, 2010a). Equilibrium thinking cannot “see” such exploitation in advance for a subtle reason: by definition, equilibrium is a condition where no agent has any incentive to diverge from its present behavior, therefore exploitive behavior cannot happen. And it cannot see extreme market behavior easily either: divergences are quickly corrected by countervailing forces. By its base assumptions, equilibrium economics is not primed to look for exploitation of parts of the economy or for system breakdowns.

Complexity-economics, by contrast, teaches us that the economy is permanently open to response and that every part of it is open to new behavior—to being exploited for gain, or to abrupt changes in structure. A complexity outlook would recommend putting carefully thought out controls in place, much as authorities put sensible building codes in place in seismic regions.” (18, italics added).

And herein lies the explanation for his neglect of Hayek and similar approaches. It does not fit into his topsy-turvy mindset, his view of the social universe in which complexity applies to everything in that universe except government regulation and policy-making. He refers to “the exploitation of the system by a few well-positioned players” in the market, but seems oblivious to the much greater danger of such well-placed players in government. Knowledge and incentive problems don’t seem to exist for him. He is in the grip of the Keynesian presumption that all that is necessary is to put the right people (the complexity economists) in charge of designing the system of regulation.

Many, I am sure many complexity-economists included, will see this as precisely the wrong lesson to learn. The correct lesson, surely, is that policy in a complex world should be humbled by the inescapable unpredictabilities implied by ongoing formative social processes in real time embodying novelty; should incline toward the setting of general abstract rules at the constitutional level, less amenable to exploitation than ad hoc regulation, as so clearly explained by Hayek, Buchanan and others (Lewin, 2014).

For me this was a revealing lesson in power of mindset. Forgive my naiveté.

References.
Arthur, W.B., 2010a. “Exploitive Behavior in Policy Systems,” Mss., IBM Almaden.
Arthur, W.B., 2013. Complexity-economics: A Different Framework for Economic Thought’ SFI Working paper: 2013-04-012, Sante Fe Institute. 
Colander, D, and R. Kupers. 2012. Laissez-Faire Activism: The Complexity Frame for Policy, Princeton.
Lewin, 2014. “Policy Design and Execution in a Complex World: Can We Learn from the Financial Crisis?” working paper,

Sunday, January 25, 2015

Pondering Piketty – A Simple Analytical Framework

Introduction

When Thomas Piketty’s book (Piketty, 2014) burst upon the international scene less than a year ago, I felt pressure to write a comprehensive review of this aggressive attack on free-market economics. After all, it was based, as its title implies, on an exposition of the essential nature of “capital” – as in “Capitalism” – and had I not spent a lifetime in the grip of capital theory?

So I got the book and began to plough through it. It proved much more tedious than the reviews I had already read had prepared me to expect. Piketty lays out his premises and conclusions in the first few chapters. So, I already realized that his approach was full of fallacies, that it was fundamentally flawed. How does one then proceed to go through the remaining part of the 655 pages knowing there is no redemption, in fact that the rest will be either irrelevant padding or a piling-on of further fallacies.

By the time I made it through the book, the reviews, scholarly and more informal, had accumulated. It is a fair bet that, numerous though they are, all of the criticisms that could be made of the book have been made somewhere. Thus the marginal value of any review I could offer is probably now close to zero.[1] However, as I was thinking about it, I realized that many, if not all, aspects of Piketty’s approach can be expressed in a simple framework which might be of use to some. I cannot say that this has not been done  before, in some form or other, only that I have not seen it, and that, in any case, it may be of value.

I will, therefore, say very little about the details of the book – how it is written and organized. I have already elsewhere delivered a sweeping evaluation, to wit: Piketty is wrong on the data, the economics, and the policy, otherwise this is a valuable book. You might think it a bit too scathingly smug. But, what I have read since writing that, has enforced my view. In addition to his dubious use of aggregates (about which I will have something to say) it now appears that a strong case can be made that Piketty has distorted and/or fabricated data (Magness and Murphy, 2014). And his economics is surely abysmal, to the point of evincing basic misunderstandings of the workings of supply and demand (McCloskey, 2014, 91). On the matter of policy, I need no confirmation of my conviction that his recommendation borders on insanity.

There are, however, two general comments I want to make about the book. First, many, though by no means all, of the reviews I have read, including some by highly critical authors, suggest that Piketty’s book is, for all its faults, admirable; that it is the work of a serious author with integrity and the best of intentions - Intelligent, industrious, but mistaken and misguided. Perhaps I lack the capacity for charitable interpretation, but I do not see it in this way. The book strikes me as pretentious and almost completely devoid of merit. Its tone, for all the superficial self-effacing expressions to the contrary notwithstanding, is arrogant, something particularly galling coming from someone who has not taken the time (in the purported twenty years of incubation that this book endured) to properly understand his subject.

Secondly, and more importantly, the book is clearly mistitled. It should be titled “Inequality in the Twenty-First Century”. It is from start to finish a book about the evil of growing inequality. Yet, while the book mounts a mountain of evidence to support the assertion that inequality is growing (a project that ultimately fails, as many have shown) there is no real effort to support the assertion that inequality, in itself, is bad. Some reviews have addressed the ethical question of how this concern with inequality elevates resentment and envy. But I have not seen any discussion of the fact that time and again Piketty tries to bolster his case by asserting, without a shred of evidence, that social inequality results ultimately in “social instability” (for example, 10, 21). Indeed, Piketty recognizes that inequality in itself may not be a bad thing, but becomes bad when it is unjustified and against the “public interest” (33). And, of course, he knows what is in the “public interest.”

A simple framework

Piketty’s framework consists of a few basic categories that can be captured using the following.

Y = rK + wL

This is an accounting identity, where Y is national income, r the rate of earnings of capital, K, and w is the wage rate, the rate of earnings of labor, L.

Piketty divides the set of all productive resources into two (exhaustive) categories capital, K, and labor, L, whose owners earn r and w per unit respectively. Thus the earnings of K and L are rK and wL respectively. And the shares of K and L are rK/Y and wL/Y respectively – which we may write as sK and sL respectively.

Piketty’s project is to show that the laws of capitalism imply that sK/sL rises without limit, thus destabilizing the society. To do this he posits the fundamental equation that i > y, where i is the rate of interest, also the rate of earnings of K (i = rK/K), and y is the rate of growth of total incomes ([1/t]dY/Y = gY, explained below).[2]

Piketty reasons that if the earnings of K grow more rapidly than earnings in general, this must imply that K’s share is growing, thus increasing inequality. QED.

Let’s consider sK and sL in a little more detail.

As a tolerable approximation we can write

g(sK) = gr + gK – gY

and

g(sL) = gw + gL – gY

Where g is the instantaneous percentage rate of growth operator (aka, dlog/dt).

If r is constant so that gr = 0 and gK  > gy, sK will rise.

But if w is constant or positive and gw + gL > gY, sL will rise.

Clearly, the variables are connected.

g(sK/sL) = (gr + gK) – (gw + gL).

If gr = 0, income inequality (sK/sL) will rise iff gK > gw + gL, that is, iff capital grows faster than labor plus the increase in wages.

So even with this simple, really simplistic, framework[3], Piketty’s conclusion does not follow unless one discounts the effects of a large increase in the real wage of pure labor. Indeed real wages have risen astronomically over the period of Piketty’s analysis, but presumably he would argue not sufficiently relative to the earnings of capital – a really astounding claim, that suggests further analysis of this framework is necessary.

What Do These Variables Mean? 

The conflation of personal and functional income distribution

By using only two categories, K and L, Piketty stacks the cards. In examining the income earned by K and L he is conflating the personal distribution of income with the functional distribution of income. To say that K earns income is at best a metaphor. It really means the owners of K earn income. And the same is true of L. Labor rents out its services in return for wages. By drawing conclusions about inequality of incomes from this, Piketty seems to think that all capital-owners own only capital (from which they derive their earnings) and, more importantly, all workers own only labor – no capital – exclusively from which they derive their earnings. What happens if workers own capital (for example by way of their pension investments)? Then the earnings of capital relative to the earnings of labor cannot be taken as coterminous of the earnings of capital owners relative to the earnings of workers. He does have a lot to say about who owns capital, but it is confused.

The neglect of human capital

This conflation is particularly egregious, potentially fatal to his argument, for the case of human capital. Piketty explicitly (and cavalierly) excludes  human capital from his consideration. Yet, human capital is arguably the single most important factor in explaining personal earnings. If we include the accumulation of human capital in capital accumulation as a whole, the tendency would clearly be toward a reduction in inequality – even in the narrow sense in which Piketty presents it.

What does capital mean?

Piketty has a sub-section with the same title (45). His answer is patently inadequate.

To use these kinds of aggregates is always to risk incoherence. This is especially true in the case of capital. A nation’s physical productive capital refers to its non-human instruments of production – machinery, raw-materials, minerals, buildings and land (some have a separate category for land). Beer-barrels, blast furnaces, harbor installations and hotel-room furniture are all capital (Lachmann 1956 [1978]). They are “capital-goods.” Clearly this is a category of diverse and heterogeneous items. In fact there are thousands of different sub-categories of physical capital goods and, owing to the persistent improvement of technology, the number is growing even while the composition of sub-categories changes.

Why are capital-goods valuable? They are valuable only because they are able, when grouped in appropriate combinations, and used together with labor services, to produce goods and services that people (consumers) value and are willing to pay for. But the value of any single capital-good is a matter of speculation. What someone will pay for it depends on his forecast of the value of the stream of future revenues that can be earned by employing this capital-good in a productive capital combination.

The value of the total of all capital goods is thus not an observable phenomenon. Yet this is what K is intended to convey. It is meant to be an index of the physical magnitude of the capital of the economy. But since this category of resources is composed of thousands of incommensurate items, the only way such an index can be constructed is by adding them together on the basis of their supposed values and deflating by some suitable price-index. Still, it is not a physical quantity of any observable entity. The value of any single capital-good depends on the flow of prospective revenue it is expected to produce, but, as this revenue is earned over time it must be discounted in order to arrive at the present value of the capital-good. In other words, an interest rate is already implicit in the construction of K; its magnitude depends on the interest rate used to discount the various income streams. Thus for Piketty to argue that the interest rate is the return to capital, is to commit an elementary but significant error (to be discussed further below).

In fact there is no such thing as a total of productive physical capital. There are only individual forecasts of what each capital-project (composed of capital and labor combinations) will earn. Only in the idealized theory of neoclassical economics, where all of these individual forecasts are identical and exactly match what will actually transpire, a world of equilibrium, can one meaningfully talk of such a total. In the real-world it is precisely the differences between these forecasts, between the visions of different and competing entrepreneurs, that drive the market-process in which many production plans fail and some succeed. It is a process of implicit experimentation, a dynamic process and there is nothing automatic about it.

What is the interest rate?

It follows that there is no such thing as a return to capital in general, an r, that is the rate of earnings on K that is equal to interest. Interest is a reflection of time-preference, of the discount applied, under various circumstance (notably different degrees of perceived risk) to future incomes. It is the cost of borrowing, the price of credit. It is the cost of financing productive projects and represents the sacrifice made for not consuming value now in favor of waiting until later. If such a sacrifice is to be made it must be deemed worth it. So, for a productive project to be undertaken it must earn at least the value of financing it, after all other expenses are paid. Interest is not the return to capital. It is the cost of financing. It is a separate cost of production.

What then does capital earn? Capital earns a rental rate. If the capital-goods were rented from a third party rather than owned, their earnings would be the rents paid for them. If they are owned it is as if the owner is renting the capital-good to himself. It is no different with labor. The value of a worker, in terms of capitalized earnings, depends on how much he can sell his services for over time. Since he is the exclusive owner of himself, his capital-value cannot be alienated from himself, the employer must rent him, he must purchase the worker’s services. If we consider labor to be human-capital, then all capital earns a categorically identical rental rate. The interest cost is never equal to the earnings of “capital” except in the sense of “financial capital” which may be used to finance both capital and labor.

Rather than just two (different types of) categories of earnings, there are very many categories all of the same type, namely, they are all potential sources of income. And their earnings depend on the nature of the productive environment in which they are created and deployed and not on any fundamental and immutable laws of capitalism.

What is profit?

In real-world economies successful entrepreneurs earn profits. Very successful entrepreneurs can earn fortunes – that they sometimes bequeath to their heirs. Profits are a disequilibrium phenomenon. There is no positive equilibrium rate of profit. In equilibrium profits are zero. Profits are the return for being right in an uncertain world. They are a residual after all other expenses have been accounted for – including contractual payments to workers (wages), capital-goods owners (rental earnings) and financiers (interest).  If the entrepreneur is also an owner of the capital-goods she uses, and part-financer of the project, these sources of income will, in practice, be inextricably comingled.

Conclusion

In the light of the realities of the dynamic economic processes that increased the standard of living of millions of people by magnitudes of thousands, it is hard to see what relevance Piketty’s i > y could possibly have. In truth, his is a bankrupt vision, based on a set of flat-earth dogmas that should never have been accorded the esteem it now has.

References

Lachmann, L. M. (1956 [1978]). Capital and its Structure. Kansas City: Sheed, Andrews and McMeel. .
Magness, P. W., & Murphy, R. P. (2015, Spring). Challenging the Empirical Contribution of Thomas Piketty's Capital in the 21st Century. Journal of Private Enterprise.
McCloskey, D, N. (2014), Measured, unmeasured, mismeasured, and unjustified pessimism: a review essay of Thomas Piketty’s Capital in the twenty-first century. Erasmus Journal for Philosophy and Economics, 7, 2: 73-115.
Piketty, T. (2014). Capital in the Twenty-First Century. Cambridge: Harvard University Press.



[1] I created a folder on my desktop called Piketty Pieces. At this moment it contains 77 separate files, being various reviews (critiques) including a 10-part review by The Economist.
[2] Piketty uses r and g to write r > g, but we need a different notation for reasons that will become obvious.
[3] It is a Ricardian-Marxist (classical) framework with land thrown in with capital.