The Lump-of-Capital Fallacy

May 9th, 2014 No comments

Dean Baker gives me the courage, in his recent post on Pikkety, to reiterate a statement I’ve made some few times in the past:

Economists have no coherent or consistent idea of what they’re talking about when they use the word “capital.”

They lump together real capital — fixed, human, organizational, whatever — with “financial capital,” an oxymoron that confutes actual productive stuff with financial claims on that stuff.

Dean (emphasis mine):

This relates to the Cambridge controversies since the Cambridge U.K. people argued that the idea of an aggregate production function did not make sense. They pointed out that there was no way to aggregate different types of capital independent of the rate of return. The equilibirum price of any capital good depended on the rate of return. Therefore we can’t tell a simple story about how the rate of return will change as we get more capital, since we can’t even say what is more capital independent of the rate of return.

The takeaway from this, or at least my takeaway, is that we don’t have a theoretical construct that we can hope more or less approximates how the economy actually works. The theoretical construct doesn’t make sense. This means if we want to determine the rate of return to capital we should not be looking to elasticities of substitution, but rather the institutional and political factors that determine the rate of profit.

So it’s not just Steve Roth, internet econocrank, making this wild-eyed claim. You’ll find similar in Jamie Galbraith’s review of Pikkety. (His opening line? “What is capital?”), and I would suggest that every other review you’ve read wallows in the same quagmire of non- or multiple-definition.

As does Pikkety, unfortunately. He explicitly defines capital as being synonymous with wealth, which is a very tricky and messy conceptual proposition indeed. That does not obviate his work’s incredible value, but he should have called his book Wealth in the 21st Century.

“Capital” means, should mean, real, productive assets: real inputs to production that require real resources to produce, and that are consumed over time (through use, decay, obsolescence, and death). There’s the obvious “fixed capital” as tallied in the national accounts (broken out as structures, equipment (hardware), and software) and there’s all that other real capital that arguably constitute the great bulk of real capital, but that is so deucedly hard to measure — skills, knowledge, ideas, organizational structures and processes, human ability, etc. Then there’s all the tricky stuff that sits on the borderline between real assets and financial assets (thing which have exchange value but cannot be, are not, consumed): land, art and collectibles, etc.

“Financial capital” — all the financial assets out there, embodying all the “money” out there — is, roughly, all the outstanding claims on that real capital, or on the future production from that capital. Financial assets are not inputs to production (though they can be exchanged for such inputs), and they cannot be, are not, consumed.

The stock of financial assets can increase in several ways. 1. A sovereign currency issuer can deficit-spend. 2. A bank can print new money for lending ex nihilo (with the help of borrowers who want to monetize their real assets; think: student loans). 3. The market can decide that the real assets out there are worth more than the outstanding claims against them, and bid up financial-asset prices. Voila, more money, more financial assets, more so-called “financial capital.”

All of this points to the fundamental problem in economic thinking that Dean states so clearly: you can’t lump together, or really even measure, real capital in dollar terms. You certainly can’t just add together the value of real capital and the value of financial capital, which constitutes claims on that real capital.

And: The outstanding value of financial assets/”capital” is not any kind of reliable representation of the value of outstanding real capital. It’s all over the map, depending on how much of that real capital has been monetized/indebted/financialized (via private and public debt and money issuances), and based on the current state of investors’ “animal spirits” — their beliefs about future returns to that financial capital.

A minor aside: The whole “reswitching” business in the Cambridge Capital Controversy is just a carefully explicated special case, or example, of the fundamental confusion that the U.K. gang pointed out (and that Samuelson admitted to): the value of capital is a function of its future returns, and future returns are a function of the value of capital. Economics is based on a circular definition.

Or in Dean’s words, “The theoretical concept doesn’t make sense.” (This is some significant relief to me, because after more a decade of really struggling to make it make sense to me, it still doesn’t make sense to me.)

I’ve made some efforts to sort out this confusion is previous posts, which you can find by wandering through Related Posts, below. I would be more than pleased if those more worthy than I were to take up this task, and deliver an adequately and convincingly theorized understanding of the relationship between real capital and “financial capital.”

Cross-posted at Angry Bear.


Lane Kenworthy, Prosperity, and the Infinite Forms of “Redistribution”

April 19th, 2014 No comments

I haven’t beaten the drum lately for Lane Kenworthy — perhaps the best researcher out there on the economic effects of income and wealth distribution. His years of careful, diligent (and voluminous) statistical and analytic work, tapping the best data sets available, and his cogent, coherent explanations of his findings, should get a lot more attention in the econoblogosphere. Lane Kenworthy rocks.

He’s especially good at trying to suss out causation, which he will be the first to acknowledge is always a difficult business in a discipline that’s inevitably dependent on retrospective data — where you can’t rerun the experiment, much less run it from the start with a randomized control group. (And natural experiments/control groups like the ones that Arindrajit Dube exploited to look at minimum-wage effects — adjacent counties across state lines with different minimum wages — aren’t thick on the ground.)

Nevertheless there are some excellent statistical techniques that can give a good indication of causation. Well-executed, they can really move your Bayesian priors. At the very least, they’re excellent at ruling out causation. Put simply, if there’s a significant negative correlation between presumed-cause A and presumed-effect B (or no correlation at all), you can feel fairly confident that A didn’t cause B. It’s difficult to prove causation with correlation; it’s much easier to disprove causation — to falsify a hypothesis.

But enough with the philosophical throat-clearing. Let’s look at one recent paper (PDF), a multi-country multi-regression analysis comparing rich countries, looking at income inequality and middle-class income growth. He finds that from the late 70s to the mid 2000s (all emphasis mine for easy scanning):

an increase of 1 percentage point in the top 1 percent’s share of pre-tax income reduced growth of income for the median household by about USD530. In the most extreme case-the United States-the top 1 percent’s pre-tax share increased by 8 percentage points between 1979 and 2004. According to this estimate, that may have reduced median household income growth by a little more than USD4,000. The actual rise in the United States during those years was USD8,000, so the estimated impact of rising income inequality is not trivial

In other words, if the 1%’s share of income had not grown by 8%, median household income would have grown by $12,000 instead of $8,000. This bears out Lane’s rather intuitive, common-sense assertion earlier in the paper:

Household income growth is not a zero-sum game because the pie tends to get larger over time. Disproportionately large gains at the top, however, are  likely to come at least partly at the expense of those in the middle.

Always careful, he adds:

At the same time, the data suggest that the income-reducing impact of a rise in top-heavy inequality has been overshadowed by the income-boosting impact of economic growth and of increases in net government transfers.…even after adjusting for these other influences, change in top-heavy inequality is not a very good predictor of growth in middle-class incomes.

So yes: income inequality in and of itself seems to have reduced middle-class income growth significantly. But obviously, of course, that’s not the only economic effect at play. (Only a wild-eyed, ideologically blinded, axe-grinding, bought-and-paid-for Republican would make that kind of foolish claim about some particular economic effect.)

Which brings me to another recent paper (prominently citing the previous one), that questions the Left’s rhetorical emphasis on (in)equality:

I fear the American left’s recent move to put income inequality reduction front and centre might be harmful rather than helpful. It may foster a conviction that the key to addressing America’s social, economic and political problems is to reduce the top 1 per cent’s share or the Gini coefficient. That could distract attention from more direct and effective efforts to address those problems.

Such efforts include fully universal health insurance; improvements in eligibility, duration and benefit level for various social-insurance and social-assistance programmes; wage insurance; early education; enhanced financial support for college; a minimum wage indexed to prices; an expanded earned-income tax credit indexed to average compensation; and monetary policy less tilted towards inflation avoidance. Policy changes like these would go a long way towards improving economic security, enhancing opportunity (and mobility) and ensuring shared prosperity in the US. Inequality of political influence could be lessened via direct reforms, such as reversal of the Citizens United decision, introduction of a strong transparency rule and public funding for congressional election campaigns.

I think Lane’s right. I’ll say it again: if you talk about fairness and equality, Americans change the channel. (They’re only somewhat more open to hearing about “opportunity.”) They want to hear about prosperity — especially widespread prosperity. And the programs Lane points to have a decades-long history of delivering widespread prosperity. Expanding those programs (and funding them with a tax system that actually is progressive) would make us all more prosperous.

And that’s exactly what Lane’s first paper demonstrates. No: just reducing inequality through redistribution doesn’t make everything peachy. No duh. (Though in the current environment of concentrated wealth and income it does improve things a lot in and of itself.) If you really want to increase prosperity, you use methods of redistribution that increase prosperity – like the programs that Lane details above. (Plus publicly funded infrastructure, research, etc.)

So the two things aren’t mutually exclusive. You implement programs that deliver widespread prosperity in and of themselves, and distributive effects also deliver the prosperity benefits of reduced wealth and income concentration. It’s a virtuous cycle, rolling forward on a path to American prosperity. Rinse and repeat.

In brief, widespread prosperity both causes and is greater prosperity.

Cross-posted at Angry Bear.

Repeat After Me: The American Tax System is Hardly Progressive at All

April 19th, 2014 No comments

The latest numbers on 2014 taxes as share of income are out, and they’re saying pretty the same thing as last year:

Above about $80K a year in income, the American tax system is not really progressive. Like, at all:

The people making $100K a year pay about the same share of income as people making $10 million a year.

This is because — while federal income taxes are reasonably progressive — payroll, state, and local taxes are horribly regressive — particularly in (blush) my home state:

Screen shot 2014-04-19 at 9.32.10 AM

Read it and weep.

Cross-posted at Angry Bear.

The Global “Capital” Glut

April 17th, 2014 No comments

No, I’m not talking about Piketty hitting the Times bestseller list. And it’s not just wild-eyed lefty Frenchman who are expressing concern about the state of world capital these days. Mitt Romney’s shop was beating this drum loudly more than a year ago.

One of the central takeaways from Piketty’s Capital in the 21st Century is the U-shaped long-term trend in the capital-to-income ratio, especially in rich countries. He uses “capital” synonymously with “wealth.” Here are the latest numbers for the U.S. from his compatriots Saez and Zucman (source PDF):

Screen shot 2014-04-17 at 12.46.35 PM

The economic relationship between wealth (or net worth, financial assets minus liabilities) and real capital  is a sticky one, even if you’re only considering “fixed capital” — structures, equipment (hardware), and software. It’s even more so if you consider  human skills, knowledge (i.e. patents), organizational capital, etc. (The line between organizational capital and “software” is getting especially blurry these days; what would Vanguard’s, much less Google’s, value be without their web presence?) And more so again if you consider natural capital like land and what’s on/under it.

But “Wealth in the 21st Century” wouldn’t have had quite the same ring to it, so let’s just go with it, with the knowledge that we’re talking about wealth (“financial capital”), and wealth has some indeterminate but somewhat representative relationship to real assets/capital. We can at least say, loosely, that financial assets are claims on real assets, or on the production that’s enabled by those assets.

So what about Bain Capital, Romney’s shop? Here from their December 10, 2012 report (PDF; hat tip to the always-remarkable Izabella Kaminska, and to Climateer Investing).

World awash in nearly one quadrillion of cheap capital by end of decade, according to new Bain & Company report

Their takeaways include:

The capital glut will be accompanied by persistently low real interest rates, high volatility and thin real rates of return.

Sound like secular stagnation to you?


The ever-present danger of asset inflation will contribute to an overall steepening of the investment risk curve… companies will need to strengthen their bubble-detection capabilities

In short, there’s a huge amount of money floating around out there relative to income and production. (In Steve World, all financial assets embody money, and the money stock is the total value of financial assets — including dollar bills, deeds, or other formal financial claims — regardless of how currency-like those things are. Equating currency and currency-like things with money is conceptually incoherent.)

With so much money around, is it any surprise that people are lending it cheap?

As usual I have much more to say on this but instead I’ll hand it off to Jesse Livermore, who recently wrote one of the clearest and most cogent posts I’ve seen in years on financial asset values, hence wealth. I’ve been meaning to link to it. Read the whole thing.

The Single Greatest Predictor of Future Stock Market Returns

Hint: it’s about what the herd does with all that money.

Cross-posted at Angry Bear.

ALEC: Destroying the American Economy, One State at a Time

April 14th, 2014 No comments

The American Legislative Exchange Council — which authors ultra-conservative legislation and promulgates it to state legislatures nationwide — has a little index measure of states’ “competitiveness,” which supposedly results in greater prosperity for those states that rank highly.

Does it? Let’s let the numbers speak for themselves:

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Source (PDF).

Cross-posted at Angry Bear.

Thinking About Piketty’s “Capital”

April 6th, 2014 1 comment

The quotes in this post’s subject line are very much intended as a double entendre. I’m of course referring to the title of Piketty’s book (which I’ve read about 80% of, jumping around). But even more, I’m talking about his definition of “capital.”

I’ve ranted frequently about economists’ failure to define this term or agree on what it means, and Piketty is very much laboring under the burden of that failure.

Don’t take my word for it. This confusion about the nature of capital (and the associated term, wealth) is the central point of James Galbraith’s critique of the book:

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

You’ll find that “capital” conundrum lurking or leaping out within every review you read.

Piketty deserves great credit. Unlike many or most economists, he makes a good-faith effort to define his usage of the term, and a not-altogether-successful effort to think coherently and consistently within the terms of that definition. He addresses his definition head-on on pages 47-49, and wrestles with various aspects of it throughout the book. See for instance page 149 (on the market value of assets), page 163 (on “human capital” that can be bought and sold in a slave society), page 188 (again on the market value of real capital), and page 210 (on “real” vs. “nominal” assets).

I’ll just highlight one subject: In the course of things he expresses disdain for the notion of “human capital.” Many will find this to be problematic, since most estimates would suggest that human capital — our ability to work and produce in the future — constitutes the great bulk of world and national capital. But Piketty’s stance is reasonable or even inevitable: it’s largely impossible to measure this kind of capital outside a slave society (and then you’re only measuring the “value” of the slaves). So for his purposes of analyzing the subject based on recorded numerical data, human capital is a non-starter.

But still, Piketty fails to address the extent to which human capital is increasingly being “capitalized” or “finacialized.” Think, for instance, of the extraordinary runup in U.S. student-loan debt, and asset-backed securities packaging those loans — debt and securities whose only collateral is those students’ enhanced ability to…work and produce in the future.

Here one measure that is at least a proxy for that runup: government-held student loans as a percent of GDP.

Where are the lines between “real” capital, “human” capital, and “financial” capital? What are their economic relationships? (If you’re under the impression that they’re obvious or clearly understood and agreed-upon, you’re not thinking very hard. At all.)

My purpose here is not to solve that capital conundrum — far be it from me. I come not to bury Piketty, but to praise him. His usages and definitions provide a very useful framework in which to discuss issues that have been hard to discuss coherently absent such framing. The evidence he’s assembled within that framework, and his remarkably cogent discussion of that evidence, gives ample evidence of that.

But even more: By tackling these definitional issues head-on (if not always successfully), he has brought an inconclusively theorized crux of economic thinking — the nature of capital (plus wealth, value, and even money) — back to the forefront of discussion. We can all hope that much good will come from that.

Cross-posted at Angry Bear.


The Incredible Vanishing Takeaway from the CBO Report on Minimum Wage

March 10th, 2014 1 comment

I’m surprised that nobody highlights what for me is the key takeaway from that report.

They predict, with a $10.10/indexed increase:

Low-end incomes increase $19 billion.

High-end incomes decline $17 billion.

For a net GDI increase of $2 billion.

Table 1, page 2:

Screen shot 2014-03-10 at 12.18.13 PM

Pie gets bigger, all that rot.

The increase is presumably explained by the last phrase in footnote F to that table:

increases in income generated by higher demand for goods and services.

Cross-posted at Angry Bear.

Why the Fed Hates Inflation: 1.2 Trillion Dollars of Why

March 10th, 2014 38 comments

Upate: Those who have qualms about the methodology and underlying assumptions here would do well to consider Thomas Piketty’s thinking on page 210 of Capital in the 21st Century. He distinguishes between “real” and “nominal” assets, pointing out that real asset values climb along with inflation and growth, while nominal asset values don’t.

A simple rule of economic arithmetic that economists seem to studiously ignore:

Inflation transfers real buying power from creditors to debtors, with nary an account transfer visible anywhere on anyone’s account books. Inflation means that debtors pay off their loans over time with less-valuable dollars — dollars that can’t buy as much bread, butter, and guns.*

Higher inflation causes, is, a massive transfer from creditors to debtors.**

And the Fed is run by creditors. Inflation is, always and everywhere, very very bad for them.

How bad? Look at the fixed-income assets and liabilities of financial corporations:

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Financial businesses are net creditors to the tune of $9-$14 trillion dollars.

If inflation was 1% higher than it is, it would transfer between $90 and $140 billion dollars to their debtors. Every year. For every extra point of inflation.

Add it up: an extra point of inflation over the last ten years would have cost financial businesses $1.2 trillion dollars.

It’s enough to get a banker’s attention.

And that’s before you even consider the Fed powers-that-be in their roles as equity shareholders, and the Fed’s dual mandate. By emphasizing low inflation over low unemployment — and stomping on growth whenever the bogieman wage inflation threatens to rear its head*** — the Fed maintains a pool of unemployed and weakly compensated employees that cripples labor’s bargain power and empowers the steady growth of corporate profits over labor earnings.

It kinda makes you think about Mankiw’s fourth principle of economics: “People respond to incentives.”

I’ve said it before: if it weren’t for inflation, the rich really would own everything, instead of almost everything.

* Some will caveat: this is only true of unexpected inflation, because contracts are written with expected inflation in mind. The proper response: since the future is impossibly uncertain, all changes in the inflation rate are unexpected.

** Meanwhile economists fetishize notions about menu costs and the like, which in their largest estimations are an order of magnitude smaller than the inexorable arithmetic effect described here.

*** It’s happening now.

Cross-posted at Angry Bear.

Dean Baker on Piketty’s Capital: Or, How FDR Proved Marx Wrong

March 10th, 2014 5 comments

Thomas Piketty’s important new book, Capital in the Twenty-First Centurypredicts a bleak future of increasing concentrations of financial assets in few hands, stagnant wages and labor share of income, and declining returns to capital — secular stagnation. He enunciates and demonstrates the part of Marx that Marx got exactly right.

But Dean Baker points out where Marx got it wrong, and where an optimist  can hope that Piketty’s got it wrong. By changing our institutions, laws, and regulations — the rules of the capitalist game — we can head off that seemingly inevitable downward spiral. Dean gives several examples of institutional changes that could prevent or even reverse it, from patent laws to cable monopolies to financial-transaction taxes.

Which prompts me to finish this post, started long ago, and to point to Steve Randy Waldman’s eloquent rejoinder to the pessimistic view. Steve ingested this contrary view with his mother’s milk:

I remember pride in my businessman father’s voice when he explained to me that this [pessimistic view] was wrong. Marx had underestimated the ingenuity and flexibility of capitalist societies, and particularly of the United States during the New Deal. Government intervened to solve Marx’s collective action problem, enabling capitalists secure their enlightened self-interest by keeping a distribution of prosperity sufficiently broad that the predicted collapse could be avoided. … To my father, American capitalism’s adaptability and ingenuity had proved Marx definitively wrong, in the best possible way — by producing a stable society that served the vast majority of its citizens, while countries whose politicians had followed Marx’s prescriptions grew into monsters.

So Marx was wrong both ways — economically and politically — even while he was right. The capitalist tendency to concentrate financial assets at everyone’s expense is inevitable – unless we as a society decide to do something(s) about it.

You’ll find this very same thinking elsewhere, for instance in this line from Joseph Stiglitz’s review of Robert Skidelsky’s Keynes: The Return of the Master.

Keynes’s great contribution was to save capitalism from the capitalists

And in this 2001 article from The Hoover Digest:

How FDR Saved Capitalism

This is a clear, cogent, and coherent story, but one I rarely hear from the left. I’d like to suggest that progressives should be moving this rather moving narrative to the front of the rhetorical bookshelf.

Now if someone could just convince Obama to go all FDR on us…

Cross-posted at Angry Bear.

Jared Bernstein Gives Us The Best Graph on the Employment Effects of Minimum Wage Increases

February 21st, 2014 2 comments

They say sample size matters. A handful of sample points in a study doesn’t tell you much, because they could just be showing random variation. This is also true not when you’re looking at many studies. You need to look at lots of research that uses different methodologies and data sets to get a confident feel for the facts on the ground.

Jared Bernstein points us to exactly such an effort, looking at 64 studies on the employment effects of minimum-wage increases, with a wonderfully informative display:

Note: “se” refers to standard error; 1/se is a measure of statistical significance. The dots up high are generally more believable.

“Employment elasticity” is a measure of the impact of minimum-wage increases. A measure of -.1 (left of the zero line) suggests that 10% MW increase reduces employment by 1%.

All the high-statistical-significance studies put elasticity at zero: no employment effect.

There’s some clustering to the left of the line versus the right down at the bottom, suggesting a small negative employment effect, but none of those studies has high statistical significance.

And this doesn’t consider “file-drawer/publication bias”: studies that find no effect don’t get published, because researchers don’t submit them or journals don’t accept them for publication. The CBO explains this in its new report on minimum-wage effects (PDF). Emphasis mine.

an unexpectedly large number of studies report a negative effect on employment with a degree of precision just above conventional thresholds for publication. That would suggest that journals’ failure to publish studies finding weak effects of minimum-wage changes on employment may have led to a published literature skewed toward stronger effects.

And that doesn’t consider (pas possible!) negative-effect researchers finding ways to get to that publishable statistical-significance level. (It’s curious that those finding a positive effect don’t display this anomaly…)

So at least, you can mentally add a whole lot more unpublished dots to that tall vertical line. At most, you can shift a bunch of those published dots on the left farther to the right, and down.

Cross-posted at Angry Bear.