Not all differences are errors: Criticism and Defense of Piketty’s Capital in the 21st Century

If you’re reading this then decent odds that you’re aware of economist Thomas Piketty’s new book, Capital in the 21st Century.  (I’ve cited journal articles by he and Emmanuel Saez as well as this op-ed piece they authored [1].)  If you’re not familiar, here’s a snippet from the Overview at the Barnes & Noble website:

Questions about the long-term evolution of inequality, the concentration of wealth, and the prospects for economic growth lie at the heart of political economy. But satisfactory answers have been hard to find for lack of adequate data and clear guiding theories. In Capital in the Twenty-First Century, Thomas Piketty analyzes a unique collection of data from twenty countries, ranging as far back as the eighteenth century, to uncover key economic and social patterns. His findings will transform debate and set the agenda for the next generation of thought about wealth and inequality.

That Piketty undertook a data-based analysis makes his effort noteworthy in and of itself.   You have tip your hat to someone does a deep dive into data, tries to suss out significant trends and relationships, and reports back their findings.  Long story short, Piketty examined data from the past 200 years across multiple nations and concluded that inherited wealth has ensured the dominance of a small class of people and, barring public policy changes, it will continue to do so for the foreseeable future.  Recently however Chris Giles, a columnist for the Financial Times, uncovered some errors in Piketty’s book.  He reported his findings in “Data Problems with Capital in the 21st Century” (Note:  The article is behind a registration wall).  Piketty has not yet responded point-by-point to Giles but read his Big Picture response here.

Since Giles’ piece came out a number of economists and journalists have blogged about the errors he called out.   The big question is:  Do the errors significantly affect Piketty’s conclusions or are they just differences of no particular consequence?  I haven’t read Piketty’s book but I do know how to analyze data.  I’ve been looking at the “corrected” numbers and discussions of the implications since Giles’ article was published.   A bibliography of relevant blog posts follows below.  In short, it looks to me like Giles is making a fuss over errors which don’t affect Piketty’s conclusions.  In terms of a Big Picture analysis of Piketty’s work, Mike Konczal offers a concise summary and robust analysis:

Let’s describe Piketty’s argument as four dominos falling into each other:

1. The return on capital is greater than the growth rate. The infamous “r > g” inequality. Meanwhile growth begins to slow, perhaps because of demographics.

2. The amount of capital, or private wealth, relative to the size of the economy will begin to grow rapidly as growth slows. This is the “past tends to devour the future” line. The size and role of wealth of the past will take on a greater relevance to the everyday economy.

3. If the rate of return doesn’t fall, or doesn’t fall that quickly, the capital share of income will increase. More of our economic pie will go to people who own capital.

4. The ownership of capital is very concentrated, historically and across a wide variety of countries. It is unlikely to fall quickly, much less spontaneously democratize itself, in response to these trends. So the income and power of capital owners will skyrocket.

So right away, rising inequality in the ownership of capital is not the necessary, major driver of the worries of the book. It isn’t that the 1% will own a larger share of capital going forward. It’s that the size and importance of capital is going to go big. If the 1% own a consistent amount of the capital stock, they have more income and power as the size of the capital stock increases relative to the economy, and as it takes home a larger slice. However, obviously, if inequality in wealth ownership goes up, it will make the situation worse. (It’s noteworthy that these numbers Giles is analyzing aren’t introduced until Chapter 10, after Piketty has gone through the growth of capital stock and the returns to capital at length in previous chapters.)

The way that Giles could put a serious dent into Piketty’s theory through this analysis is by showing that inequality of wealth ownership is falling in the recent past. This is not what Giles finds. He mostly finds what Piketty finds, except in England, where it’s flat instead of slightly growing in the recent past.

From the four dominos, we can also see what flaws in the data would make people believe that Piketty’s argument is fundamentally unsound. Remember that Piketty has constructed data for each of these trends, not just the fourth one. Piketty and Zucman’s data on private wealth and national income, for instance, is here. But to really dent the theory you need to take down one of the dominos. Most have been fighting about the third one – that either the rate of return on wealth will fall quickly, or that it is determined by institutional factors that are politically created.

But the idea that the ownership of capital will become more concentrated isn’t an essential part of the theory. Though obviously if it does grow, then it’s an even greater problem.

Q.E.D.  Read Konczal’s full post but that section is definitely a keeper.  Other posts worth noting follow below:

Posts which compare Giles’ numbers with Piketty’s:

Other discussions:

Notes:

  1. I haven’t read Capital in the 21st Century yet and at 696 pages I’m probably not going to do so anytime soon.  I read very slowly when I’m reading to understand something in detail.  Journal articles are about as long as I can handle.

UPDATE 5/30/2014:  See Brad DeLong, The Daily Piketty:  May 30, 2014 and Daniel Kuehn Reads Howard Reed on Piketty vs. Giles: “It’s All About the Discontinuities”.  See also Paul Krugman, That Old-Time Inequality Denial.

UPDATE 6/4/2014:  See Brad DeLong, The Daily Piketty:  June 2, 2014.