Saturday, Apr 18, 2015

Fairy tale capitalism

Piketty clearly recognises that there are powerful forces that can mitigate inequality. Piketty clearly recognises that there are powerful forces that can mitigate inequality.
Published on:April 24, 2014 3:11 am

By: Mihir Shah

Piketty’s work underscores need to address its legitimacy amid growing inequality.

As students of economics, we are quite used to being told fairy tales. The most famous one is the Invisible Hand of Adam Smith. Another fairy tale, not as well-known, is the Kuznets Curve. The name derives (rather unfairly as we shall see) from the Belarusian-American 1971 Nobel Prize winning economist, Simon Kuznets. So goes the tale: the natural progression of development is towards industrialisation and urbanisation. Initially, this leads to increased inequality in society, as capitalists get richer and the influx of rural labour holds wages down.

But as employment opportunities grow and the flow of rural labour dries up, wages rise and an equalisation tendency appears, which gets stronger over time. Thus, if we plot inequality against time, we get an inverted-U or bell-shaped curve, the Kuznets Curve. If this hypothesis were true, it would show that the “trickle down” of the benefits of growth to all is a natural and automatic part of capitalist development. In former US president John F. Kennedy’s memorable phrase, “a rising tide lifts all boats”.

The recent work of Thomas Piketty, Capital in the Twenty-First Century, provides the strongest demolition of the Kuznets Curve hypothesis so far. Piketty’s biggest achievement is that he is able to match the monumental statistical edifice that Kuznets pioneered. The publication in 1953 of Kuznets’s Shares of Upper Income Groups in Income and Savings was a truly landmark event i

n the history of economics. Kuznets showed that between 1913 and 1948, there was a sharp decline in income inequality in the United States. His work was transparent in a manner that was unprecedented in the history of economics, with every source and method revealed in the finest detail. And what gave even greater credence to the Kuznets Curve was that the trend of declining inequality persisted right up to the 1970s.

Piketty adopts both Kuznets’s methods and his data, and extends their coverage over time and space. He shows that since 1980, there has been a sharp rise in inequality in the US, Japan and Europe. Mind you, Piketty is no loony left-winger. He makes it abundantly clear that he has never felt “the slightest affection or nostalgia” for the collapsed communist regimes of his youth. He also unabashedly speaks of having “experienced the American dream” when he came to the US at the age of 22.

So it is not ideology but the robust 200-year data he marshals that makes Piketty decisively reject the Kuznets Curve. Indeed, his data shows a U-curve in the trends of inequality in the advanced capitalist nations of the world — US, Japan, Germany, France and Great Britain — the exact opposite of the Kuznets Curve. Inequality grows sharply after having fallen initially for a few years.

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