Skip to comments.A Case Study of Why Growth Trumps Inequality
Posted on 04/30/2014 12:21:14 PM PDT by Kaslin
Theres a new book by French economist Thomas Piketty, called Capital in the Twenty-First Century, that supposedly identifies the Achilles Heel of the market economy.
Piketty argues that the rate of return to capital is higher than the economy-wide growth rate and that this will lead to untenable inequality as the rich grab a larger and larger share of the pie.
The solution, he claims, is confiscatory tax rates.
Im not impressed.
Garett Jones of George Mason University has a very good review that casts doubt on Pikettys hypothesis, but I also think Margaret Thatcher pre-debunked (if Im allowed to make up a word) Piketty in this classic video from the House of Commons.
Simply stated, if you care about those with lower incomes, your goal should be faster growth.
If the economy is more prosperous, that means a rising tide that will lift all boats.
Pikettys class-warfare prescription, by contrast, almost certainly will hurt the poor because of anemic growth, largely because higher tax rates will discourage productive behavior and exacerbate the tax codes bias against saving and investment.
This means less capital and there should be no doubt about the strong link between the capital stock and worker compensation.
But I sometimes worry that this type of analysis sounds too theoretical for a lot of people and that perhaps it would be helpful to offer some tangible real-world evidence.
So it is quite fortuitous that Im currently in Lithuania as part of the Free Market Road Showand that one of the participants is John Charalambakis, who teaches at the Patterson School of Diplomacy and International Commerce at the University of Kentucky.
In discussing the importance of economic growth, he explained that Singapore and Jamaica were economically similar in the early 1960s and then asked why they are so different today.
I have to admit that I was skeptical. I know Singapore is much richer today, but was it actually the case that it had the same level of per-capita GDP as Jamaica as recently as 50 years ago?
So I looked at the long-run data and John was exactly right. Take a look at this chart and youll understand why rapid growth caused by free markets is so vastly superior to the stagnation caused by statism.
I also included the world average for per-capita GDP so you can see that Singapore easily out-paced a lot of nations, not just Jamaica.
P.S. Keith Hennessey of the Hoover Institution writes that it makes more sense to think of the economy as a garden rather than a pie.
The pie metaphor for the economy is misleading and damaging, especially if you place a high priority on economic growth. because dividing a pie is zero-sum, the flawed metaphor assumes that if one persons slice grows larger, it comes at the expense of others. The inapt metaphor and its accompanying flawed logic lead one to conclude that when rich people have a larger share of a bigger economy, they do so at the expense of others lower on the income scale. A flower garden is a better metaphor for looking at economic growth and income distribution. A flowers growth depends on the individual characteristics of that type of flower and that particular seed. the rapid growth of a sunflower at one end of the garden largely does not come at the expense of a struggling tulip at the other end. The sunflower may have advantages the tulip does not, even unfair ones, but the fast-growing sunflower is not taking growth from the slow-growing tulip. Flowers will grow at different rates for a variety of different reasons. Policymakers should focus their energies on absolute growth rates rather than relative ones.
Keith is correct.
Or, if he isnt correct, its because the garden analogy doesnt go far enough. If my neighbor is akin to a fast-growing sunflower, that presumably creates more wealth that will benefit me and the other tulips of the world.
In other words, Im more likely to get richer if my neighbor gets richer.
But if you like the pie approach, then this pizza graphic is very appropriate because it gets across the message that the pie isnt fixed in size.
P.P.S. For more on the inequality vs. growth issue, heres my PBS debate.
P.P.P.S. The indispensable Tim Carney addresses the relationship between growth and inequality in this post.
P.P.P.P.S. Last but not least, heres a post with some very sage analysis by George Will, Ronald Bailey, and Scott Winship.
It doesn't even matter that it works better.
Growth is based on freedom. Efforts at "equality", which don't actually produce it, but rather create a connected-ocracy and a brutality-ocracy to replace an (admittedly imperfect) meritocracy, are based on central control.
QED, Growth is better than false promises of equality. Shocking.
The garden metaphor is even stronger than the authors let on. I’m willing to bet, as profligate as some are, there there are few multibillionaires — outside of the Middle East — who have more than a billion dollars worth of stuff, even including all their Vail ski lodges and Malibu beach houses and Gulfstream jets.
Almost all of any billionaire’s wealth is tied of up in investments. Since they generally want their investments to make money, their wealth is generally in companies that actually employ people, produce products, and serve customers. Billionaires help keep the garden fertile so that seeds may germinate and flowers may bloom.
When the average rate of profit is too high, the solution is:
1) increased freedom in society
2) increased respect for individual natural rights including property rights
3) increased rationality in society
4) increased security of property.
These lower the time preference which leads to decreased net consumption by capitalists, which leads to a decrease in the rate of profit and decreased accumulation of wealth in the form of consumers' goods by capitalists.
A decreased time preference also leads to more capital accumulation which leads to decreased hoarding of precious metal and increase demand for, production of, and supply of capital goods, which leads to greater economic progress, which leads to greater general prosperity.
A decreased time preference and a decreased net consumption also leads to increased savings and increased productive expenditure, which leads to greater total productive ability, which leads to larger aggregate supply, which leads to a lower general price level, which leads to higher average real wage rates, and an increase in the standard of living of the average worker.
the rich grab a larger and larger share of the pie.
The way to increase the wage share of consumption is to promote a pro business environment is to lower the time preference and net consumption of capitalists, which leads to more saving and productive expenditure, which leads to more aggregate demand for labor, which leads to a higher ratio of aggregate demand for labor compared to aggregate demand for consumers's goods which leads to a higher ratio of consumption by wage earners compared to capitalists. A higher ratio of aggregate demand for labor compared to aggregate demand for consumers' goods also leads to higher average real wage rates and higher standard of living for the average worker.
The solution, he claims, is confiscatory tax rates.
Confiscatory taxes is a direct assault on saving, productive expenditure, and capital accumulation, which nullifies all of the beneficial effects of the above.
I like the garden analogy.
This reminds me of the movie, “Being There”, starring Peter Sellers. Chauncy Gardner was borderline mentally retarded, and all he knew and talked about was gardening. When he accidentally became associated with some of Washington DC’s rich and powerful elites, they thought he was a visionary because of the way he talked.
And he was.
He knew that the garden must be cultivated if it is to grow. All of the elites thought he was making analogies about the economy. Interpreted in that fashion, Chauncy’s simple advice about gardening became very profound, indeed.