Category: inequality

Chasing the Why

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May 25, 2025

By Stephen Stofka

This is part of a series on persistent problems. The conversations are voiced by Abel, a Wilsonian with a faith that government can ameliorate social and economic injustices to improve society’s welfare, and Cain, who believes that individual autonomy, the free market and the price system promote the greatest good.

Cain said, “We left off last week talking about the strong correlation between personal income and life expectancy in the U.S.”

Abel looked up to the acoustic ceiling tile as he searched his memory, then looked at Cain. “I think it was .85 across the states.”

Cain glanced down at his phone. “I wondered how strong the correlation was among developed countries. It’s not pretty. Mexico and the U.S. are the only two countries below 80 years life expectancy. Oh wait, and the Slovak Republic, what people call Slovakia.”

Abel asked, “Is that where Melania Trump comes from?”

Cain shook his head. “No. Her family is from Slovenia, another central European country. Slovakia is the eastern half of what used to be Czechoslovakia. A fun fact. They are not a top producer of automobiles, but for the size of their population, they have the world’s largest auto manufacturing per capita (Source).

Abel asked, “How small is their population?”

Cain replied, “About 5.4 million. So, a little less than Denmark. Well, I started digging into auto production figures for the other two countries with relatively low life expectancy.”

Abel spread some honey on his toast. “What, like there’s a link between auto production and life expectancy?”

Cain shrugged. “I don’t know. Environmental hazards? Just wandering around in the data maze. Never know what I’ll find. I was surprised to find that the U.S. and Mexico have about the same auto production per capita. Not the same overall. Just per capita. Volume wise, the U.S is the number two producer in the world (Source).”

Abel asked, “Who is #1? China?”

Cain nodded. “Yeah, they produce three times what the U.S. does. Of course, they have four times the population. Anyway, I looked at what has happened to auto production in the U.S. We are producing the same amount of vehicles as we did thirty years ago (Source). Meanwhile, the population in this country has grown 30%.”

Abel raised his eyebrows. “And Trump is going to restore that imbalance with tariffs somehow?”

Cain smirked. “All presidential candidates overpromise. Trump’s not the only one. In a deep housing and financial crisis, Obama promised to do what was best for working class families like the grandparents who raised him. What a bunch of B.S. that was. He did what was best for the banks and broker bonuses as millions lost their homes and most of their net worth.”

Abel sighed. “I don’t think most presidential candidates understand the forces that control the energy in this country. Trump says it’s the deep state. It’s the deep everything. The deep oil and gas industry, the deep defense industry, finance, healthcare, education and the tech ‘bros.’”

Cain laughed. “Good point. And they all have their lobbyists in Washington. It’s the swamp and its deep.”

Abel smiled. “And each president promises to clean up some part of that swamp. Then the gators in the swamp get a hold of their ankle.”

Cain shook his head. “I think it’s us the gators get a hold of. The politicians always seem to get away somehow.”

Abel grunted. “Too true. Anyway, so get back to life expectancy across developed countries.”

Cain replied, “Oh, yeah. So, the correlation between income and life expectancy across developed countries was not as strong the correlation between states, but it was still a moderately strong .6 (Source). I thought GDP growth would help produce better health outcomes and life expectancy, but no.”

Abel asked, “What if a lot of Americans are not benefitting from that economic growth? Too much inequality? We were comparing the U.S. and Great Britain last week on obesity in school kids. Great Britain has a much lower GINI coefficient than the U.S. so incomes over there are more evenly distributed (Source).”

Cain asked. “That measure includes transfer payments in income, right? Pretax or after tax?”

Abel nodded. “Yeah. It includes Social Security, Medicare, Medicaid and supplemental income. Any income that doesn’t involve an exchange of goods or services (Source). The OECD tracks both before and after tax. England has the same GINI index as the U.S. in pre-tax income, but their tax system reduces inequality more than the U.S.”

Cain shrugged. “What’s the GINI for Mexico?”

Abel flicked a finger across his phone. “Wow. The same as the U.S. after taxes. Boy, I thought we would be better than Mexico. Let’s see, what about Slovakia? No, that breaks the trend. They have an even lower GINI index than Great Britain, so more equality, and a low life expectancy as well.”

Cain smiled. “Every time I think, ‘that’s the key indicator,’ the data throws me a curve.”

Abel said, “So far what we are seeing is that average income has a strong influence on life expectancy but not the distribution of income. Is that the secret sauce to longer life expectancy? Raise average incomes?”

Cain replied, “It’s not that simple. We have a high income but relatively low life expectancy. But comparing the U.S. and Great Britain over time was interesting. Forty years ago the two countries had the same life expectancy. Since then the U.S. has averaged 3.6% real GDP growth (Source). That means that real GDP doubles in 20 years. Great Britain, on the other hand, has had only 2.5% annual growth, so it takes like 28 years for their GDP to double. Yet improvements in U.S. life expectancy have been far lower than Great Britain over that time.”

Abel asked, “What about healthcare spending? Inefficient overspending on healthcare and the military increases GDP. Any insights there?”

Cain sighed. “Well, you have a point there. The U.S. spends the highest amount of developed countries on healthcare, almost double the average (Source).”

Abel replied, “So other countries are spending less and getting better health outcomes. The public-private partnership in U.S. healthcare is not working and is not efficient. Are you ready to endorse universal health care?”

Cain smiled. “Them’s fighting words. Mexico has universal health care and it’s life expectancy is worse than the U.S. The same story for Slovakia.”

Abel argued, “Yeah, but Mexico and Slovakia are both rated poor in healthcare quality and innovation. The U.S. has good quality health care and the highest innovation ranking, but poor access and a fiscally unsustainable system (Source). Quality healthcare has to be accompanied by easy access to care. Will you agree with that?”

Cain frowned. “On the face of it, yes, but there are all these other factors we’ve looked at. This is a big country.”

Abel asked, “Ok, what about population density? There was a .5 correlation between life expectancy and density among the states.”

Cain nodded. “That was weird. It was the same between countries, so density has some effect on life expectancy, but the stronger factor was income.”

Abel frowned. “That’s surprising. In many European countries, the government provides healthcare so income should be a weaker factor.”

Cain replied, “The contradictions in these indicators drives me nuts. That’s why I say it’s too complicated to point to one or even two factors and say, ‘fix these and you’ll fix the problem.’”

Abel argued, “Well, we can’t sacrifice the good for the perfect.”

Cain studied the pancake on his fork for a moment. “I want simplicity. I dream of a society where we make clear rules, a society where people play by the rules.”

Abel laughed. “I was reading a book by David Graeber this week called The Utopia of Rules. He says it’s a wish that many of us have. You know, everybody knows and plays by the rules and those who play by the rules can win.”

Cain lifted his eyebrows. “Yeah, it seems like it’s the cheaters who win. That was the bitter truth that many of us learned during the financial crisis. No accountability for the cheaters.”

Abel argued, “Even before that. No accountability for actions in the Iraq war. Abu Ghraib. Hollywood had constructed a noble portrayal of American soldiers in combat. John Wayne. Gregory Peck and the like. Torturing prisoners was something the North Koreans and Chinese did. Not American soldiers.”

Cain sighed. “A reminder of Vietnam? Something’s happened in the past few decades. I’m still trying to get my head around it.”

Abel replied. “Graeber talks about sovereignty, something we normally associate with countries. In the post-Watergate consensus, Congress put constraints on the president. That’s changed in recent decades after 9-11, when Congress began to defer to the president. As Graeber notes, presidents can now order people assassinated, extradite prisoners of war to places where they can be tortured. They can conduct surveillance on ordinary citizens with flimsy pretext and sporadic oversight.”

Cain leaned back in his seat. “In Trump v. United States (Source) last year, the court conferred legal sovereignty on a president. A former president has absolute immunity for ‘official acts,’ although the court declined to define those. They used a previous 5-4 decision in Nixon v Fitzgerald holding that a former president had absolute immunity against civil litigation for damages.”

Abel argued, “But Trump v. United States was a criminal matter, not civil. The court just expanded the scope of the previous decision. I mean, this court has overruled previous court precedents about abortion and gun rights made during the 1970s. Then they base their ruling on a closely decided case in 1982?”

Cain nodded. “They created a radical expansion of presidential immunity, then didn’t have the backbone to establish any limits on official acts. I mean, Fitzgerald was a civil case about back pay and wrongful employment termination, not trying to overturn an election. To use that as a basis for their decision indicates just how arbitrary the conservative justices have become.”

Abel argued, “They might say that it is incremental jurisprudence.”

Cain smirked. “Incremental policymaking is a hallmark of our political system. That’s what these conservative justices have become. Activist politicians.”

Abel raised his eyebrows. “Why did you vote for him?”

Cain took a deep breath. “You keep asking me that. The better of two bad alternatives. Why did you vote for Harris?”

Abel laughed. “The better of two bad alternatives.”

Cain replied, “I thought that there was still a Republican Party that would restrain Trump’s impulses. The party is gone. Only the nationalist radicals and hesitant members remain. The name is an empty shell.”

Abel said, “Last week, you mentioned activist courts and an activist executive branch. I don’t attach much meaning to the word. If people don’t like certain policies they attach the word “activist” to whoever made the policy.”

Cain shook his head. “You’re right. A lot of people do that. I mean it in the sense that some political actor makes a rule that makes it likely there will be more rules to refine that first rule.”

Abel argued, “We’ve got a complex society managed by a big bureaucracy. The proliferation of rules is inevitable.”

Cain took a sip of coffee. “Those are procedural rules. What I’m talking about is something different. ‘Principle’ would be better rule. Like sailors back in the old days using the north star as a guiding rule. Then they had a bunch of procedural rules to help them keep to that guiding rule.”

Abel interrupted, “You said political actors made the rule. So you’re not talking about some rule made at an office meeting.”

Cain nodded. “Right. The Supreme Court’s Heller decision in 2008 established an individual right to have a gun (Source). Since then there have two more decisions. McDonald in 2010 extended that right to include the states. The Bruen decision in 2022 ruled that gun laws could no longer use state interests as a balancing test. They had to be consistent with historic tradition. Three cases in fourteen years made it to the Supreme Court? That indicates that the Heller decision was not a well constructed principle. Of course, that applies to a lot of laws.”

Abel replied, “So compare that to Roe, the abortion decision in 1973. The Casey decision in 1992, then Gonzalez in 2007. That’s 34 years for two refinements.”

Cain nodded. “Someone could argue with the reasoning in Roe, but the length of time between refinements of the rule indicates that it was a well constructed rule, as rules go.”

Abel continued, “Maybe I’m not clear on the distinction. If the precedent or outcome of a rule is flawed, how can it be a good rule?”

Cain smiled. “A rule should be clear. It should have as few exceptions as possible.”

Abel looked doubtful. “That’s unreasonable. Take, for example, the rule against killing. There are lots of exceptions. War, self-defense. Is abortion an act of killing? Depends on your definition. Hunting animals? Isn’t that killing? This is the real world. It’s complicated.”

Cain smirked. “Of course it is. I said, ‘as few exceptions as possible.’ I didn’t say ‘no exceptions.’ When lawmakers make rules, they should ask themselves, ‘Does this rule invite a lot of exceptions? How can I change the wording of the rule to reduce exceptions?’ It’s just a principle to keep in mind.”

Abel asked, “So give me an example of a rule that you like as a rule, even though you might disagree with the reasoning.”

Cain barely paused. “The DOGE cuts. The rule was simple. Cut anyone who had less than a year’s employment, I believe. While the rule was clear, it produced undesirable outcomes. They had to hire some critical people back. We won’t know the full impact of the DOGE cuts for a while.”

Abel nodded. “They will cover up the mistakes. That decision was more a programming rule. Code in a criteria and get a list of employee names, then give them notice. Can you think of a law, like something that a legislature deliberated over?”

Cain stared into his coffee cup as though it held the answer. “How about a so-called bathroom bill? They are clear. Only people of a particular sex as listed on their birth certificate can use a single sex bathroom (Source). I might sympathize with people who are struggling with their gender identity. But the language of the bill is clear.”

Abel shook his head. “That, to you, is a good rule? How many of us carry our birth certificates with us when we use the bathroom? It has an impractical condition.”

Cain nodded. “But that’s not what I’m talking about. That’s the distinction. The language of the bill itself is clear. Take for instance the 1972 Clean Water Act. It gave the EPA regulatory power over the ‘waters of the United States.’ Courts and agencies have been fighting over that term and its, let’s see, boundaries for decades. What does that term include and exclude? A clear rule has terms in it with good boundaries.”

Abel frowned. “The Supreme Court often asks what is the limiting principle.”

Cain replied, “Yeah, a good defining characteristic.”

Abel asked, “So you don’t like the term ‘general welfare’ in the Constitution.”

Cain smiled. “You’re right. I don’t. The anti-Federalists at the Constitutional Convention didn’t like it either.”

Abel nodded. “Right. Yeah, Michael Klarman discussed that in his book ‘The Framers’ Coup.’ Did you ever think that politicians might purposely choose a term that has no clear boundaries? It’s the only way that lawmakers can agree on something. The astronomer Carl Sagan once said that people find agreement when they use a broad term like ‘God,’ which encompasses a lot of different concepts (Source).”

Cain nodded. “Good point. It’s a way of kicking the can down the road. It signals that lawmakers wanted to complete some law, to claim an accomplishment when there were still parts not done. So they take the undone stuff, the stuff they can not agree on, and slap a label on it, like ‘general welfare’ or ‘waters of the united states.’”

Abel set his glass of water down. “Those conservative justices who use a textualist approach to analyze a case may be looking at text that was written using ill-defined terms, terms without clear boundaries, to use your term. The textualists claim that their approach is grounded in empirical evidence, but the evidence itself, the text of the law, lacks definition.”

Cain smiled. “I like that connection. It shows the limits of any judicial interpretation.”

Abel replied, “So let’s get back to activist policies. You sounded fed up last week.”

Cain nodded. “Yeah, Democrats are activist. That’s their brand. A hallmark of the Republican Party used to be a certain policy restraint, a prudent caution. No more. It’s so disappointing and it leaves a lot of voters like me in a political limbo. Neither party represents our approach to governing. You know, quit meddling. This tariff business is meddling in the extreme.”

Abel raised his eyebrows. “It was a Republican president and strongly Republican House and Senate that initiated the Smoot-Hawley tariffs in 1930. They imposed tariffs on more than 20,000 goods.”

Cain interrupted, “And imposed no tariff or low rates on a lot of goods. As I said, the hallmark of a badly constructed rule is a lot of exceptions.”

Abel continued, “Ok, the tariffs were activist policymaking by Republicans who held the Presidency and strong majorities in the House and Senate. The Republicans are all about restraint. They restrain free trade, individual choice, government support of child care, to name a few.”

Cain smirked, “Like the Democrats don’t do the same. Restrict guns, oil and gas drilling, dictate to automakers the kinds of cars they can produce. I mean, it’s the Democrats who created the bureaucratic state. All that rule-making limits choices.”

Abel laughed as he slid out of the booth. “Ironic. In his book, David Graeber writes about a paradox. He calls it the Iron Law of Liberalism. When a government tries to promote the free market, it often creates even more regulations. In their own way, both parties are guilty of making too many rules, of creating bureaucratic tangles.”

Cain looked up at Abel. “I wish we could change that somehow. See you next week.”

Abel gave a short wave. “I’ll pick up the check. Till next week.”

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Image by ChatGPT

Equity and Equality

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This week the debate over the minimum wage continued in the Senate, on C-Span, other news outlets and social media. The Wall St. Journal presented the minimum wage in Big Mac terms. In 1968, it took 18 minutes of minimum wage to buy that iconic hamburger. Today, it takes 30 minutes of minimum wage. Using that as a guideline, the minimum wage should be at least $12.

Why don’t Democrat politicians propose a minimum wage that varies according to each region’s cost of living (COL)? According to survey data, Colorado’s COL is 73% of California’s COL (MERIC, 2021). Using that as a guideline, Colorado’s minimum wage would be about $11, the same as the current minimum. Missouri’s minimum would be $8.35, which is LESS than the state’s current minimum of $8.60. Many states have implemented a $15 COL-adjusted minimum wage.  

Advocates for a uniform minimum wage argue that they want to erase some of the disparity between urban areas and low paid rural regions, many of which are black or Hispanic. Those in rural areas worry that small businesses will lay off workers, driving the unemployment rate higher than it already is. Others worry that businesses will raise their prices, making it more difficult for those on fixed incomes. In that case, the minimum wage would benefit some at the expense of others.

Twenty years ago, an analysis of minimum wage increases and employment data found only one statistically significant correlation: increases had a minimal effect on teenage employment (Burkhauser, Couch, & Wittenburg, 2000). Other studies have found no effect on employment in the fast-food industry. A recent study examined minimum wage increases in the states and found that increases greater than a $1 had a negative impact of 1% on low-skill employment (Clemens & Strain, 2018). Smaller increases had either no effect or a positive impact. How can we have an informed debate if history does not provide a clear lesson?

Since Plato’s time 2500 years ago, we have wrestled with equality, equity, and justice. Equity measures by outcome, varying the inputs until the outcomes are about the same. Equality measures by inputs; if everyone gets the same chance, the same inputs, then equality is satisfied. Plato argued that justice was an individual functioning well within community. Some of his companions in The Republic argued for alternate versions of justice: that it was the interests of the stronger, that it was helping friends and harming enemies, or telling the truth and paying your debts.

John Maeda posted a Tony Ruth graphic that depicts these concepts of inequality, equality, equity, and justice (2019). Two kids stand on opposite sides under a leaning apple tree so that one kid below the overhang gets most of the apples that fall. That is inequality. They are both given a ladder of equal height; since they each have the equal tools, that is equality. The kid below the overhang is given a shorter ladder to compensate for his better opportunity at picking apples; that is equity. Justice is the equalization of opportunity and tools; using braces and ropes, the tree is straightened, and each kid is given the same size ladder. Justice is both equity and equality.

As a society we often can’t straighten the tree; if we could, who pays for the labor, braces, and ropes? Who owns the ladders? Writing 500 years ago, Machiavelli said that a republic is the best form of government because the two main political classes of society constantly wrestle with these issues. The two groups may be labeled nobles and common people, or Republicans and Democrats, but they are essentially a tug of war between these notions of equity and equality. One group champions equity over equality; the other fights for equality as a priority above equity.

As we listen to debates in Congress, the workplace, and our households, we can identify those two elements. The argument then evolves into the particulars of process, and this is used to justify either side of the equity / equality debate. Machiavelli wrote that people make fewer mistakes when they focus on the particulars. In working out the details we uncover the broad issues that we tussle over. The road of history is curved; to keep from running off the road, we adjust the steering wheel left and right, repeatedly correcting our previous course corrections. This is a time for correction.

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Photo by Splint on Unsplash

Burkhauser, R. V., Couch, K. A., & Wittenburg, D. C. (2000). A reassessment of the New economics of the minimum Wage literature with monthly data from the current population survey. Journal of Labor Economics, 18(4), 653-680. doi:10.1086/209972

Clemens, J., & Strain, M. R. (2018). The short-run employment effects of recent minimum wage changes: Evidence from the American community survey. Contemporary Economic Policy, 36(4), 711-722. doi:10.1111/coep.12279

Maeda, J. (2019, March 11). Design in Tech Report 2019 | Section 6 | Addressing Imbalance. Retrieved March 06, 2021, from https://designintech.report/2019/03/11/%F0%9F%93%B1design-in-tech-report-2019-section-6-addressing-imbalance/

MERIC. (2021). Cost of living data series. Retrieved March 06, 2021, from https://meric.mo.gov/data/cost-living-data-series

Minority Control

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October 13, 2019

by Steve Stofka

On September 15, 2008 the trading firm Lehman Brothers declared bankruptcy. A small number of outstanding shares traded on the stock market that day. The SP500 lost almost 5% of its value. New Yorkers gathered in Times Square to watch the ticker tape display. A small number of people controlled the direction of the market and constructed a reality that they sold to the rest of us.

In politics, a few key people control the direction and fate of legislation. In the Senate, the Majority Leader decides whether to bring legislation up for a vote. Even if a bill makes it out of a Senate committee, the Majority Leader can stop it from reaching the full Senate.  Unlike the Majority Leader in the House, his position is practically impregnable. Legislation vetoed by the President can be overridden by Congress. There is no recourse to a veto by the Senate Majority Leader.

The current holder of the position is Sen. Mitch McConnell from Kentucky. He is up again for re-election next year. When Democrats held the Senate, Sen. Harry Reid ruled with a similar disregard for others in his own party as well as the minority.

In 2014, 800,000 voters chose McConnell. In effect, less than 1% of the country’s voters control the course of legislation in the U.S. Did the founders of this country intend that one person should control Congress? James Madison, the chief crafter of the Constitution, worried that a majority would overwhelm and take advantage of a minority (Feldman, 2017). Accordingly, the Constitution is structured so that a minority controls power. However, one person is a very small minority. What would the founders think of the current arrangement in Congress? If Americans wanted a king with veto-proof power, America would still be a colony of Britain.

Our method of electing a President is a 230-year-old compromise between republicanism and democracy. An electoral college composed of men not subject to the passions of the crowd would elect the leader of the country. It was an Enlightenment model of dispassionate rationality.

Even if they had Fox News and CNN on Election night at the time of the founding, all the thirteen states were in the same Eastern time zone. At a recent symposium on our election, former RNC chair Michael Steele pointed out the west coast states are mostly taken out of the Presidential election (C-Span.org, 2019). By 5 P.M. Pacific time, they are discouraged from voting because much of the action has already been called. The founders did not design a system for four time zones.

We have 50 states but the election for President takes place in eight to twelve battleground states. Most polling is done at the national level, not in the battleground states. Many polls do not accurately survey the sentiments of the critical minority of voters in the states that will decide the election.

A minority of people own and control much of the wealth of the world. They now pay a lower percentage of their income than the bottom 50%. That includes federal, state and local taxes. In the Triumph of Injustice, due to be released next week, authors Saez and Zucman (2019) tally up the tax bills for the rich and ultra-rich. The book is #1 bestseller at Amazon and it hasn’t been published yet.

In 1980, the top 1% paid 47% of their income in total taxes at all levels. Now they are down to 23% and below the rate paid by the bottom half of incomes. Two sets of rules – one set for the peasants and one for the castle royalty. The Constitution prohibits the granting of titles so the rich granted themselves the titles. This book is sure to get a lot of media attention. Like we need more controversy.

Notes:

Feldman, N. (2017). Three Lives of James Madison: genius, partisan, president. [Print]. New York: Random House.

C-Span.org. (2019, October 7). National Popular Vote Election, Part 2. [Video]. Retrieved from https://www.c-span.org/video/?464997-2/national-popular-vote-election-part-2

Saez, E. & Zucman, G. (2019) Triumph of Injustice: How the Rich Dodge Taxes and How to Make Them Pay. [Print]. Available for pre-order at https://www.amazon.com/Triumph-Injustice-Rich-Dodge-Taxes/dp/1324002727

Effective tax rates: If you make $100,000 and you pay $25,000 in federal, social security, state, sales and property tax, then your total effective tax rate is 25%.

Photo: WyrdLight.com [CC BY-SA 3.0 (https://creativecommons.org/licenses/by-sa/3.0)%5D Page URL: https://commons.wikimedia.org/wiki/File:Bodiam-castle-10My8-1197.jpg

Piketty’s Capital

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May 25, 2014

No graphs this week!  Awwww!

A few months ago, Thomas Piketty, a French economist, released Capital in the 21st Century, a book that I mentioned to readers back in January before its publication.  Piketty’s book has aroused much interest, praise and denunciation.  What could arouse such fire in the hearts of men, you ask?  Inequality.  We humans are a social bunch and, like our chimpanzee cousins, are especially sensitive to inequality.  “She got more chocolate milk than me!  It’s not fair!” is a familiar lament to many parents.

To understand Piketty’s thesis, let’s review some fundamental concepts of capital and income.
“Income is a flow…the quantity of goods produced and distributed in a given period…Capital is a stock…the total wealth owned at a given point in time.” (p. 50)  Piketty’s thesis is based on a ratio of the capital of a nation to the national income.  His definition of capital is so encompassing that my immediate suspicion was the accuracy of estimates of the total wealth of a nation, a flaw that Piketty acknowledges.

The main thesis of Piketty’s book is: as the capital wealth of a nation accumulates, capital’s share of annual national income increases.  For long periods, the rate of growth of accumulated capital is larger than the growth of the economic output/income of a nation.  The process is self-perpetuating, so that capital takes an ever increasing share of national income.  The higher the capital/ national income ratio the more inequality of wealth and income.  Piketty estimates that, in 2010, the capital/income ratio was 450% for the U.S., a bit above Germany and Canada’s ratios, and far below those of France and Great Britain. Piketty proposes a solution to this inexorable process:  a progressive tax on wealth.  Mount up your steeds, men!  The Marxists are coming!

Wealth = Capital

I’ll begin a review of some criticisms of Piketty’s methodology with a brief primer on some measures of capital.  Economists and accountants often analyze the flow generated by a store of capital, but it is capital that can be more easily counted. In finance, there is a metric called Working Capital Turnover Ratio which calculates the flow of sales from the working capital of a firm, and is used to assess both the value and liquidity of a firm.   Piketty rarely uses the term liquidity in his book, but I think it may be an unstated implication of his work.

ROIC, or Return On Invested Capital, is frequently used to measure how well a firm uses the capital and debt invested in the firm to generate a profit.  These measure net after tax profits as a percentage of the stock of capital and debt in a business.  Piketty also measures flow but it is sales, not profits that is his primary focus.  Profits are of course an intrinsic component of sales since they are that portion of sales income that is left over after all expenses.  The change in real GDP is the percent change in that flow.  Piketty’s concern is the accumulation of the residual of past economic flows, the stock of wealth that he claims earn a greater rate of return than the increase in the annual flow of economic activity.  Capital is a key component of economic growth but Piketty raises concerns that Capital can become too large relative to the flow of economic activity.
  
Hopefully, this brief background will enable the reader to appreciate the criticisms of Piketty’s thesis.  Charles Gave is a forty year veteran of investment management and cofounder of the international investment firm GaveKal.  Coming from the world of finance, Gave understands capital as meaning invested capital or working capital. Keep that in mind as you read Gave’s denunciation of Piketty’s thesis:

The extraordinary thing is that Piketty’s analysis is based on a massive logical error. His thesis runs as follows: if R is the rate of return on invested capital and if G is the growth rate of the economy, since R is greater than G, profits will grow faster than GDP, and the rich will get richer and the poor poorer. This is GIGO (garbage in, garbage out) at its most egregious. Piketty confuses the return on invested capital, or ROIC, with the growth rate of corporate profits, a mistake so basic it is scarcely believable.“ [Gave’s emphasis]

On page 46 of his book Piketty writes: “In this book, capital is defined as the sum total of nonhuman assets that can be owned and exchanged on some market.”  While this includes invested capital, it is not solely invested capital, for it includes residential real estate, government capital, land and natural resources, some of which are very difficult to value.

In short, Gave read “invested capital” when Piketty wrote just “capital.”  Gave read “corporate profits” when Piketty wrote “return on capital, including profits…” (p. 25).

The economist James Galbraith takes issue with Piketty’s all inclusive  definition of capital: “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.”

Piketty anticipated his critics: “some definitions of ‘capital’ hold that the term should apply only to those components of wealth directly employed in the production process…Capital in all its forms has always played a dual role, as both a store of value and a factor of production.  I therefore decided that it was simpler not to impose a rigid distinction between wealth and capital.” (p. 47) 

Let me rephrase the ” R is greater than G” formula that piqued Gave’s derision.  Picketty uses small ‘r’ and small ‘g’ so I will adhere to that: the annual income r derived from capital, as a percentage of that capital stock, will be more than the annual percentage change in real, or inflation adjusted, income/output g.  As Piketty writes: “the inequality implies that wealth accumulated in the past grows more rapidly than output and wages.”

An example:  In the teeny tiny kingdom of Miniscule, the total nonhuman capital stock at the beginning of this year is $100.  It  generated output/income of $10, or 10%. That is r, the return on capital.  This income from capital was part of Miniscule’s total output/income of $30, an increase of $2 over last year’s income/output of $28. To keep the math simple, let’s pretend there was no inflation or depreciation in that year.  The growth in total income/output is about 7%, or $2 / $28.  That is g, the growth rate of output/income.  To recap,  r = 10%, g = 7%.  “r can be significantly higher for long periods of time than the rate of growth of income and output, g.” (p. 571) Is this true?  That’s what Piketty claims to show.

Like Galbraith, I question Piketty’s inclusion of many different forms of wealth which are difficult to measure.  Piketty acknowledges the difficulties in the appendix to a paper he co-authored with Gabriel Zucman in December 2013, “Capital Is Back” and is included as one of the data sources for his book.  Piketty’s thorough explanation of the shortcomings of capital measurements led me to scratch my head and wonder why he decided to include them.

Piketty has no control over accounting conventions adopted by international bodies, yet I’m sure he and his team will be taken to task for the computation of the data that is the responsibility of the various nations included in the study.  A big shout out to Piketty and his collaborators for making the data available.

Back to our tiny kingdom of Miniscule. What if we missed some capital in our tally?  If the capital stock were closer to $120, not $100, then ‘r’, the return on capital would be 8%, not $10% and approximately the same rate of growth as the economy as a whole.

How accurate are the public, or government, capital computations?  In the U.S., the Comptroller General is responsible for auditing the financial statements of the country as part of the Federal Budget.  For ten years, from 1998 – 2008, Comptroller General David Walker refused to certify the financial statements,  listing a number of accounting problems: inadequate  monetary controls, poorly supported adjustments, outdated computer systems, unsupported cash disbursements, an inability to track internal or external fraud and a poorly documented inventory system.  These flawed financial statements are the basis for the capital computations in Piketty’s book.  In the appendix to Capital Is Back, Piketty explains the methodologies used by different nations.   Implicit in these standards is that public capital is understated in the national accounts.  This undervaluation decreases the capital/income ratio while increasing the r, or rate of return, of the capital stock.  Piketty notes the deviations in the various computations of land capital.  In the U.S. only the value of agricultural land is measured (Appendix p. 15).  A vast store of capital in 770 million acres of range land (Source) , more than half of which is private, is thus uncounted, further inflating the r, or return on capital.  70% of the land surface in the U.S. is devoted to livestock grazing (Source). A fundamental weakness in cross country valuations is the assumption that developed countries are more or less similar in most respects.  Key differences in the composition of economies are  factored out of the models.

Human Capital

Piketty separates capital into two categories: human and non-human, including only that non-human capital that can be traded on a market.  This exclusion of human capital may be an appropriate methodology in an analysis of an agrarian economy but is not so when applied to the developed economies of today which rely much more heavily on the human capital amassed through education. This point has been raised by economists Robert Solow and Robert Gordon and Piketty acknowledges this on page 586, note 35.

What are the implications of including educational capital?

Today a person may spend $40,000 to $150,000 to get a college education and expects an inflation adjusted return on that investment  that is greater than the 4% one could get investing in long term Treasury bills.  Developed economies depend greatly on the capital investment that they make in educating most of the young people in a society.  An educated mind is both a capital investment and a leaseable, if not outright tradeable, commodity.  While an employer can not buy an employee’s brain the way one can buy a machine, an employer does lease the knowledge, the output from that brain, by paying a compensation premium to that employee.  Income data from the Census Bureau, the IRS and the Bureau of Labor Statistics enables us to quantify the implied store of value of a college education.  If Piketty’s expansive definition of capital were to include educational capital, what would the resulting capital/income ratio look like?

The Bureau of Labor Statistics estimates an annual return of approximately $24,000 in 2013 for a bachelor’s degree. In 2011, the Census Bureau estimated the number of people in the U.S. with college degrees at 63 million, or 40% of the workforce.  If we guesstimate an average cost of $50K per degree, that is over $3 trillion of capital investment not counted, almost 20% of the $17 trillion in GDP (BEA News Release)  If we were to use the international standard (System of National Accounts) method of computing the present value of a college degree using an average 4.5% return (p. 572), then the capital value of a college degree over a working period of 35 years is over $400,000 per degree and the total is $26 trillion in uncounted capital, 150% of the nation’s GDP.   That inclusion would add $26 trillion to the $65 trillion capital base of the U.S. (p. 151)

If educational capital were included,  the capital/income ratio in the U.S. in 2010 would rise to 620%, far above the 450% calculated by Piketty’s team.  The higher this ratio, the greater the inequality in income and wealth.  By excluding educational capital, Piketty has understated his thesis.  Like Galbraith, I would exclude land and natural resources that are impossible to value.  Unlike Piketty and Galbraith, I would include educational capital, since it is a productive capital.

If we use the BLS figures and guesstimate that 63 million people with college degrees earn an additional $24K per year, then the share of income attributable to capital would increase by $1.5 trillion, from $4 trillion to $5.5 trillion.  As a share of national income, the income from capital would increase to 38% from 28% (p. 222)  The return on capital, r, would stay about the same at a bit over 6%, and more than twice the growth rate of national income in the U.S.

Liquidity

Piketty does not mention the liquidity of a national economy but implies it.  As the capital of a nation becomes more concentrated in a rather small group of families, individuals, and endowments, the trading of capital takes place within a small pool.  The onset of the 2008 financial crisis revealed that a small coterie of investment firms, sovereign funds and mega-banks traded financial instruments among each other.  Contagion in one class of asset – mortgage backed securities – poisoned the financial pool.  Like a gene pool, diversity is the key to survival.

As capital’s share of national income becomes greater, the buyers of capital as a percent of the population shrinks.  Fewer buyers = lack of liquidity.  A nation does have an abiding interest to reduce threats to the stability of its financial system.  The mobility of capital in the global world of finance may be hiding an underlying lack of liquidity.

Solutions

To offset the increasing accumulation and concentration of wealth, Piketty recommends (p. 517) a progressive wealth tax, ranging from .1% to .5% for most Americans, those with assets of less than 1 million euros, $1.36 million dollars at today’s exchange rate.  Piketty is not done yet.  He notes that the progressive income tax taxes only the income from inherited wealth.  In some countries in Europe, that capital income is exempt from the income tax (p. 496).  Piketty advocates a return to the confiscatory income tax rates of the early half of the 20th century (p. 512 – 513), citing an optimal top tax rate at above 80%.  Bill Gates and Warren Buffett have both pledged to give away most of the billions they have amassed.  Why bother, guys?  If Piketty’s solutions were implemented, the politicians bickering on C-Span every night will take care of that for you guys.  In the U.S. the Constitution would have to be amended if the Federal Government were to enact a wealth tax because the 16th Amendment allows only a tax on incomes.  However, that does not prevent the States from enacting such a tax.

Will a wealth tax solve the problem of growing inequality?  In principle, in a mathematical utopia – the kind of world that economists assume in their models – governments would take corrective action by taxing wealth, thereby offsetting the growing accumulation  and concentration of capital and its increasing share of national income.  Unfortunately, we don’t live in that world.  In the real world, politicians – real people that you and I know – would say “Hey, this is a great excuse to grab more money from the private sector to solve problems!  Solving problems wins votes!  Votes get me re-elected!”  Politicians love problems, and solving them.  That’s why they create so many of them with their policies.

If people think income tax reporting and accounting is a nightmare, wait until they see the wealth tax forms.  Since the rich would pay a progressively higher tax, they would be highly motivated to develop ways of sheltering assets.  The hiding of wealth will become a national pastime.  Gold miners and dealers are shouting “Huzzah!”  Accountants and lawyers will cook up complicated investment vehicles that offer rapid depreciation of assets to reduce the amount of notional wealth one has to report.  Insurance companies will lobby for the purchase of annuities that are then excluded from one’s wealth.  The lobbyists are singing in the streets.  Strike up the band and join the tax parade!

In short, I heartily endorse this proposal just as soon as I sell my house, convert any assets to gold and find a private island in the Caribbean where I can bury my assets in the sand. I do heartily recommend this book, though. The book contains far more that caught my interest than I can touch on – public and private debt and capital, a survey of income taxes in developed countries, to name a few. The author has taken great pains to lay out historical trends in the data, acknowledging and anticipating many objections.  But, like the old country doctor, Dr. Piketty has but one solution. Got a problem?  Add another tax and call me in the morning. I also salute the translator, Arthur Goldhammer, for the flow and grammatical construction of his  English translation.

Next week I’ll look at another disturbing and related topic – education.  A recent analysis suggests that the financial advantage of a college education may be eroding.