Calculus of capitalism

Shahid Mehmood discusses inequality and its causes

Calculus of capitalism
Over the course of the last decade, French economist Thomas Picketty and Emmanuel Saez have been in the news for their pioneering research on inequality. Both of them have managed to bring to fore an issue that had been pushed remote corners of the field, especially in the presence of heavyweights as monetary policy and economic growth.

A few years ago, Picketty gained an almost immortal status in economics with the publication of his bookCapital in the 21st Century. It is an exhaustive study of capital, its attributes and its returns over the course of two centuries. Many reviewers have put it right up there with Karl Marx’s Das Kapital, another magnum opus. That book, in case the reader has not heard of it, by communism’s founding father was all about the rise of capital, its attributes and how the capitalist uses capital to take advantage of miseries of lower classes.

Picketty’s book became an instant hit, which was not surprising given the misgivings about working of capitalism in the aftermath of Great Recession of 2008 . Moreover, it is becoming an intellectual weapon in the substantially diminished armoury of anti-capitalist’s and Marxists cum communists. However, my argument is that the joy of anti-capitalists is a bit misplaced, and it represents a case of reading too much into a specific perspective. Moreover, I will argue that economics is not simply a case of black and white; there are no clear cut answers to vexing questions like the use of capital and its returns. Circumstances change, and so do perspectives.

This kind of analysis of single component of economic activity is labelled as partial equilibrium analysis in economics’ lexicon, and is done by keeping other components (and any change in them) as constant. As anybody can guess, this is impractical since things don’t stay constant when circumstances around it are changing. This is even truer in economic activity where a change in one variable leads to changes in other variables (for example, income). Majority of the interpreters of the book seem to have fallen into this trap. Over the course two centuries of study of capital, other variables never stayed the same. A full analysis (which is extremely difficult, if not impossible) would have taken into account every change due to a change in composition of capital and its returns. I have little doubt that the book probably represents ground breaking research, but it is partial in nature. Therefore, it seems a bit futile to attempt to make definitive interpretations from a book that focuses solely upon returns.

Is inequality itself a problem? If so, why? That is the real question to ask, rather than merely frowning at inequality. There are reasons that give rise to inequality, and its effect upon the economy and the society that should be the subject of study. Inequality that arises out of rent seeking and unfair means is rightly condemnable. As many writers on economics have rightly pointed out, substantial part of inequality in developing countries can be explained due to these factors. But one has to address the question whether factors like rent seeking are the fault of a particular system? And the answer is no. It is not the fault of a particular economic system; rather, it is the exploitation of that system by agents (individuals and groups) plus the lack of institutional options to check these sorts of abuses that give rise to inequality. I agree that the returns on capital in this kind of system are socially and economically unfeasible, and should be curbed.

But what about the inequality that arises due to fair means, industriousness, hard work and intellect? The examples of people like Bill Gates, Warren Buffet and Carlos Slim are in front of us. They made their wealth by the sheer dint of hard work and their intellectual abilities. Moreover, what they accomplished in the process of accumulating their wealth has benefited the society as a whole. Bill gates’ hard work and intellect has spawned a whole industry, and millions earn their sustenance through working in it. Now should Bill Gates be punished for having wealth, or earning returns on his wealth? Any person with an iota of fairness in his conscious would surely say no to this. Interested readers can compare the list of top earners in the Wall Street in 2000 and now to see that some of the big names at that time have vanished now. This does not owe to rent seeking but to Schumpeterian ‘creative destruction’, whereby the most creative survive a competitive environment.

And if he would like to pass on his inheritance to his children, then why is it anybody’s problem? After all, he has worked hard for earning what he has, and he has earned the right to do whatever he wants to do with it. History is replete with examples of prodigal sons and daughters who lost their inheritance within a generation or two since they were not in the same league as their predecessors. In essence, a society with an institutional and legal setup based on fairness, hard work and intellect ensures that such inheritance does not remain forever in case the inheritors do not possess these traits. So if the inheritors have managed to hold on to their inherited capital and made returns out of it, it must be that they themselves possess some of characteristics of their forefathers that made them wealthy in the first place.

Capital accumulation and economic growth definitely have an inherent outcome in the form of unequal incomes, but the question should also revolve around social outcomes. By all means, curbing capital accumulation through unfair means (like monopoly) is advantageous. One way to do it is through higher taxation. But in societies where capital accumulation rests on thrift, intellect, hard work and use of human capital, a high tax on capital is a disincentive since it is a deterrent to capital accumulation through fair means. Why should one work hard, invest time and intellect if he knows that ultimately a large chunk of his income would be confiscated later on in the name of making society equal?

Let there be no doubt that Picketty’s book is a ground breaking work on a difficult question confronting a society and its policy makers. Leaving everything aside for a moment, the amount of data that he has gathered (two centuries at least) is just astounding. What lessons can be drawn from Picketty’s research? Inequality is part of every society, and it is as much a matter of perspective as of economics. In general, the most important lesson that one can learn from all the research done on capital accumulation, returns on capital and the resulting inequality is that there should be a level playing field for every individual. Social, economic and legal institutions should be set in place that ensures that intellect and hard work is rewarded. In these kinds of societies, capital accumulated through unfair means is hard to come by. Even if capital is accumulated through unfair means, it tends to dissipate within a few generations.

Let there be debate upon the merits and demerits of capitalism, but the debate should rest upon a base that takes into account all the relevant aspects.

The writer is an economist

The writer is an economist. He tweets at @ShahidMohmand79