Monday, April 14, 2014

R vs. g

In his new book, Thomas Piketty argues that R, the rate of return on capital (which is different than the safe interest rate "r") is greater than g, the rate of economic growth, and that this fact can be expected to continue into the indefinite future, resulting in an ever-rising capital share of income and an ever-falling labor share. The big question is whether R really will be greater than g into the foreseeable future.

It occurs to me that this is just the "robots vs. globalization" argument all over again. 

The "robots" argument basically says: "Labor" is just the flow income from renting out one specific type of capital, i.e. human capital. If technology continues to make more and more obsolete, then the value of human capital will fall as a percentage of total capital, and thus labor's share of income will continue to fall toward zero. That's the scenario I considered in this Atlantic article a while back. This thesis is supported by the research of Loukas Karabarbounis and Brent Neiman, and is often labeled the "rise of the robots" in econ blog discussions.

The "globalization" argument basically says: In 1973, when the world finally began re-globalizing after the period of restricted trade brought about by the world wars, there was a lot of labor with very little capital, in China and India and Southeast Asia and Latin America and Africa and the communist bloc. Capital was scarce, and was highly concentrated in rich countries. After trade barriers started falling, all that labor was dumped on global markets, resulting in a global labor glut and capital shortage, raising the return to capital and decreasing the return to labor. That imbalance will eventually right itself, but only after enough time has passed. This thesis is supported by the research of Michael Elsby et al.

These explanations aren't mutually exclusive, of course. But in terms of policy, if the "rise of the robots" is the biggest factor, we need to think about all kinds of difficult policy decisions and welfare arguments. But if globalization is the main reason for R>g over the last 4 decades, then all we can do - and all we should do - is wait for the big wave to end.

Which is why strikes me as a little weird that conservative-leaning economists seem to want to embrace the "robots" argument, while liberal-leaning economists seem to want to embrace the "globalization" argument. If globalization is at fault, then even trade barriers will avail us little, since we trade in a global marketplace; all we can do is wait until the poor countries fill up with capital, and labor's share bounces back. That is an outcome that conservatives would favor. But if robots are to blame, then Piketty is right, and labor's share will never bounce back...leaving some kind of radical redistribution as the only option for preventing mass human misery. That is not an outcome that conservatives would favor.


  1. "But if globalization is the main reason for R>g over the last 4 decades..."

    You know, it really depends in large part how we define R. If R is the US stock market return, or anything close, it's blown away g for over 200 years. From the anthem tome, "Stocks for the Long Run" by Wharton's Jeremy Siegel, the average real return 1802-2012 was 6.6%. And breaking it into three major sub-periods, it was earily just about that in every one: 1802-1870: 6.7%, 1871-1925: 6.6%, 1926-2012: 6.4% (5th edition, page 83)

    By the way, interesting on stocks for the long run: Roger Farmer agrees that his new model implies that stocks do have an abnormally high risk-adjusted return if you can take a long run view. See the comments here:

    1. Is this result adjusted for survival bias (i.e. that firms have a finite life and eventually fall out of the indexes).

    2. Anonymous8:51 AM

      Hasnt delisted firms outperformed new inclusions since the emergence of ETFs?

      Because everybody goes into ETF it pushes price up of index companies, and price down of delisted companies. Thus the opposite is happening.

    3. Anonymous12:20 PM

      It’s supposed to be all income from capital divided by the market value of all capital, including stocks but also bonds and real estate. According to Piketty, in most Western countries, about half of capital is financial assets and the other half is residential real estate.

    4. Siegel took into account survivor bias, and the various other pitfalls when compiling an index like this. In addition to being an accomplished Wharton financial economist, he's close with Shiller, one of the kings of this kind of data.

  2. ".leaving some kind of radical redistribution as the only option for preventing mass human misery."

    Or mass education and human development, starting prenatal, Heckman-non style:

    "The United States was the clear leader in primary education in the first half of the twentieth century, having realized that inequality was a "race between education and technology", to use a phrase coined by Jan Tinbergen (winner of the first Nobel Prize in Economic Sciences) and used by the economists Claudia Goldin and Lawrence Katz as the title of their influential 2010 book."

    -- The Second Machine Age, page 208.

    I quote it in my guest post at Carola Binders, which I think makes an interesting main point, but I haven't gotten much feedback:

    1. mmm...
      But doesn't education just to some extent extenuate inequality (as some individuals get more benefit than others). Do we really want to consign large swathes of humanity to the scrap heap? Don't we have enough alienated youths already?

    2. I read your piece and I see another problem - the technological singularity, or a version of it. Those skilled people you need are SPECIALISTS. It used to be that training in a speciality was a once in a lifetime event. Now maybe technology is changing so fast, that you need constant forward looking training. And the risks of doing this (of wrongly seeing where technology is going) are too great for any but the very rich to bear.

    3. It does depend on the kind of educational and developmental programs. Is it focused just on advanced professionals, or is it a great increase in development, education, and training for the vast majority. Things like universal high quality prenatal efforts, universal high quality Montessori daycare and preschool, high end after-school and summer programs for everyone, not just the wealthy, universal free bachelor's degree or high quality vocational training, and so on. This would dramatically decrease financial insecurity, unemployment, poverty and homelessness for the vast majority, as well as really increasing the pie over the long run.

      As far as education today, the vast majority will have to constantly learn to have financial security. But if you get a very good base of basic skills and ability to think, analyze, and learn well from a strong college education, this will make you far better at keeping up over a lifetime with the constant necessity to learn more. It's very doable, but a high quality education and development when you're young -- prenatal through grad school -- is really important (although with effort people can often turn it around later in life from a poor start).

  3. Anonymous2:43 AM

    " But if globalization is the main reason for R>g over the last 4 decades, then all we can do - and all we should do - is wait for the big wave to end. "

    Wait what , 20 years ? 50 ?

    Progressive taxation of income and wealth , Piketty's rec , applies to both scenarios - robots or globalization. We already have a history of success using this method , what we lack for implementation is support from economists and others who know this is the only viable solution available to us , but fear they'll be tapped for a few bucks in extra taxes.

    Greed got us here and greed will keep us here , even as the economy stagnates with inequality as the causal factor , egging the faces of our top-notch economists once again.

    1. Agreed. Noah, your comment 'But if globalization is the main reason for R>g over the last 4 decades, then all we can do - and all we should do - is wait for the big wave to end.' was rather reflexive (in the 'spinal cord' sense).

    2. Anonymous7:50 PM

      If the economy is truly globalized, then we need a global fiscal and regulatory program - or else we'll get a global scale "gilded age". Piketty gives strong reasons for thinking these problems don't fix themselves. As he points out, the mid-20th century decrease in inequality was probably an anomaly caused by the destruction of the two great wars. We need to start thinking in terms of radical international solutions: global wealth registry, global redistributive tax regime, etc.

    3. " ... or else we'll get a global scale "gilded age".

      Get? We're about a generation into it.

  4. argosyjones2:57 AM

    " If globalization is at fault, then even trade barriers will avail us little, since we trade in a global marketplace; "

    1. Anonymous4:30 AM

      Economists really need some history lessons. Many countries put up trade barriers to globalisation to industrialise. In some cases they succeeded, in some cases they did not. Perhaps it was not the trade barriers that explains the success. Infant industry arguments get footnotes, if lucky, in economics books. Infant industry protection cases get whole chapters in history books.

      We need to move away from model and start looking at the complexities and contradictions of how the world really works if we are going to make progress in economics.

    2. argosyjones8:47 AM

      "Many countries put up trade barriers to globalisation to industrialise."
      Noah knows that. Which is why I wonder what he's trying to say here.

    3. Anonymous8:53 AM

      Trade barriers, work, if you can have your cake and eat it too, like China, whos industries are more protected from imports than exports going to other countries. They do this by infiltrating the WTO.

    4. "Many countries put up trade barriers to globalisation to industrialise. In some cases they succeeded,..."

      IIRC, every single successful industrialization after England's use serious trade barriers.

    5. Anonymous1:00 AM

      "IIRC, every single successful industrialization after England's use serious trade barriers."

      South Korea

    6. Anonymous5:17 AM

      I think it is more the case that small African countries do not have the resources to protect or nurture potential growth industries vis a vis China or American multinationals in the WTO - which is a legal minefield.

  5. Anonymous3:23 AM

    R and g are not mutually exclusive.Technological change and globalisation often go together (two way causation). The British Empire and the industrial revolution, for example, were heavily linked. Robotisation is to some extent a consequence of intense foreign competition that resulted from globalisation. So behind the robotisation was the globalization.

    1. Anonymous4:32 AM

      Furthermore, globalisation (international capitalism) opens up markets calling for economies of scale in production, inducing automation.

      The link between industrialisation and international capitalism is of course well explained by Karl Marx.

    2. Yes, this. I don't know why the two are presented as a choice.

  6. Anonymous4:07 AM

    The problem with all this is that technology is making the economic arguement redundant. Machines will take over vast swathes of areas currently using humans. Eventually you could have the sort of environment seen in "Wall E" where humans use all of their time for liesure and work will be done by robots.

    1. "Eventually you could have the sort of environment seen in "Wall E" where humans use all of their time for liesure and work will be done by robots."

      That's not a bad outcome; what's more likely is a future where a large swathe of the labor force is either not needed, or needed only for very low-paying, nasty and temporary labor - 'Elysium'.

    2. BTW, Noah - you asked why human labor was used in the robot factory in 'Elysium'. The answer might have been is that it was extremely cheap and extremely expendable.

    3. The scenario where all labor is automated is problematic in the sense that the only thing that most humans have to trade is their labor - if there are no paying customers for it, how are these people supposed to earn the income they need to purchase the goods and services they need?

  7. Noah,

    you need to be a bit more careful on the logic here I think. Piketty is making two distinct claims, r>g only pertains to the second.

    The first claim is that a growth slowdown is happening and goes hand with a very high capital to income ratio. He's got lots of data backing this up.

    However, a Solow growth model with Cobb-Douglas production tells us that it's entirely possible to have r>g and yet capital's share of income never, ever changes. So, the inequality r>g has nothing at all to do with capital's share.

    Now, Piketty does say that actually the elasticity of substitution between capital and labour is greater than one which means that as the capital/income ratio rises we do see captial's share rise but this is somewhat incindental to the two main arguments. It's role appears to be to justify the forecast that in the future r>g will be the norm and that the difference between them will increase.

    The role of the actual inequality r>g is entirely in the second half of the book and has nothing to do with capital's share. It is all about the concentration of wealth increasing over time, that's what r>g gets you.

    Notice though that if r>g but we had Cobb-Douglas produciotn then the concentration of wealth would increase even though capital's share would be constant.

    So, the two claims are distinct in the sense that neither needs to imply the other and the inequality r>g only pertains to the second.

    1. Good post, plus one needs to be very careful to make distinction between capital (in form of robots) and land. It was well explained by Nick Rowe here:

      Short summary, in robots only scenario if human is equivalent to robot then human real wage will remain constant. The key distinction here is between "wage" - that is ammount of consumption produced by a single labor unit - be it robots/humans on one side and the price of robots on the other side. With robots only scenario the price of robots (and change in this price that reflects technological change in production of robots) affects only the interest rate, not wages.

      Now the real nightmarish scenario happens in case there is a limit to production. It may be for instance land as a necessary complement and there will be not more produced of it. Here owners of land will extract the rent from produce of labor units (humans and robots). So the labor earns wage as Marginal Product of labor (as a whole) and as number of robots increases the wage earned by produces is driven down by diminishing returns. In short - both human laborers and owners of robots get screwed by rentiers.

  8. Anonymous7:02 AM

    >> leaving some kind of radical redistribution as the only option for preventing mass human misery. That is not an outcome that conservatives would favor.

    Well, not all conservatives, perhaps even the majority of conservatives. But there is a sizable fraction of self-named "conservatives" for whom increased human misery would be a net positive. Punish the prols, as long as it's the Others who are suffering. Being poor should hurt, after all, and -- much like people who won't take medicine unless it tastes bad, regardless of effectiveness -- the current conservative thought leaders believe that it doesn't hurt enough.

    And there is a non-negligible fraction of those, who don't even care about the harshness "teaching" the poor not to be poor. That fraction can feel good only if they know that, out there, someone is feeling bad.

    1. An a generally punitive environment for 'them' is rather useful for keeping people in line. For an extreme example, let's say that people who were unemployed were drafted into some rather horrible penal labor units. That would give employers more power over their employees.

  9. Stefan7:18 AM

    What I do not get in this story is why the accumulation of capital and the rise in beta does not drive down r in the end. When capital has decreasing returns of scale then a growing capital stock should decreas returns. Or am I wrong?

    1. Eventually yes. Eventually capital income (growing at rate r if all is reinvested) would exceed GDP which is clearly not possible.

      But before we get there, the fact that r>g would create more and more inequality and we might want to do something about that, rather than just waiting for the moment when capital income = GDP and then finding comfort in the fact that now, it simply cannot get any worse.

    2. Stefan6:11 PM

      Yes I see that, but it could well happen also before that extrem case right?

  10. Noah,

    I wonder if you are missing one of Picketty's main points. Capital becomes dominant largely because wealth becomes concentrated in the hands of a small group of families. In order to preserve this wealth across generations these families act to influence the political environment. Because of their vast wealth, they are largely successful. Rather than using the capital they have to compete against other capitalists, they use it to entrench their established firms. R > g because of policies that favor established wealth at the expense of innovative new firms as well as labor. It is this concentration of hereditary wealth that artificially keeps r > g.

    1. This. Noah, your comment 'But if globalization is the main reason for R>g over the last 4 decades, then all we can do - and all we should do - is wait for the big wave to end.' ignores the overwhelming fact that concentration of wealth leads to concentration of political power.

    2. Anonymous10:56 AM

      Then Piketty should explain why if you compare Forbes list 1984 and 2014, its nothing to do between each other. Almost all millionaries from 1984 lost their wealth, and the left that still appears on the list, only had an estimated average of 2.5% annual wealth increased, in stead of 6,6% that Piketty calculates :-) ...

    3. "Almost all millionaries from 1984 lost their wealth,..."

      Note that at the level under discussion, a 'millionaire' is like a squire, in the old nobility, meaning they are on the fringe of the fringe of the group in power. They just look powerful to a peasant.

  11. Anonymous10:26 AM

    I wonder if there's a misunderstanding &/or a typo here. Piketty thinks that g has been >r between ~1913 & ~2012, but thinks that this is a historical anomaly that will reverse in the near future and stay reversed indefinitely. I don't see how this is consistent with the idea that the reason r has been >g is because of globalization.

  12. Anonymous11:02 AM

    In the beggining of xx century, 80% of population was working for agriculture. Nowdays 2%. There were predictions (mostly marxists and malthusians) that mechanization of agriculture labor was going to bring hordes of hangers.

    In the middle xx century, labor moved from agriculture to manufacturing. When mechanization and technology brought productivity, malthusians and marxists predicted that it was going to bring hordess of hungers.

    Now, in the beggining of xxi century, marxists and malthisians predict that tecnology will bring more armies of hungers and exploited workers.

    always the same history ...

  13. There's a Coase Theorem solution here: just give workers the right to sue their robot replacements.

  14. the problem is it's nearly impossible to falsify Thomas Piketty's claims or even agree on what values to substitute for his variables. A lot of vagueness, hypotheticals, and unknowns.

    1. Anonymous5:42 PM

      @ Grey Enlightement: "A lot of vagueness, hypotheticals, and unknowns."

      Welcome to economic history, bro. And actually, it is possible to falsify him. The guy may be full of it, but at least he did a gentleman's work of gathering tax data from 19th century France, England, US, and data like that from dozens of countries through a large period of time. It is not perfect but it is SOMETHING.

  15. If R is calculated as being net of all taxes and net of consumption by the holders of the capital then capital might have a growing share. But, better robots and technology will make robots cheaper (reducing the value of existing investments) and the accumulation of capital will bid down the returns on capital. I guess I better go find some temperate farmland to invest in.

  16. Anonymous4:50 PM

    Who cares whether it is robots or globalization? The point is that the US economy has underutilized resources in a world of infinite needs: the result of a stupid, if not downright immoral monetary policy.

    The R versus G thing reminds me of James Ingram's book, International Economic Problems (John Wiley, 1970), where "he tells of a mysterious entrepreneur, Mr. X., who announces to the world that he has found several amazing discoveries that allow him to produce cheap televisions, automobiles, cameras, and other goods. He sets up a plant on a large tract of land along the coast of North Carolina; hires 5000 employees who are sworn to secrecy; and begins buying grain, coal, and machinery. As the trains of grain and coal roll into his factory, other trains full of televisions and automobiles roll out of his factory into showrooms across the country. Mr. X is hailed as another Edison or Bell, and his company becomes a favorite with Wall Street investors.

    Consumers love Mr. X because his products are so much cheaper than what they could buy before. Of course, his competitors dislike him, but their attempts to get laws restricting his operations get nowhere. The Houses of Congress ring with speeches saying that some economic adjustment is an inevitable by-product of technological progress.

    Then, one day a small boy trying out his new skin-diving gear accidentally penetrates Mr. X's security shield and learns Mr. X's secret. Nothing is produced at the factory. It is all a front for a giant import-export business. Mr. X transforms grain and coal into autos and televisions by trade. His secret revealed, Mr. X is reviled and his factory shut down. Members of Congress proclaim that the American standard of living has had a narrow escape from the threat of cheap foreign labor and urge more money for research in industrial technology."

    Again, R, G, who cares? Tight monetary policy -- observable in low interest rates and slow NGDP -- is a much more plausible and credible driver of US resource underutilization: workers want demand, consumers want stuff/services, but the price signal in NGDP ain't there.

  17. "They all welcome my "kind of radical redistribution."

    Evidence? CYB: sure. They consider that the status quo. There is nothing preventing anyone from quitting tomorrow -- in THEORY. And that's good enough for Cruz or Paul. They would be happy to outlaw labor unions while claiming this allowed CYB, but that is the only support you would get.

    But a guaranteed income? Show me some evidence. I think you are projecting your ideas onto members of your political tribe.

  18. Anonymous12:33 AM

    Soon, our new robot overlords will solve the labor glut by exterminating us.

    Economists everywhere will be surprised, and yet claim that this was consistent with their model predictions.

  19. seriously? huh? Oh well...

  20. J.K. Galbraith has a pretty damning critique of Picketty here:

    From a liberal perspective JKG demolished the book and his Utopian prescriptions as basically wrong.

    "Piketty wants to provide a theory relevant to growth, which requires physical capital as its input. And yet he deploys an empirical measure that is unrelated to productive physical capital and whose dollar value depends, in part, on the return on capital. Where does the rate of return come from? Piketty never says. "

    "The basic neoclassical theory holds that the rate of return on capital depends on its (marginal) productivity. In that case, we must be thinking of physical capital—and this (again) appears to be Piketty’s view. But the effort to build a theory of physical capital with a technological rate-of-return collapsed long ago, under a withering challenge from critics based in Cambridge, England in the 1950s and 1960s, notably Joan Robinson, Piero Sraffa, and Luigi Pasinetti."

    "Piketty devotes just three pages to the “Cambridge-Cambridge” controversies, but they are important because they are wildly misleading. He writes:

    Controversy continued . . . between economists based primarily in Cambridge, Massachusetts (including [Robert] Solow and [Paul] Samuelson) . . . and economists working in Cambridge, England . . . who (not without a certain confusion at times) saw in Solow’s model a claim that growth is always perfectly balanced, thus negating the importance Keynes had attributed to short-term fluctuations. It was not until the 1970s that Solow’s so-called neoclassical growth model definitively carried the day.

    But the argument of the critics was not about Keynes, or fluctuations. It was about the concept of physical capital and whether profit can be derived from a production function. In desperate summary, the case was three-fold. First: one cannot add up the values of capital objects to get a common quantity without a prior rate of interest, which (since it is prior) must come from the financial and not the physical world. Second, if the actual interest rate is a financial variable, varying for financial reasons, the physical interpretation of a dollar-valued capital stock is meaningless. Third, a more subtle point: as the rate of interest falls, there is no systematic tendency to adopt a more “capital-intensive” technology, as the neoclassical model supposed.

    "In short, the Cambridge critique made meaningless the claim that richer countries got that way by using “more” capital. In fact, richer countries often use less apparent capital; they have a larger share of services in their output and of labor in their exports—the “Leontief paradox.” Instead, these countries became rich—as Pasinetti later argued—by learning, by improving technique, by installing infrastructure, with education, and—as I have argued—by implementing thoroughgoing regulation and social insurance. None of this has any necessary relation to Solow’s physical concept of capital, and still less to a measure of the capitalization of wealth in financial markets."

    "There is no reason to think that financial capitalization bears any close relationship to economic development. Most of the Asian countries, including Korea, Japan, and China, did very well for decades without financialization; so did continental Europe in the postwar years, and for that matter so did the United States before 1970."

    "And Solow’s model did not carry the day. In 1966 Samuelson conceded the Cambridge argument!"

    "Thomas Piketty’s book about capital is neither about capital in the sense used by Marx nor about the physical capital that serves as a factor of production in the neoclassical model of economic growth. It is a book mainly about the valuation placed on tangible and financial assets, the distribution of those assets through time, and the inheritance of wealth from one generation to the next."

    Just a small part from one of the better PK economists.

    1. Anonymous1:49 PM

      @Unknown: "J.K. Galbraith has a pretty damning critique of Picketty here."

      This guy Piketty was slaughtered by economists, right and left. I've not seen A. SINGLE. DAMN. REVIEW. PRAISING. HIM. IN. TOTUM. Even the ones who SEEM to be out of their minds with the book, like Paul Krugman are damning it with faint praise, see:

      "[T]he most conspicuous example of soaring inequality in today’s world—the rise of the very rich one percent in the Anglo-Saxon world, especially the United States—doesn’t have all that much to do with capital accumulation, at least so far."


      p.s.: Even so, hats off to this guys empirical work. It was laborious and difficult and we can follow it with better -- less PINKOish hued -- economic theory.

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  22. Anonymous9:48 AM

    Hi Noah,

    Could you please speak a little bit to the quality of the data used in finding that labor's share is falling?

    The Karabarbounis paper speaks of a 5 ppts decline in the "corporate gross value added paid to labor over the last 30 years".

    The share is computed at Wages Paid x Hours Worked.

    What is captured by "Wages Paid"? Does it include various benefits?

    For example, I have friends who work at companies that spend tons of money on corporate retreats, team building activities, and office perks for their employees that are surely a form of labor compensation but never show up in any paychecks.

    Is the Google Bus accounted for ;) ?

    Are the ridiculously nice offices that a lot of service workers get to work in these days accounted for?

    These days everyone seems to get an iPhone or Blackberry with data plans for work, plus a laptop and iPad, which tack another ~$2,000 to an annual salary.

    Also, if hours worked are falling because people prefer to work less, we would see a decline in labor's share even though that's just due to the choices made by people, no?(post-materialism, etc.)

    Lastly- more and more companies are competing for labor not with higher wages but with promises of flex-time, work-from-home, "meaningful" work / time to work on person projects, free education via corporate education programs, etc.

    How does all that figure into these calculations?

  23. Society's ultimate purpose - the maintenance of cattle-like homo sapiens, most of which neither work for their upkeep nor are innately talented enough to contribute on an artistic level. This is what happens when the Enlightenment meets technological progress.

    But maybe some dark Nietzschean minds will have other ideas of the destination of humanity.