Tuesday, May 20, 2014

A Common Sense Economic Observation

By Common Sense

This article pertains to Thomas Picketty's new book Capitalism in the 21st Century.

In having read the back and forth in the financial press, Picketty's book has added to the current political discussion on income inequality by arguing that income inequality is at its most extreme in this country in over 100 years as the divergence in wealth holding is something that has been unseen in this country since the days of the Robber Barrons and the Progressive era of 1895 - 1915.

Piketty argues that in capitalist countries,
the return to wealth (r­) tends to exceed the rate of growth (g­) of the economy. In the most basic sense, this improbably famous “r > g” tendency means that the share of national income workers receive as compensation (“labor income”) falls and the share of income going to owners of wealth (“capital income”) rises. Because capital income is less equally distributed than labor income, these dynamics will increase the share of income received by the top 1 percent. Finally, if the wealthy reinvest most of their returns, wealth inequality will also rise. It’s a triple-whammy.

In looking at the data compiled by Picketty and his research team, one cannot help but be impressed with the thorough research job and the contribution it will have to the field of economics. Picketty's research of the existence of inequality was more than confirmed and validated 130 years earlier by Jacob Riis' How the Other Half Lives: Studies among the Tenements of New York (1890) which documented squalid living conditions in New York City slums in the 1880s.

What I believe Picketty and his research team fail to appreciate is the impact of immigration and the creation of "short term" inequality. As we see from the link below, European immigration to this country witnessed a 30 year wave from 1880 - 1910 with immigration peaking between 1905 and 1913.


As a percentage of the population, immigrants accounted for about 15% of the US population between 1180 and 1910

The historical record shows that yes immigrants did arrive in this country with often nothing moer than the clothes on their backs. In an economic sense, it does explain why there was such a large spread between the rich and the poor. Quite simply there were a lot of poor Europeans coming into this country through Ellis Island every year. So, with a constant immigration to this country in this time frame a conclusion of the existence of inequality can be drawn given the lack of wealth and income held by those newly and recently arrived immigrants.

What is not asked though is

1.) Why did 30 million immigrants leave their homes in Europe?
2.) Did 30 million immigrants stay poor?

The answer to question #1 is opportunity that did not exist in their home lands.

Question #2 is answered by own family history. My grandmother came to this country with her mother in steerage to join her father who was building a new life for his family in Northern New Jersey. 35 years later, my grandmother took her father and her 2 children back to the old country for a visit. This time around, they went first class on the ship that had brought her to this country 35 years earlier.

The bottom line is that yes there was inequality during this time period, but it was matched and exceeded by a fierce determination to succeed and to achieve the American Dream. In looking at indexed wage growth in the 1920s, we see that despite a decline in wages after WW1, wages steadily increased through the 1920s showing that income inequality was temporary.

During this era of immigration there also existed the Progressive impulse to use the power of Government to reign in the abuse of capital through legal and regulatory means such as:

- Pure Food and Drug Act (1906/1911)Required that companies accurately label the ingredients contained in processed food items.

- Meat Inspection Act (1906)In direct response to Upton Sinclair's The Jungle, this law required that meat processing plants be inspected to ensure the use of good meat and health-minded procedures.

- Hepburn Act (1906)Strengthened the Interstate Commerce Commission, allowing it to set maximum railroad rates.

- Federal Reserve Act (1913)Created 12 district Federal Reserve Banks, each able to issue new currency and loan member banks funds at the prime interest rate, as established by the Federal Reserve Board.

- Clayton Antitrust Act (1914)Strengthened the Sherman Antitrust Act by outlawing the creation of a monopoly through any means, and stated that unions were not subject to antitrust legislation.

- Federal Trade Act (1914)Established the Federal Trade Commission, charged with investigating unfair business practices including monopolistic activity and inaccurate product labeling.


1.) Continued immigration which provided a continuous source of new employees which depressed wages
2.) Progressive legislation that was directly aimed at the abuses of capital and not so much at income inequality
3.) The ending of the Progressive Era by WW1

we will never truly know what impact the Progressive Era had / could have had at addressing social and income inequality.

Fast forward to the 1960s and the last round of Progressive expansion of government

As George Will observes -
When Johnson became president in 1963, Social Security was America’s only nationwide social program. His programs and those they subsequently legitimated put the nation on the path to the present, in which changed social norms — dependency on government has been de-stigmatized — have changed America’s national character.

In 1964, 76 percent of Americans trusted government to do the right thing “just about always or most of the time.” Today, 19 percent do. The former number is one reason Johnson did so much; the latter is one consequence of his doing so.


Government transfer payments also mark a big problem for Mr Picketty as his comparison between income inequality of today and 100 years ago does not reflect the impact of transfer payments on today's population. Reflecting transfer payments, inequality drops and is not as pungent as Picketty would have you first believe.

As a solution for income inequality, Picketty argues for a international wealth tax as a means of globally redistributing wealth and thus reducing inequality. A global wealth tax prevents immigration as an effective tax solution since the global field would be leveled and thus there would be no geographic area to shelter one's wealth.

The first problem with this proposal is noted by Robert Schilling in a Project Syndicate column
Increasing wealth taxes now, as Piketty proposes, would strike many people as unfair, because it would amount to imposing a retroactive levy on the work carried out to accumulate that wealth in the past – a change to the rules of the game, and its outcome, after the game is over. Older people who worked hard to accumulate wealth over the course of their lifetime would be taxed on their frugality to benefit people who didn’t even try to save. If they had been told that the tax was coming, maybe they would not have saved so much; maybe they would have paid the income tax and consumed the rest, like everybody else.


Picketty himself acknowledges international cooperation on a wealth tax is remote at best due to

1.) Lack of international cooperation,
2.) competition among nations in reducing the business tax rate over the 10 years,
3.) The competitive nature of nations for wealth.

There would be one country that would not abide, would cut its tax rate, and would thus welcome with open arms "persecuted wealth". Don't believe me? Take a look at the London housing market and how many international millionaires and billionaires are buying up property so as to reside in a lower tax jurisdiction.

While the international front may present problems, domestically the idea of punitive taxation historically holds sway for only so long as inevitably high tax rates are almost always reduced. (see attached chart).

While Picketty presents the problem, he provides an entirely wrong solution. Instead of tearing those at the top down, why are we not asking - What can we do do to build the bottom up so that a rising tide lifts all boats?

Higher taxes do not work. That has been demonstrated the world around. Excessive governmental transfer payments do not work. Communism and socialism do not work

So what does work?

Its a very complicated problem with a very simple solution - We need to create opportunity.

By opportunity, I mean that all parties have equal access to opportunity to get ahead (Note I do not advocate guarantee of outcome) through a reduction in the presence of government in our lives.

Opportunity unleashes the American Spirit and when that Spirit thrives, economically anything is possible. It was this same spirit that transformed this nation from an agrarian economy to the world's largest manufacturing power in 1900. It was this same spirit that won the Cold War.

Its that same spirit that can shake the malaise of inequality.

We must be attuned to the reality that it is nothing more than a utopian flight of fancy which can suggest that we can completely eliminate inequality. Somebody is always going to be poor and someone is always going to be rich. The bridge between the too is determination and opportunity.