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Piketty’s Model of Inequality and Growth in Historical Context, Part 2

Many individuals helped construct neoclassical economics, often with financial support from the robber barons and their successors.

Pareto

French economist Thomas Piketty has proposed a grand model of inequality and growth. In Part I of this series, we looked at what “classical” economists had to say about these phenomena. Here in Part II, we trace how the “neoclassicals” responded.

Part II: The Neoclassical Response to the Classical Theories of Inequality and Growth

Mason Gaffney has shown how many individuals helped construct neoclassical economics, often with financial support from the robber barons and their successors. I will focus on two: in the United States, John Bates Clark (1847-1938), and in Europe, Vilfredo Pareto (1848 to 1923).

Recall from Part I that the classical economists divided society into three classes: Owners of land and other natural resources received unearned income or “rent” from their holdings—often derived from conquest or inheritance. Capitalists (who often overlapped with landowners) owned physical capital (like factories or ships) and received interest or profit from investing. Workers received wages. Also recall that the classical economists favored taxing “rent” by taxing land values; Henry George crusaded for this tax.

John Bates Clark of Columbia University, for whom is named the prestigious John Bates Clark Medal, transformed economics into an inequality-free abstraction.

In the new neoclassical world, there is no unearned “rent”, only legitimate “profit.”

Writing in the 1890’s, Clark merged land into physical capital, thus obliterating the classical understanding of land. In the new neoclassical world, capital (including land) originates solely from productive investment. There is no unearned “rent”, only legitimate “profit.” (Ironically, Marx merged rent into profit because he considered both illegitimate.)

Clark reduced economics to only two “factors of production”, capital and labor. In Clark’s model, “supply and demand” in a free market ensure that capital and labor each earns its “marginal product”, that is, the contribution of the final amount supplied. This outcome is supposedly both fair and efficient. Clark writes, “the share of wealth that falls to any producing agent tends, under natural law, to equal the amount that he creates. A man’s pay tends to equal the value of the product or fraction of a product that can be specifically imputed to him.” (Clark, 1898: 4)  So much for any claim that laborers are exploited!

Clark also eliminated time, —giving us the familiar time-less, space-less, context-less world of Economics 1. But without time, there can be no history, and without history, no questioning the justice of property ownership, or the legitimacy of institutions.

Neoclassical economics in the United States followed Clark, to the extent that the future Clark Medal and Swedish Bank “Nobel” prize winner Robert Solow could joke in 1955 that “…if God had meant there to be more than two factors of production, He would have made it easier for us to draw three dimensional diagrams.” (Solow, 1955: 101)

By Pareto’s logic we should have paid the slaveholders in full after the Civil War!

Meanwhile, over in Europe, Italian nobleman Vilfredo Pareto made two key contributions to the emerging neoclassical paradigm. First, he estimated that 80% of the land in Italy belonged to 20% of the population, from which he concluded that inequality follows a natural law: the 80:20 rule, with which we shouldn’t tamper. More famously, he developed the policy rule known as “Pareto improvement.” Pareto improvement holds that we should undertake no policy changes unless they make at least one person better off and no one worse off. Sounds fair and reasonable, doesn’t it? By that logic we should have paid the slaveholders in full after the Civil War! By that logic once having cut taxes on the rich, we cannot raise them again! The status quo rules, no matter how cruel or illogical the route that got us there.

Under the new neoclassical regime, mathematical models proliferated like kudzu vines in the south, their very complexity keeping them safely obscure. Few are more famous (among economists) than Robert Solow’s 1956 simple two-factor growth model. Assuming a world of uniform depreciating physical capital (implicitly ignoring durable natural resources like land), and uniform quality labor, Solow’s model predicts that economies will grow towards a steady state where depreciation just equals new investment. And because the richer you are the slower you grow, poorer economies and poorer people within economies will catch up. Solow’s model is cute as a button!—but its extreme abstractness lies poles apart from Smith’s original common sense model explaining growth in terms of cooperation and specialization.

Almost sixty years later, Thomas Piketty has taken Solow’s model and added his own twist. In Solow’s model, the poor catch up to the rich. In Piketty’s model, the modern decline in growth does not affect investment. Consequently, now that return to capital investment exceeds the rate of growth, then inequality must inexorably increase. This model, he says, determines the fate of the twenty-first century.

As the classical economists understood, inequality derives from power, ultimately the power of conquerors to extract tribute from the conquered.

Critics have torn into Piketty’s model—including some, like James Galbraith, who still give Piketty kudos for stirring up debate. In my view, Piketty’s and Solow’s models are both fundamentally flawed in that they rest on the same ahistorical, apolitical, two-factor neoclassical foundation. As the classical economists understood, inequality derives from power, ultimately the power of conquerors to extract tribute from the conquered. And as the Progressives, the New Dealers, and the civil rights activists have demonstrated, democratic societies can counter that power with well-designed tax and regulatory policies supported by an aroused public. We are not prisoners of a mathematical model.

  • Jack

    Wow, one of the few people who actually gets it. How and why people, including apparently Piketty, manage to ignore the unique aspects of natural resources (for example, that they were not created by any, just claimed by some) when thinking about economic distribution, is beyond me.

  • Pingback: Thomas Piketty’s Model of Inequality and Growth in Historical Context, by Polly Cleveland | Punkonomics (@DearBalak)()

  • Nelson

    I’m confused. Hoe can you say Piketty’s book is ahistorical when chapters 1-12 are entirely based on analyzing the history of wealth since approx 1710? I learned more of the history of France in this book than I ever learned in school. As for apolitical, he states numerous times that wealth inequality is a political decision and not a “natural” event or “god-given” right. Just because he doesn’t use inflammatory rhetoric to advocate one single solution doesn’t mean that he doesn’t see a need for political changes to put us one a sustainable future. In Part Four, (Chapters 12-16), he advocates for the same ideas that you expressed, “well designed tax and regulatory policies.” Perhaps if Piketty’s had not blandly titled Part Four, “regulating capital in the 21st century”, but instead titled it, “Executing the Greedy Bastrds by the Wrath of the Rightous and Poor Public”, you would have been more likely to agree with him….

    The one thing that surprised me was that he didn’t even suggest eliminating inheritance of wealth. Instead of trying to muster the political power to implement a global tax on wealth, as Piketty’s suggests, why not just eliminate inheritances, which would eliminate the ever-increasing accumulation of wealth in the hands of the few? It seems the simpler solution.

    • HopeWFaith

      Your attempts to discredit would have been much more considered had you not needed to insult the writer’s sex. A profound statement of your tendencies towards women is made clear by it. The term “Hoe” is completely out of line.

      • Nelson

        No, no, hoe is a garden tool and not gender specific. The insulting term is ‘ho,’ (pronounced “h”, “o”, comma). In this case, hoe is an alternate spelling of ‘how’, commonly used when typing without adult supervision.

  • HopeWFaith

    Polly.
    We are captives-prisoners of the current GOP designs of our voting blocks to lean heavily towards the GOP preferred outcomes. The districts’ designs are what need to be fixed first. I disagree with you in that it is not so easy to accomplish what you assert. “Progressives, the New Dealers, and the civil rights activists have demonstrated, democratic societies can counter that power with well-designed tax and regulatory policies supported by an aroused public. We are not prisoners of a mathematical model.” – See more at: http://inequality.org/pikettys-model-inequality-growth-historical-context-pt-2-2/#sthash.IcVTOmVN.dpuf

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