I thought it was worth a whole post just to link to James Galbraith’s review of Thomas Piketty’s Capitalism in the Twentieth Century, now newly translated into English and gaining so much attention. I think the review is great, but some people have reported finding it obscure. Thus I present a small explanation of what I think one of Galbraith’s main points is, and, as a bonus, a tribute to Karl Marx.
Piketty’s argument is that capitalism leads inexorably to inequality, unless mitigated by progressive taxation. This is because the rate of return on capital grows faster than the rate of growth in the economy. In the beginning, the way to make money is to produce and sell things. But as time goes on, a much better way to make money is to start off by having it, and to profit from interest and returns on investment. Capitalism begins by rewarding those who work hard, produce things that people want, and innovate. But it ends by distributing much greater rewards to those who start off wealthy, inherit wealth, or marry into it.
One point in Galbraith’s review that interests me is that Piketty casts darkness on the key issues by identifying capital accumulation with the total return on financial and tangible assets. Thus he fails to distinguish between assets that appreciate due to new production and assets that represent financial claims on existing product and merely inflate through the injection of credit. Insofar as capital accumulation comes in the form of the latter, the primary thing driving inequality isn’t the rate of return on capital. Rather, it’s the returns the finance sector can gain by using credit to generate asset bubbles and then lending at interest to those who speculate on assets. Since Piketty overlooks the distinction between genuinely productive returns on capital and returns on bubbles of this nature, he gives far too small a role to debt in his analysis.
Also, Piketty is on the wrong side of what Steve Keen calls ‘The Holy War over Capital’. He supposes that the rate of return on capital is determined by its marginal productivity. But this can’t be right, as Pierro Sraffa, Joan Robinson, and Luigi Pasinetti argued in the famous Cambridge-Cambridge controversy (that’s Cambridge, England vs. Cambridge, Massachusetts). The basic problem lies in trying to determine the marginal productivity of capital without assuming its rate of return, which turns out to be impossible (if you want a better explanation you’d better click on one of the last two links). Piketty wrongly claims that the arguments put forward by the Cambridge, England side (Sraffa, Robinson) were defeated by the Cambridge, Massachusetts side (Robert Solow and Paul Samuelson). But in fact Samuelson conceded that the other side were correct. The major relevance of this is that since Piketty wrongly assumes that returns on capital can be identified with its marginal productivity, he sees no need to make any distinction between productive and non-productive returns: between returns that are generated by new production and returns that are merely extracted from somebody else’s income.
The good thing about Piketty’s newfound fame, however, is that it gives new life to a Marxist idea: the idea that the goals capitalism begins by serving it ends by undermining. It’s high time this idea received a reappraisal by mainstream economists and political advisors (no other thinking person ever lost sight of it).
Marx, you may know, also wrote a book called Capital, in which he showed that capitalism begins by being a system that guarantees profits to those who own the means of production and ends as a system that ruins them, in the process driving workers into intolerable exploitation and making revolution inevitable. Some of the explanation has to do with the falling rate of profit, which in turn is explained in terms of the classic labour theory of value. The latter idea has fallen on hard times, yet there is something to be said for it.
Piketty sees the problem with capitalism lying elsewhere. But he also sees capitalism as undermining its own original purposes. On his theory, as I said, capitalism starts off rewarding production and ends up by rewarding hereditary capital.
Marx’s oversight was, it seems, in the same place as Piketty’s. The modern banking system, Marx wrote in Volume Three of Capital, ‘signifies no more and no less than the subordination of interest-bearing capital to the conditions and requirements of the capitalist mode of production.’ This may have been becoming true in Marx’s day as the German descendants of the Saint-Simonian Crédit Mobilier largely controlled the supply of credit and deliberately directed it towards productive investment. It was certainly true in the Western world in the early twentieth century, when governments controlled interest rates, imposed capital controls, and maintained large public finance institutions to achieve the same direction of credit.
But it is not usually true. Usually most credit goes into non-productive uses: war in the past, war and the fuelling of asset bubbles today. What Michael Hudson calls the ‘financial overhead’, the total cost of servicing debt in the economy, grows at the rate of compound interest (much faster than production). As a result it eats more and more into profits from production, transferring wealth from workers and capitalists alike to financial rentiers. Today, financial crises indicate the long-term instability of this arrangement. In ancient Mesopotamia, as Hudson and his research team have found, the instability was revealed by the need for leaders to periodically cancel all outstanding debts: ‘It was these debt annulments that kept Mesopotamia’s volume of debt carry-overs within the economy’s ability to pay.’ (Source)
This is, I think, the right analysis of inequality. Again, it is driven not by the increase of returns on capital as such, but by the accumulation of non-productive debt. The creation and compounding of such debt is what explains the capacity of capital returns to rise faster than the rate of growth of the economy as a whole (something Piketty doesn’t seem to have even attempted to explain). Hence the low level of inequality in the early twentieth century, when governments worked to deliberately direct credit into productive uses.
As valuable as his research undoubtedly is, Piketty actually makes this harder to appreciate, by obscuring the distinction between what Marx calls ‘real’ (productive) and ‘fictitious’ (non-productive) capital. Marx does better in this respect. He is perfectly aware of the distinction; he just makes the mistaken judgment that industrialization guarantees that credit will henceforth be used to meet ‘the conditions and requirements of the capitalist mode of production’, and so the role of fictitious capital will become increasingly marginal. Discounting for this error of judgment, his discussion in Volume Three of Capital is still perfectly topical.
So, for that matter, are his ideas about the inevitable instability of capitalism. It is true that in the twentieth century, governments gained some control over the finance sector, press-ganging finance into genuinely productive uses. Yet the system became a victim of its own success. The more virtuous the uses of credit became, the stronger became the argument for relaxing the regulations and control over Big Finance: it was, after all, an engine that reliably served the needs of productive investment. Also, the more creditors profited from productive investment, the more they gained wealth and hence influence over the political system.
The inevitable result was the relaxing of controls over lending, the untaxing of capital gains, and the rest of the general programme of neoliberalism that taken broadly, it must be said, constitutes the third-greatest crime against humanity of the twentieth century. Big Finance took up again its predatory and extractive attitude. The debt overhead became again a drag on productive income rather than fostering production. Credit became again the primary instrument of inequality, with no compensating contribution to production to mitigate its evils. Capitalism has resulted in a system that exploits the majority to generate completely pointless wealth for the minority, not to mention destroying the environment in a vain attempt to extract natural resources to pay off exponentially growing debts.
Something has to give, and it’s hard to see any error in Marx’s general prognosis. Certainly Piketty’s proposal for an international progressive tax system looks hopelessly inadequate. Taxing wealth hits genuine wealth-creators in the real economy and financial rentiers equally hard. It thus does nothing to restore the balance of power between the real economy and the parasitic financial sector. More importantly, the latter always either is or has the capacity to become powerful enough to reconstruct the tax system to its own advantage. Collapse or revolution (in some form or other) look to be the only ultimate destinations, just as Marx claimed.
Still, Piketty deserves high praise for raising again these fundamental questions about the long-term dynamics of capitalism. I hope that his book will also provoke a rekindling of interest in the classic discussion of these issues that is perhaps even more relevant today than his own. The problem is that Marx’s most important discussions of these issues are all in Volume Three of Capital, and hardly anybody reads that volume, even those who read Marx generally. Indeed, the Wordsworth Classics edition of Capital leaves it out entirely. I hope Piketty’s work can give some new life to this unjustly and imprudently neglected piece of a masterpiece.
I’ve used the expression ‘give new life’ twice in this post. Happy Easter.