Economics and politics - comment and analysis

Thomas Piketty, neoclassical economics and reality

The French economist Thomas Piketty is regarded by many on the Left as something of a lifesaver. Did Piketty not clearly and unequivocally demonstrate that distribution ratios frequently change in favour of capital, because the return on capital is regularly higher than growth? The formula r > g which expresses this has become famous. Many consider this a particularly important insight because Piketty’s analysis remains strictly wedded to a neoclassical model. However the economy functions, be it Marxist or neoclassical, according to Piketty the result will always be the same: capital will win. Friederike Spiecker and I have explained on two occasions in recent years that things are far from so simple (here and here).


Picture 1: Thomas Piketty and his book, Capital in the Twenty-First Century (Source: Google Images).

The Right, on the other hand, has been and remains quite often confused about Mr. Piketty’s work. In their view, somehow, the man managed to use a completely correct theory and reach completely wrong conclusions. This is difficult to digest. Because of Piketty’s neoclassical framework, he cannot be dismissed as easy as just yet another Leftist who is annoying people with Marxist or Keynesian insights. His conclusion, that taxes on the rich should be increased in order to improve redistribution, are anathema to these people. To them, exactly this has to be fought by all possible means.

Now, however, the Frankfurter Allgemeine Zeitung (FAZ), in trying to discredit Piketty’s distribution demands, may have slightly overshot the target. Patrick Bernau cites a recent IMF study on equality and concludes that: ‘Scientists at the International Monetary Fund have taken another look at the numbers that Piketty has used and found that there is no evidence that the modern economy actually works as Piketty claims.’

The editor of the FAZ and the IMF are absolutely right about this: modern economies do not function in the way that Piketty thinks they do. There is no growth, which would depend on savings. There is no investments, which would be induced by more savings. There is no neutral money. There is no technical progress which falls from the sky and there is no fixed relation between the amount of capital that is used in the production process and the overall economic growth rate. There is also no substitution of labour and capital in accordance with the ‘relative prices’ of the factors of production and the idea that free trade is efficient because it equally benefits all participants is mere fiction (see here for a short article on this).

If the modern economy is not working as Piketty believes it does, how does it work then? And if Piketty is wrong, does that mean that the FAZ and the IMF are right?

Let us assume that the ideas of Joseph Alois Schumpeter on economic development and growth are in principle correct. Pioneering entrepreneurs need money (created ex nihilo) to enter into dangerous inflationary processes and give the economy fresh impulses. No savings are necessary to finance these investments because the banks and the central bank can make money for investments available without any restriction.

Imagine a world in which the productivity gains which are being created through the Schumpeterian process of creative destruction must be passed on in full on wages over and over, because otherwise the purchasing power to buy the products that the economy produces is lacking. Imagine that each national economy would be embedded in a reasonably well thought out monetary system, which prevents individual countries to accumulate huge trade surpluses. In such a situation, mercantilism is impossible. Let us furthermore imagine that the attempts of companies to improve upon their financial situation requires that public finances permanently go into a deficit.

One could continue almost indefinitely. No, the world does not work as Thomas Piketty explains (he has by now seen it himself and today he defends redistribution with altogether different arguments). But the world also does not work in the way that the FAZ has it every day again and on which this newspaper bases it its far-reaching political demands and criticism of others who disagree. It would be positive if all sides would realize that without a serious and objective discussion on a realistic economic theory, there will be no progress, no good economic policy and no reasonable distributive rules.

In particular, one should be able to agree between reasonable people fairly quickly that we have no growth theory worthy of this name except for the rudimentary Schumpeterian one. Everything the neoclassical economists (and others, who call themselves Keynesians) have offered are in essence predicaments that are based on definitional relationships (such as the equality of savings and investments). It is impossible to build a comprehensive theory on the basis of these definitional relationships. However, to acknowledge this would require that a lot of political prejudices which make life easy and often provide the right friends be shelved. And who wants to do that?