Dark Tales from the Early Days of the American Economic Association

The American Economic Association was founded in 1885 with a view that an Economics based in history and statistics was necessarily Scientific, and that Government based on this ‘Economic Science’ would necessarily be a force for good. As the founding Statement of Principles expressed it: “We take no partisan attitude” towards the “industrial and commercial policy of governments” which should be based on an Economics developed “not so much [by] speculation as [by] the historical and statistical study of actual conditions of economic life”. “We regard the state as an agency whose positive assistance is one of the indispensable conditions of human progress.”

The view of the founding members of the AEA that policy should strongly socially proactive fitted their largely Protestant backgrounds: twenty-three of the fifty-five charter members were clergymen. They viewed economic policy as something to be decided by experts in the service of society. These experts should make decisions based on science and proceed to implement them. As Arthur Hadley put it in his 1898 AEA Presidential address, the greatest opportunity for economics lay “not with students but with statesmen”, and the brightest future for economists was in “the leadership of an organized body politic.”

This view that experts should be the ones actively making decisions, not just influencing or implementing them, was premised in the idea that the economic experts were superior people. Putting experts in charge, and side-lining inferiors, went far beyond the modern conception of public policy where technical tasks with well-defined objectives should be handed over to experts for implementation. It had more in common with Plato’s Republic in which the wise men should be put in charge to the exclusion of others.

Case in point was Richard T. Ely, a key founder and the 6th President of the AEA. The keynote lecture at the annual AEA meeting is named the Richard T. Ely Lecture. Ely was of the opinion that economic reform required the leadership of “superior men”.  Economics needed to abandon the outmoded doctrine that all men were equal. Economics must become less dismal! Ely once stated that New York City would be better run “if thirteen per centum of the poorest and most dependent voters were disenfranchised.” In 1922 he went further stating that the “human rubbish heap” was far larger than “a submerged tenth”, pointing to intelligence testing of US Army recruits as scientifically demonstrating that 22 percent were inferior.

In a similar vein Irving Fisher, President of the AEA in 1918, declared that “the world consists of two classes—the educated and the ignorant—and it is essential for progress that the former should be allowed to dominate the later.” Economists he clearly considered the former, “not only can society be reformed but to do so is the principle service of economic and social sciences”.

If Economists were to play the role of scientific professionals there would need to be plenty of them. In 1880 US universities employed just three academics who dedicated themselves to political economy. The number of university courses in Latin outnumbered those in Economics by ten-to-one. Fortunately the founding of the AEA coincided with an explosion in economics and by 1900 the ratio of Latin courses to Economics was down to two-to-one, with parity in the leading schools. By 1912 only English had more undergraduate majors than Economics at Yale University. Many of these students went on to roles in government, as epitomized by Woodrow Wilson who attended Ely’s economics course at Johns Hopkins University and went on to become US President.

If some people were superior and others inferior then the experts must make sure that the future belonged to the superior men. Race suicide —superior people having less children than their inferiors and therefore being out-bred and overrun— was a risk! Francis Amasa Walker began his 1890 Presidential address to the AEA warning of the threat to the Anglo-Saxon race in the US posed by immigration. Walker felt that the superior American worker rightly refused to lower his standards compete with the immigrant who accepted low wages and chose instead to have less children. His evidence? Population forecasts for 1850s US made in the early nineteenth century were quite accurate, despite assuming little to no immigration. The 2.3 million Immigrants who had arrived in the US in the intervening decades had therefore not added to the population, but simply displaced natives by causing Americans to have less children. Walker described these immigrants from Austria, southern Italy, Hungary, and Russia as “beaten men from beaten races, representing the worst failures in the struggle for existence.” who would displace their superiors, the “native” Americans. This anti-immigrant view was not just held by a few bad apples in the AEA; in 1888 the AEA offered a prize for the best essay on the evils of unrestricted immigration!

In 1907, fearing the threat of race suicide, President Roosevelt supported establishing The Dillingham Commission to look at immigration as part of the response. The job of summarizing the findings was given to the Economists Jeremiah Jenks (9th President of the AEA) and his protégé Jett Laucke. They described their task as that of objective scientists: We are not “advocates, but interpreters of facts.” The commission built on racial taxonomies such as Races of Europe by William Ripley (President of the AEA in 1933) which classified racial groups by measurements such as head size and eye colour. Part of Jenks contribution was as coauthor of a Dictionary of Races which set out to establish “whether there may not be certain races that are inferior to other races… to show whether some may be better fitted for American citizenship than others.”

These views on immigration of course did not apply to the colonialists. Richard Mayo-Smith, another AEA co-founder, described Native Americans as a “few thousand savages” over whom the colonialists were victorious because the later were of higher civilization, and progress required that the superior be granted “the moral right to triumph”.

Naturally the view that experts were superior, together with putting experts in charge of policy, led eventually to policies targeting the inferior. One particularly egregious example where policy was explicitly based on the idea that some people were better than others was sterilization or fertility control. While policies on birth control nowadays tend to be more about preventing access to birth control in the past the focus was on forcing its use on those deemed undesirable or inadequate. These policies were largely outside the remit of Economists and involved sterilization of both men and women; the US forcibly sterilized over 20,000 people in the 1930s.

While Economists did not set sterilization policy many were still in favour. Frank Taussig, 1904 President of the AEA, authored Principles of Economics, the most widely used undergraduate Economics textbook of the its time. In Principles he wrote among those not productive enough to find employment under regulations requiring minimum labour standards included some people, namely those “helpless from causes that tend to be cumulative, such as congenital feebleness of body and character, alcoholism, dissolute living” who should “be simply stamped out”, they should not “be allowed at large. Still less should be allowed to breed. We have not yet reached the age where we can chloroform them once for all; but at least they can be shut up in refuges and asylums and prevented from propagating their kind. The opinion of civilized mankind is rapidly moving to the conclusion that so far at least we may apply the principle of eugenics, and thus dispose of what is the simplest phase of the problem of the unemployable.”

Along with Immigration another policy issue closer to home for Economists was the minimum wage. The argument here began from the premise that certain people were unemployable, not in the sense that they couldn’t find jobs but in the sense that they should be excluded be excluded from employment. Journalist Walter Lippman, two-time Pulitzer prize winner and founding editor of the New Republic, captured the idea writing that workers who were “old, or weak-minded, or physically feeble, or so utterly untrained and illiterate that under American conditions they cannot be employed at a living wage” should not be permitted “to debauch the labor market, to wreck by their competition the standards of other workers”. Or as William Z. Ripley, 1900-01 Vice-President of the AEA, put it the “American worker is underbid by the Scandinavian. He in turn is cut under by the Jew and Bohemian. The Pole will take even less than these, and finds at last his standard of living undermined by the Syrian and the Armenian.” With this in mind the minimum wage debates of the 1910s included many of the same arguments we continue to see today with one added twist: some argued for minimum wages precisely to exclude some workers from the labor market! Those to be excluded were a mix of the disabled, certain races, and women. Henry Seager, 1922 President of the AEA, argued that a minimum wage protected American workers by “merely extend[ing] the definition of defectives to embrace all individuals, who even after having received special training, remain incapable of adequate self-support” and would thus become unemployed under a minimum wage.

Eugenics. Racism. Sexism. The early days of the AEA were not so Dismal. But they were certainly Dark!



Fortunately todays American Economic Association bears little resemblance to that described here.

Case for the Defense :P The racism evident in the Economics of this time was by no means unique to Economists. Racism was widespread in society, and more immediately interestingly was also widespread in Science in the form of Eugenics which was favorably viewed at the time. While Eugenics is nowadays held in contempt, back in the early 20th century it was widely considered as scientific. Supporters of Eugenics included many Statisticians of the day, such as Karl Pearson whose contributions include such fundamental statistical concepts as the correlation coefficient and the p-value. Eugenics found especially deep rooted support among Biologists. Artists were by no means exempt. Virginia Woolf (an otherwise favourite author of mine) wrote in her diary that imbeciles should be “should certainly be killed”. D. H. Lawrence went so far in 1908 as to pen the disturbingly prescient extermination fantasy that “I would build a lethal chamber as big as the Crystal Palace.” Nor is this about laissez-fair vs interventionist Economics; plenty of laissez-fair Economists of that time agreed with the eugenics and racism, they simply thought that the best way to further those ends was to let the free market select for the fit and eliminate the inferior or unemployable.

The ‘scientific’ legitimacy of Eugenics in the early 20th century might be trivialized as a cautionary tale on the difference between correlation and causation, and the problems of endogeneity. ;)

The AEA was founded with a set of Objectives and a Statement of Principles. Other than being renamed as Purposes the Objectives remain largely unchanged. The Statement of Principles has been long-since jettisoned having only been intended as a statement as not as a binding condition of membership. Interestingly, while it never made it into the AEA’s founding principles the proposed platform included the phrase “we hold that the doctrine of laissez-faire is unsafe in politics and unsound in morals”.

One Economist who comes out of this whole affair looking particularly good is John Bates Clark —a founding member of the AEA after whom the AEA’s Young Economist award is named— who often provides a voice of caution and reason on many of the issues described above. Richard T. Ely does not. He even argued that food-aid for famine in India should be suspended, saying “let the famine continue for the sake of race improvement.”

The post is heavily based on the book,
Thomas C. Leonard – Illiberal Reformers: Race, Eugenics & American Economics in the Progressive Era
almost all quotes were sourced from there. If you found this post interesting the book contains much more. Much of two of my sentences, that on Mayo-Smith and that on Lippmann, should come in quotation marks as sourced from Leonard, but this would involve quotes of quotes so I mention it here instead. My focus was on Economists, the AEA, and Racism, but the book also discusses sexism, looks at how these issues were bipartisan in manifesting on both the left and right sides of politics, and includes journalists, business leaders and social workers.

The following other sources were also used
Ely, Richard (1910) – The American Economic Association 1885-1909
Taussig, Frank (1911) – Principles of Economics [Specifically Vol. II, Chpt 56.]

A criticism/review of the book:
Steinbaum & Weisberger (2017) – The Intellectual Legacy of Progressive Economics: A Review Essay of Thomas C. Leonard’s Illiberal Reformers


An Illustrated Tale of A.W. Phillips and his Eponymous Curve

A.W. Phillips led an interesting life. Born in New Zealand he left before finishing high school, worked as a crocodile hunter, and found himself in a country when the Japanese invaded not once, not twice, but three times! The last of these resulting in him spending three and a half years as a prisoner of war. But perhaps even more interesting than the life of A.W. Phillips is the life of his eponymous curve and it this life story which follows.

Source: Phillips (1958) - The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957.

The Original Phillips Curve: Rate of Change of Wages against Unemployment, United Kingdom 1913 – 1948.

In 1958 William Phillips published his eponymous Phillips curve, showing a negative correlation between wage inflation and gross domestic product in the United Kingdom, 1913 – 1948. Similar results in other countries led many Economists during the 1960s —including the future Nobel winners Robert Solow and Paul Samuelson— to conclude that this negative correlation between inflation and unemployment was a deep relationship in the economy, and one that could be exploited. Interpreted as a structural relationship the Phillips curve suggested that a country could permanently lower it’s unemployment rate simply by putting up with a few percentage points more of inflation. This was an opportunity not to be missed!

A combination of stimulatory fiscal policy by the US Government, and expansionary monetary policy by the Federal Reserve Bank during the 1960s and 1970s was implemented do just this.1 The Federal Government ran a budget deficit that increased gradually from around zero in 1960 to 5 percent of GDP in the early 1980s.2 This combination of stimulatory fiscal and, especially, monetary policy achieved its first goal: increasing inflation. The US inflation rates went from an average of 1.3 percent for 1960-65, to a peak of around 14 percent in early 1980. So the first goal of increasing inflation to exploit the Phillips curve was attained. But the second goal of decreasing unemployment was not. Instead the Phillips curve fell apart!

Rather than increasing inflation leading to decreased unemployment as predicted based on the interpretation of the Phillips curve as a structural relationship, unemployment increased. This breakdown of the Phillips curve when exploited was not entirely unforeseen. Milton Friedman and Edmund Phelps, two Economists who would go on to win Nobels, had both warned that the Phillips curve was a mere correlation, and not a structural relationship that could be exploited. Friedman, in his 1968 Presidential address to the American Economics Association argued that the Phillips curve was simply as short-run phenomenon. The relationship was really between fluctuations in inflation and the unemployment rate. When inflation was deliberately increased to exploit this relationship people would simply adjust their expectations about inflation upwards. This would appear as an upward shift in the short-run Phillips curve. So the long-run Phillips curve could be thought of as a vertical line, with any average inflation level giving rise to the same unemployment rate. Also in 1968, Phelps published “Money-Wage Dynamics and Labor Market Equilibrium”, setting out a model of inflation and unemployment in which imperfect information gave rise to the short-run Phillips curve (short-run inflation was unexpected), while people’s ‘adaptive expectations’ meant that the short-run Phillips curve would gradually shift up in response to any increase in average (expected) inflation. The success of these predictions over the following decade demonstrated the importance of expectations, uncertainty, and dynamics in macroeconomic theory.3

The ‘Great Inflation’ of the United States found parallels in many other countries. In some, such as the United Kingdom, this occoured for much the same reasons, namely attempts to exploit the Phillips curve. In others inflation was ‘imported’ throughout the 1960s under the Bretton Woods international monetary system. Under Bretton Woods the US dollar was convertible to gold (i.e. pegged to gold), and other countries then pegged their currencies to the US dollar. To maintain their currencies at a fixed exchange rate with the US dollar meant that if the value of the US dollar fell due to US inflation, then other countries had to decrease the value of their currencies by inflation. In this way increasing US inflation lead to increasing inflation in other countries, even those not actively trying to exploit the Phillips curve. This situation continued until US President Nixon suspended the gold convertibility of the US dollar in 1971. This made the US dollar a fiat currency —destroying the Bretton Woods international monetary system— and a number of countries followed suit by floating their exchange rates. Not all other countries experience a great inflation, one particularly noteworthy exception being Germany; highly averse to inflation after its traumatic experience with hyperinflation in the early 1920s.

The end of the Great Inflation in the US came in the early 1980s following the appointment of Paul Volcker as Chairman of the Federal Reserve Bank in 1979, and the election of Ronald Reagan as US President in 1981. Under Volcker the Federal Reserve started tightening monetary policy towards the end of 1979, and began targeting the monetary base rather than the fed funds rate as the policy instrument. In late 1979 and early 1980 interest rates rose significantly. Then came a short recession in early 1980, accompanied by an increase in unemployment and an easing of inflation; the Federal Reserve —reacting in part to political pressure4— blinked and allowed the Fed Funds Rate to fall. The second half of 1980 saw an economic recovery, while inflation remained high. The Federal Reserve began to tighten again. The election of Reagan in January 1981 provided Volcker and the Federal Reserve with the political cover to continue with a tight monetary policy. The economy entered another recession in July 1981, more severe than the earlier one, and recovery did not begin until November 1982. By the time the recession ended inflation was down below 5 percent. But this came at a cost with the recession leading unemployment to peak at 11 percent. With inflation broken, the Federal Reserve eased off and the economic recovery of 1983 and 1984 was swift, with substantial growth in GDP and rapidly falling unemployment. Inflation remained low. The Great Inflation had ended.

The importance of inflation as a political issue in late 1970s US is easily overlooked today, but is shown strongly by the polls. “In a September 1979 survey, 67 percent of the public said that “holding down inflation” was a bigger problem than “finding jobs” (21 percent). On Election Day 59 percent of Reagan’s supporters said that inflation was a “determining issue for them,” according to the New York Times/CBS exit poll.” (R. Samuelson, 2010) While opposition to the Federal Reserves tight monetary polices came from many sources, Reagan was supportive in private meetings with Volcker. Attesting to the importance of the political cover Volcker has written: “No central bank can — or should, in my judgment — conduct policies for long that are out of keeping with basic, continuing objectives of the political system.”

In many other countries high inflation continued for a while longer. Australia for instance did not return to low inflation until after the recession of 1990. A recession described by then Treasurer Paul Keating as “The recession we had to have”.5 New Zealand returned to low inflation around the same time with the introduction of a policy of Inflation Targeting, innovative for its time and now standard for monetary policy in many countries.

In the world of Economic models and theory the success of the then new style of Macroeconomics which emphasized microfoundations and expectations, asserting that reduced-form relationships such as the Phillips Curve are misleading when thinking about the effects of economic policies, received a major boost based on the view that it not only explained but had correctly predicted the failure of attempts to exploit the Phillips curve. But that is a story for another time.

William “A.W.” Phillips
William Phillips was born in New Zealand in 1914. Unusually for an Economist he also had an interesting life. Here is a short version:

Alban William Housego Phillips was born at Te Rehunga near Dannevirke, New Zealand. As a young student he rebuilt the engine of a broken down car and (illegally) drove it to and from High School. He left New Zealand before finishing school to work in Australia at a variety of jobs, including crocodile hunter and manager of his own cinema. In 1937 Phillips headed to China, but had to escape to Russia when Japan invaded China. He traveled across Russia on the Trans-Siberian Railway and made his way to Britain in 1938, where he studied electrical engineering.

At the outbreak of World War II, Phillips joined the Royal Air Force and was sent to Singapore. When Singapore fell he escaped to Java, Indonesia. When Java, too, was overrun Phillips was captured by the Japanese, and spent three and a half years interned in a prisoner of war camp. During this period he learned Chinese from other prisoners, repaired and miniaturized a secret radio hidden in a clog, and fashioned a secret water boiler for tea which he hooked into the camp lighting system. In 1946, he was made a Member of the Order of the British Empire for his war service.

After the war he moved to London and began studying sociology at the London School of Economics (LSE), because of his fascination with prisoners of war’s ability to organize themselves. But he became bored with sociology and developed an interest in Keynesian theory, so he switched his course to economics and within eleven years was a professor of economics.

While a student at the LSE Phillips used his training as an engineer to develop MONIAC, an analogue computer which used hydraulics to model the workings of the British economy, inspiring the term hydraulic macroeconomics.6 It was very well received and Phillips was soon offered a teaching position at the LSE. He advanced from assistant lecturer in 1951 to professor in 1958.

His work focused on British data and observed that in years when the unemployment rate was high, wages tended to be stable, or possibly fall. Conversely, when unemployment was low, wages rose rapidly. In 1958 Phillips published his work on the relationship between inflation and unemployment, illustrated by the Phillips curve. He made several other notable contributions to economics, particularly relating to stabilization policy and Econometrics.

He returned to Australia in 1967 for a position at Australian National University which allowed him to devote half his time to Chinese studies. In 1969 the effects of his war deprivations and smoking caught up with him. He had a stroke, prompting an early retirement and return to Auckland, New Zealand, where he taught at the University of Auckland. He died in Auckland on 4 March 1975.

This bio is based on the Wikipedia article on his life, the Memoirs of his sister Carol Somervell, and Bollard article on his professional life.

Further reading:

The Great Inflation and Its Aftermath: The Past and Future of American Affluence, by Robert J. Samuelson: For those interested in reading more on the history of the Phillips curve and the Great Inflation, both political and its importance to the development of Macroeconomic theory. The book is US centric, but does discuss some of the international aspects.

Phillips (1958) – The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957.
Provides graph shown above. Also emphasizes that the same graph is stable across sub-periods of the time period he considers. Phillips was not the first to posit a relationship between prices and unemployment/output, but was the first to provide convincing empirical evidence.

Samuelson & Solow (1960) – Analytical Aspects of Anti-Inflation Policy
Describe Phillips curve as a “menu of choices”. They are aware that the curve can shift, although they emphasize shifts for non-monetary reasons (changing union power, employment legislation, etc.). That a permanent shift in inflation might shift the curve does receive a single mention, but only as one point in a lengthy laundry-list of possibilities, not as anything remotely likely to occour. They emphasize that the Phillips curve “menu of choices” should be viewed as something existing on a sub-five year timescale, but with the view that shifts will be due to changes in institutions/structure of economy, and that a slightly different menu of choices would then continue to exist.

Friedman (1968) – The Role of Monetary Policy (1968 Presidential Address to the American Economics Association)
Emphasizes expectations and that the ability of monetary policy to effect unemployment (and interest rates) is a short (sub-five year) phenomenon, with longer term unemployment and interest rates determined by real economic fundamentals.

Phelps (1967) – Phillips Curves, Expectations of Inflation and Optimal Unemployment over Time
Phelps (1968) – Money-Wage Dynamics and Labor-Market Equilibrium
Provide an explicit model/theoretical basis for why expectations matter and will shift the Phillips curve. From the perspective of Economic Theory these articles provide the basic framework by which the Phillips curve is understood today.


1. The role of the Federal Reserve Bank was that of enabler. It did not deliberately aim to create inflation to exploit the Phillips curve (at least based on a reading of its minutes), instead it simply accommodated increasing inflation under the justification of the Phillips curve.
2. Another part of the justification for this was Keynesian counter-cyclical fiscal stimulus, but while the deficit is somewhat counter cyclical it never closed as much in the booms as it opened in the recessions. The growing trend in Government deficits makes sense under the goal of increasing inflation to exploit the Phillips curve. It makes no sense as counter-cyclical Keynesian fiscal policy.
3. Adaptive expectations has since largely disappeared from formal models, pushed out by rational expectations. It does still get some use however and also finds parallels in modern models in the form of learning under imperfect information (which is not a violation of rational expectations).
4. While Carter had recognized the failure of voluntary and involuntary price and wage controls and appointed Volcker to fight inflation Miller and Schultze, Carter’s Treasury Secretary and chairman of the Council of Economic Advisors respectively, both opposed the actions of the Federal Reserve.
5. While the Reserve Bank of Australia was running a tight monetary policy at the time of the 1990 recession, unlike in the US case of 1980 and 1981-82 recessions this was not viewed as a recession induced by the central bank to fight inflation.
6. MONIAC, Monetary National Income Analogue Computer, is a small open-economy ISLM model with a financial accelerator. Videos of a MONIAC in action can be found online, as can a simulated version with explanation. The MONIAC draws graphs that Economists would recognize as the transition paths between steady-states. A few MONIACs remain in existence, with the only regularly working one located at the Reserve Bank of New Zealand where it can be seen in action once a month. The precise mathematical model solved by the MONIAC consists of nine differential equations, see Phillips (1950) – Mechanical Models in Economic Dynamics. The only other working MONIAC is located in Cambridge, UK and is run once per year.

Modern Monetary Confusion (a.k.a. Modern Monetary Theory)

Modern Monetary Theory claims that Governments which control their own currency do not face a ‘fiscal or financial’ limit to their ability to spend, they can always borrow more (issue more debt). We go in search of the new ‘Theory’ behind this claim and find that the only new theory is the Modern Monetary Confusion.

The Modern Monetary Confusion: always being able to issue debt does not equate to being able to have an ever increasing debt.

Ninety-nine percent of Modern Monetary Theory is in no way different from standard economic theory. A Government wishing to increase spending can fund this by issuing debt. And as long as the Government controls a currency, it can always do this. Either people will be willing to buy this debt –to lend the Government the money– or the Government can simply print money to make up the difference. So far, so good.

Where is the new ‘Theory’ in Modern Monetary Theory? If the claim is simply that Government could spend more this can always be achieved by increasing taxes in tandem. With both Government revenue and spending going up there would be no need for any Modern Monetary Theory to make this possible; whether or not this would be desirable is for another day. Clearly then Modern Monetary Theory must be about more than just increased Government spending. For some reason this spending should be paid for by increased Government debt. Nor can Modern Monetary Theory be about increased Government spending during major recessions that is paid for by debt with a view to paying off the debt during future good times. This would just be standard economics of a Keynesian variety. Our search for the new ‘Theory’ in Modern Monetary Theory continues.

Modern Monetary Theory is left arguing that the Government should increase spending paid for by issuing Government debt on the ground that it can just continue issuing debt forever. In the lingo of Modern Monetary Theory the idea of an ever increasing debt is described as that the Government faces no ‘fiscal or financial constraint’ to Government spending. At this point Modern Monetary Theory finds a ‘Theory’! But in doing so loses all grasp of reality and wanders off into La La Land.

The problems begin with observing that either the increase in spending paid for by debt is going to be a one-trick pony –in which case we can all yawn and move on– or the Government is going to do this repeatedly/permanently, leading to ever increasing Government debt levels. Modern Monetary Theory’s divorce from reality comes from confusing the fact that a Government that controls a currency can always issue more debt –either someone buys the debt or can print money– with the idea that a Government can therefore have an ever increasing debt. This is the Modern Monetary Confusion: always being able to issue debt does not equate to being able to have an ever increasing debt!

A Government that issues its own currency can always issue more debt. It cannot have an ever increasing debt. Why? Let’s return to why the ‘issuing own currency’ is an important part of this argument in the first place. Any Government can increase debt if someone is willing to buy the debt (i.e., to lend them the money). But as the Government debt continues to pile up at some point there will be no-one willing to lend more money, because they don’t think the Government will be able to afford to pay them back and so it would be a losing proposition to lend. Or in a logically possible but unrealistic scenario, simply because the Government has already borrowed all the savings of everyone in the economy and there is nothing left to lend. This is where the Government controlling a currency comes into play. If the Government wants to borrow by issuing debt and no-one wants to lend them money then they can print money to pay for the debt instead. When a government does this it is not really issuing debt at all, and so debt stops going up. Of course, the flip-side is that the Government is now paying for things by printing money. This is money-financing of the Government and we are just back to standard economics. A Government can finance itself by printing money. The printing of money sooner or later generates inflation, this raises revenue for Government in the form of an ‘inflation-tax’; it works by redistributing income from people holding money to the Government by making the money those people hold worth less, while the Government now holds more money.

So Governments cannot have an ever increasing debt: the Theory of Modern Monetary Theory is divorced from all reality. Either people will stop lending to the Government, or the Government will switch to money-financing of Government spending. Money-financing of Government spending is not a new Modern Monetary Theory. At low levels –printing money valued at one-or-two percent of GDP per year– it is largely benign simply acting as another form of taxation, albeit one that is highly regressive (poor people hold more cash relative to income). But used as a major source of revenue as Governments have occasionally done in the past it has often ended badly. In its most extreme form money-financing is how countries get hyperinflation. In fact the cause of every hyperinflation, from Germany between the World Wars, to Zimbabwe’s which peaked in 2008-9, is Government printing money to finance itself. Again though, money-financing of Government spending is just standard economics.

So what Theory is left for Modern Monetary Theory? Naught but a Modern Monetary Confusion.





  • What is Modern Monetary Theory? Here are links to two short pieces, and two long ones:
    Explainer: what is Modern Monetary Theory?
    The Rock-Star Appeal of Modern Monetary Theory (mostly on the political side in US context)
    Modern Monetary Theory and Practice – An Introductory Text
  • That sooner or later people will simply refuse to lend to the Government is evidenced by two observations. First, that some Governments end up borrowing from the IMF: why would you borrow from the IMF, with all the harsh conditions that imposes on the borrowing country, if there was any alternative person to borrow from? Second, that some Governments that do control their own currency end up borrowing money in foreign currencies. If there was always someone who would lend you money in your own currency why would you ever want to borrow in a currency you don’t control?
  • There are two other options for how the Government might pay for debt that I ignore above for expositional purposes. First, the Government might (partially) default on the debt. While default will sometimes be a sensible option for countries that find themselves in unforeseen bad situations it hardly seems like a good idea to run a Government that borrows with the deliberate intention of defaulting on the debt. This would be a one-way street to becoming an economic backwater. Second, the Government can force, or strongly incentivize, people and firms to hold Government debt. This is called Financial Repression and it is common practice. At root though Financial Repression is just a more hidden, and typically more distortionary, way of paying for the debt than just taxing; e.g., forcing the financial sector to hold lots of Government debt at low interest rates is just a way of redistributing income from the finance sector to the Government, and this could just as easily be done with a tax on the finance sector. Financial Repression, like default, is something that countries finding themselves struggling with high levels of debt might find is a least-bad option. Or Financial Repression may sometimes represent an appealing alternative to taxation. But again while Financial Repression will sometimes be a good idea for countries already struggling with high levels of debt, it is not a reason to start borrowing in the first place.
  • Another option would be to increase taxes in the (near) future. But this is just a delayed version of increasing taxes to pay for increased spending. So we will ignore this here as again it doesn’t leave any ‘Theory’ in Modern Monetary Theory.
  • Technically modern Governments would be unlikely to ‘physically print’ money. They simple credit it to bank accounts; the Treasury has an account at the Central Bank. For present argument though the effect is essentially the same.
  • In practice/history another reason countries often embark on major increases in Government spending paid for by debt is to fund wars. I ignore this here.
  • Not all countries issue their own currency and so have this ability to always issue more Government debt that either someone will buy or that the Government can pay for by printing money. The obvious exceptions are Eurozone countries. These share a currency and so an individual country, be it Greece or Germany, cannot unilaterally decide to print more money. The Government can therefore only issue debt if someone will buy it. The Eurozone debt crisis that started in 2009 reflects what happens when a country wants to issue debt but struggles to find someone to buy it.
  • Fiat currencies is a technical economics term for a currency issued by the Government and which is ‘enforced’ with legal backing. One example is the US dollar which is issued/printed by the US Government and which the US government says that you must accept as ‘legal tender’ for transactions, and is the only currency in which you can pay your taxes. It is closely related to the idea of a currency which is controlled by the Government, but not quite the same as the Euro illustrates. The Euro is a fiat currency in that it is legally mandated and accepted by the various Eurozone Governments, but those same Eurozone Governments cannot unilaterally print more Euros, this can only be done as a joint action of the Eurozone Governments.
  • Modern Monetary Theory is often also linked to the idea that because of the erroneous claims about Government borrowing it follows that the Government should promote full employment. Were a country to decide that it wished to create full employment through a program of the Government of hiring everyone who wanted a job it could do this without any need for Modern Monetary Theory, just raise taxes to pay for all the people the Government employs. Modern Monetary Theory brings nothing new to the discussion of whether or not a policy of full employment by Government employment is desirable.

The Dismal Science

This is the story of how Economics came to be called the Dismal Science. It is a story I choose to begin with Piano wire…

Piano wire is known for producing beautiful sounds from Turning Point by Nina Simone, to Changing Opinions by Phillip Glass, to the Goldberg Variations of J.S. Bach. The sound made by piano wire when threaded into a whip and used to rend flesh from the backs of plantation slaves is presumably not among them. But it was this sound of piano wire on flesh, or news of it, that caused uproar in London during the year 1865. The whipping of slaves with piano wire had occurred in Jamaica on the orders of the Governor George Eyre. Among those who came to his defense, arguing that the whippings had been an important part of suppressing a rebellion, was Thomas Carlyle.

Over a period of many years prior to this event Thomas Carlyle had often made the case that while slavery itself may not be strictly desirable it was a reflection of an innate superiority of whites over blacks. He had a long running and public feud with John Stuart Mill on precisely this topic, including an 1849 essay entitled “Occasional Discourse on the Negro Question” in which he described Economics — “the Social Science […] which finds the secret of this universe in ‘supply-and-demand’ ” — as the “Dismal Science”. This was the coining of the term Dismal Science to describe Economics.

Economics was a dismal science, indeed “a dreary, desolate, and indeed quite abject and distressing one” because it denied the superiority of certain men. This was in direct contrast to Carlyle who held that some men, mostly White ones, were innately better than others, namely “Black Quashee”.  Addressing himself to Blacks in the West Indies he advised, “You are not ‘slaves’ now; nor do I wish, if it can be avoided, to see you slaves again: but decidedly you will have to be servants to those that are born wiser than you, that are born lords of you, — servants to the whites, if they are (as what mortal can doubt they are?) born wiser than you.”

Carlyle felt that “Black Quashee” was “indolent” and that if left to his own devices would simply choose to sit around eating “Pumpkin”, which would be against his “sacred appointment to labour”. To save “Black Quashee” from his own indolence he had an “indisputable and perpetual right to be compelled” to work. Economists, in a most dismal fashion, denied that certain men were inferior and should be compelled to work. Instead they suggested that a wage be offered for work and the “poor indolent blockhead, black or white” simply be left to decided for themselves whether or not to work at that wage.

While Carlyle’s essay certainly has racial undertones — less undertones than blaringly loud tones — his point was also part of a larger argument. Part of the essay and an opinion Carlyle shared with his contemporary supporters, among them John Ruskin and Charles Dickens, was the idea that some men are simply Great Men who are from birth simply destined for great things. It was the opposition of Economists to such ideas of innate superiority and their insistence on a more egalitarian view of mankind to which Carlyle objected.

A denial that some men may be innately better than others lead Economics to be known as the Dismal Science. Dismal was to insist that all men and women be treated equally. If only Economists were more Dismal today!


If you decide to read Carlyle’s essay it will help to know that Exeter Hall was the home of the anti-slavery movement. It would also help to know what Carlyle’s obsession with Pumpkins is all about, but on this point I have no idea. Among Thomas Carlyle’s main opponents on the issue of slavery was the Economist and Moral Philosopher John Stuart Mill. The trial of George Eyre, the Jamacian Governor, led John Stuart Mill together with Charles Darwin and others to form the Jamaica Committee to push for the prosecution of George Eyre. Thomas Carlyle formed a rival committee for the defense, with supporters including Charles Dickens and John Ruskin.

Carlyle’s argument in the Occasional Discourse is, strictly speaking, made not in favour of slavery, merely of compelling people to work. However Carlyle was certainly not averse to the idea; “Quashee, if he will not help in bringing out the spices, will get himself made a slave again (which state will be a little less ugly than his present one), and with beneficent whip, since other methods avail not, will be compelled to work.”

A nice quote from Adam Smith’s Wealth of Nations that captures this egalitarian view of early Economists is,

The difference of natural talents in different men is, in reality, much less than we are aware of; and the very different genius which appears to distinguish men of different professions, when grown up to maturity, is not upon many occasions so much the cause, as the effect of the division of labour. The difference between the most dissimilar characters, between a philosopher and a common street porter, for example, seems to arise not so much from nature, as from habit, custom, and education. When they came into the world, and for the first six or eight years of their existence, they were perhaps, very much alike, and neither their parents nor playfellows could perceive any remarkable difference. About that age, or soon after, they came to be employed in very different occupations. The difference of talents comes then to be taken notice of, and widens by degrees, till at last the vanity of the philosopher is willing to acknowledge scarce any resemblance.


Further readings:

  • In addition to Carlyle’s essay as linked above there are a series of modern essays examining the racial context in which the term the Dismal Science first arose in the book of essays How the Dismal Science got its Name by David Levy, this was my own introduction to the topic. A good book, but dense.
  • A contemporary report from The Spectator on the Jamaica Affair.
  • For more on Britain’s anti-slavery movement, one of the world’s first international humanitarian rights campaigns, try Bury the Chains: Prophets and Rebels in the Fight to Free an Empire’s Slaves by Adam Hothschild. Britain did not just ban slavery within its own borders (and colonies), it actively protested the trading of slaves by other countries, and by the end was patrolling the waters off Zanzibar to blockade the shipping of slaves to the Arabic Peninsula.
  • Hard Times by Charles Dickens, a book he dedicated to Thomas Carlyle, argues against a narrow conception of behaving in a rationalist utilitarian fashion in which all actions should be based in facts while imagination and compassion are foreign concepts.
  • What happened to the egalitarian views of the earlier Economists? Try The “Vanity of the Philosopher”: From Equality to Hierarchy in Post-Classical Economics by David Levy and Sandra Pearl. As with the other Levy book mentioned, this is not light reading.

Summary of Piketty: Criticisms

[This is the fifth of five posts on Capital in the 21st Century. The first is here.]

The following are mini-summaries of some of the main criticisms of Piketty’s Capital in the 21st Century that relate to his descriptions of the historical changes in inequality and their current trends. I do not consider criticisms of Piketty’s policy prescriptions (a global wealth tax). I put some that I would describe as more substantive first, and the less important ones later. A good summary of criticisms is provided by Wolfers.

  • Global growth (eg. Rogoff): The global income distribution has become more equal over the last decades. It is possible, perhaps even likely, that this is related to the lack of growth in median income in the rich countries. This has happened alongside the large increases in the shares of Income and Wealth of the top percentile, which is Piketty’s main focus. It is something worth remembering, but has no direct bearing on Piketty’s arguments about inequality in developed countries, expect perhaps putting them in the broader context. In short, while globalization may account for the increasing equality of the global income distribution, the stagnation of lower and middle incomes in developed countries, and the rising returns to higher education, it does not appear to explain the rising income share of the top percentile. (Global income growth. For global wealth distributions similar data simply does not exist (yet))
  • Inequality within the 99% (eg. Autor):
  • US after-tax vs pre-tax incomes (BL&S and Burtless), and changing US households (BL&S and GGKS): Piketty’s income inequality numbers are based on pre-tax incomes. One criticism of his numbers is thus that what really matters is after-tax incomes. Using after-tax incomes the top percentile still hugely increases it’s share of (after-tax) income. The main thing that looks different using after-tax incomes is that median US household incomes no longer look stagnant over the last few decades, they have increased (albeit not nearly as fast as those of top percentile). Another criticism of Piketty’s income inequality numbers for the US is that the ‘average’ US household has changed over time, it used to be the nuclear family (Mum, Dad, Two Children), but there are now many more households with only one parent. It also used to be case that only the Husband would work, this is no longer true and nowadays high income husbands tend to have high income wives. Accounting for changing households makes the increases in income inequality “less severe” (quotation marks as the increase is still the ‘same’, just changes how one sees the causes), although the trends are in the same direction. It does however change the story of stagnant median US incomes, which do grow, albeit still by less than the US economy.
  • Wealth versus Capital (eg., Blume & Durlauf): Piketty does not really measure Capital, but rather Wealth. The distinction is that Wealth is the market value of all assets (ie. houses are valued by the price of houses), while Capital is only assets that are used in production and are valued by their marginal product. Among the criticisms this leads to are that Piketty measures aggregate Wealth by asset value as his numbers are susceptible to house price movements (hence BBCW and Rognlie criticisms below). Also since the inequality ‘share of income’ measures are based on marginal product there is an inconsistency between how Piketty measures aggregates and shares. They also observe that many of Piketty’s ideas about drivers of inequality — negotiating power of managers, ability of large funds to get better rates of return on assets — imply that the marginal product measures of inequality used will be invalid (validity of the marginal product measures assumes perfect competition).

Some less important criticisms are,

  • Acemoglu & Robinson – The Rise and Fall of General Laws of Capitalism: Their first point is that there are no such thing as inescapable laws of capitalism (except accounting identities!). They provide some preliminary cross-country evidence on the relationship between income inequality and \( r-g \) which, while too weak to convince anyone not already convinced, does provide a useful starting point (also has weakness that it is income inequality, while argument is really about wealth inequality). Using examples of Sweden and South Africa they point out importance of looking at many different measures of inequality, not just focusing on the one percent.
  • Krussell & Smith (VoxEU): Criticize the “theory” in Piketty’s book. The objection is essentially the following. Piketty uses the formula \( K/L = s/g \) (capital/output ratio=savings rate/growth rate) when he should use the formula \( K/Y = s/(g+n+\delta) \) (capital/output ratio=savings rate/(growth rate+population growth rate + capital depreciation rate)). The later formula being that of the Solow growth model (and the one I just used directly in my summary). Their objection is that if \( g \) goes to zero then Piketty’s formula would predict that the capital/income ratio goes to infinity — clearly unrealistic. It seems clear from the surrounding text that Piketty is aware of the Solow growth model and capital depreciation but leaves it out for simplicity, and because Piketty’s main use for the formula is to argue that as population growth rates slow, possibly accompanied by a slowing per-capita growth rate, we would expect the capital/income ratios to rise; and thus Frances historically lower population growth rate and higher capital/income ratios provide a better guide to what we should expect capital/income ratios to be in the future, than the historical experience of the US with its higher population growth rate. At least by my reading the book does not claim that \(K/Y\) is about to go off to infinity. I call this a lesser criticism not because the point is unimportant, but because it feels like they are taking down a Strawman.
  • BBCW (the four French) Economists: Object to Piketty’s use of house prices as way to measure wealth. Suggest using rental prices of housing instead. Doing this for French data makes the increase in the French Capital/Income ratio since World War II smaller, but still in same direction, as Piketty’s findings. Their objection seems somewhat misguided as Piketty is using the price of assets as a measure of their value which is very much following the standard approach and it is not clear why using rental prices might be better (other than being less affected by booms and busts). In any case, they find much the same trends as Piketty; a rising ratio in France since WWII, only less pronounced. They also suggest that this is important for Piketty’s ideas on wealth inequality being self-reinforcing, but since the wealth of the rich is in stocks & bonds, not houses, it does not seem so important.
  • Rognlie: Loosely, makes same point as the Four French Economists only for the US economy, and focusing on capital share of income rather than wealth-to-income ratio. Namely that it is substantially about housing prices.
  • Financial Times: Points out some (¿)minor(?) spreadsheet errors relating to Chapter 11 (Wealth Inequality). Important, but do not appear to change any of the main conclusions. In his response Piketty mentions that the World Top Incomes Database, the definitive data source, will shortly be expanded to include Wealth data.

Summary of Piketty, Part 3: Inheritance of Capital

[This is the fourth of five posts on Capital in the 21st Century. The first is here.]

The third part of Piketty’s Capital in the 21st Century is about the Inheritance of Wealth; there is also some discussion of global wealth and of taxation but I shall skip those here. Piketty investigates inheritance of wealth looking at just France as that is the only country where the data is good enough to do so.

Piketty considers two key aspects of inheritance: the value of inheritance relative to incomes, and how concentrated inheritances are in the hands of a few.

The value of inheritance relative to the economy as a whole is shown to have been high in the 19th century, fallen massively as a result of the two World Wars, and is currently rising, although not yet back to 19th century levels. The concentration of inheritances however reduced substantially during the 20th century and remains much lower; this does not mean that inheritance is no longer important, just that inheritance matters in a different way than it used to.

So how important are inheritances relative to earnings from working? Piketty shows that in the 19th century Inherited Wealth offered riches simply unattainable by working and saving; a ratio of three-to-one as measured by lifetime resources. This ratio fell below one just after the world wars, and while trending upward is now only just above one. Thus in the 19th century the richest French inherited their wealth, while nowadays the richest French are much more mixed between earning and inheriting. Piketty predicts that inheritances will become more concentrated in the future, perhaps leading to a return to a situation in which the richest people are those who inherited their wealth. It is in this increasing concentration of wealth by inheritance that Piketty sees the main role for \(r>g\). \(r>g\) further allows for greater accumulation of assets over the lifetime, leading to higher ratios of assets at age of death to assets at age of receipt of inheritance, meaning a larger role for inheritance. This combination of an increasing role for inheritance, together with it’s increased concentration, are the channels by which \(r-g\) is proposed to drive increased inequality.

The following facts are all for France, except F11.12. This reflects that France is the only country where we have good inheritance data over a long time period. This is especially true of gifts, inheritance transferred between living parents and children (such as helping to buy a house) rather than transferred upon the death of the parents.

Inheritance of Capital:

Wealth inequality a century ago was much higher than now. Then most capital was land, and the wealthiest 10 percent owned nine-tenths of it. Now most capital is housing, industrial and financial, and the wealthiest 10 percent own around two-thirds of it, rest is owned by next 40-or-so percent, with poorest half owning none. Whether we will return to the wealthiest 10 percent owning nine-tenths depends on how concentration of wealth evolves, and the inheritance and accumulation of wealth are key to understanding this.

There are two main ways to accumulate capital, savings (whether from earnings or from capital income) and inheritance: this is where Piketty argues for key role or \(r>g\), namely that when \(r-g\) is large, inheritance will become more important relative to savings. And within savings large \(r-g\) is likely to increase the importance of capital income relative to earnings.

So how important is the role of Inheritance in Wealth? There are two questions here, first how much of Wealth is inherited on average, and second how concentrated is this Inheritance.

How much of Wealth is inherited on average? In France inheritance accounts for 18% of the lifetime resources (sum of all the income and assets you will have over a lifetime) of the average individual; calculated for those presently 50 years old which is the average age at which people inherit. In the late 19th century it was 25%. Following the World Wars it fell to 10%, since rising to 18%, and Piketty forecasts that it will continue to rise back to 25% (F11.9)

How concentrated is Inheritance? Measuring the concentration of inheritance as the ‘Faction of each cohort receiving in inheritance at least the equivalent of the lifetime labor income received by bottom 50% labor earners’, we see that in 19th France this was around 10% of the population, for those inheriting in mid-20th century this fell to 1% and has since returned to 10%. Piketty forecasts that it will continue to rise to 15%. (F11.11)

Combining these findings on how much of Lifetime resources are inherited, and on the concentration of inheritance, we see that while the importance of inheritance in the economy on average has returned to the levels of the late 19th century, Piketty’s forecasts suggest that it is more widely spread. This argues for both a substantially increased role of inheritance relative to recent decades, but not one with the same levels of concentration as seem in the late 19th century. Piketty forecasts inheritance to play a much larger role in the incomes of the Top 1%, but not to the complete exclusion of labour earnings as in the 19th century.

Other points on Inheritance of Wealth:

  • Inheritance flows as a percentage of total private wealth, also called the annual rate of transmission of wealth by inheritance, has been rising. By accounting identity, these flows can be expressed as \(m \mu\), where \(m\) is the mortality rate and \(\mu\) is the ratio of average wealth at time of death to average wealth of living individuals. \(m\) has fallen due to people living longer than before (F11.2), but this has been more than countered by the increase in \(\mu\) (F11.5), with the result that \(m \mu\) has increased (F11.4).
  • A technical modification of \(\mu\) is needed to include ‘gifts given’ in the wealth at time of death. \(\mu\) will reflect savings decisions and depreciation. For example if retirees draw down assets and die with none left than \(\mu\)=0. Piketty argues that changes in the pattern of assets across age groups among Parisians over time (T11.1) can be explained by changes in \(r-g\); Parisians are chosen simply as they are the only group for which Piketty has the required data.
  • The importance of gifts (a.k.a. intervivos transfers) has increased substantially in the past few decades and now account for around half the value of inheritances (F11.5). This is likely a response to ageing, with the average age of recipients of gifts being 35-40. The average age at which one received inheritance used to be 30 and has now increased to 50. This directly reflects parents living longer, with the difference between average age at death and average age of heirs (aka. generational duration) remaining roughly constant at 30 years (F11.3).
  • In 19th France the annual flow of inheritance accounted for around 20% of GDP, around 1920 this fell to about 5%, and in last decade or two has increased again to 10-15% of GDP (recall that capital income averages around one-third of GDP). (F11.1; shows Fiscal flows measure, based on declaration of gifts and inheritance to tax authorities, and Economic flows, explained below. Both measures in theory should give same number.) (F11.12 shows similar findings for UK & Germany.)
  • Economic Flow of Inheritance: the annual flow of inheritance as a percentage of GDP can be calculated as \(m \mu \frac{K}{Y} \); ie. as inheritance flows as a percentage of total private wealth times the capital-output ratio.
  • How big are Top 1% of Inheritances compared to the Top 1% of Earnings? Measured as the Lifetime Resources that each contributes Piketty finds that Top 1% inheritances in the 19th century were some three times the Lifetime resources from Top 1% earnings; meaning that inheritance offered the possibility of earnings unachievable by working. Nowadays this ratio is around 1, meaning that it is possible to enter into the Top 1% of lifetime resources by earnings alone (F11.10). This finding is reflected in the earlier findings on the Share of Capital Income amongst top incomes (US & France: F8.3, F8.4, F8.9, F8.10).

Part 4: Some Criticisms of Piketty

Summary of Piketty, Part 2: Income Inequality and Wealth Inequality

[This is the third of five posts on Capital in the 21st Century. The first is here.]

The second part of Piketty’s Capital in the 21st Century looks at inequality within developed countries. Two main types of inequality are considered: income inequality (inequality in how much people earn each year) and wealth inequality (inequality in how much people own).

For income inequality two main trends are evident, the rise of the top 10 percent (top decile), and the rise of the top one percent (top centile) or even 0.1 percent. The increasing share of the top decile is likely a reflection of changes in education, technology (computers and the internet), and globalisation; it is ‘bigger’ in the sense of accounting for a larger share of national income. The increasing share of the top centile is often described as the rise of the supermanagers (high-aid CEOs), but this is not enough, as the top 0.1 percent have risen even further and their income comes mostly from capital income. It is this rise of the top centile (and 0.1 percent) that Piketty considers most alarming.

Wealth Inequality fell substantially during the first half of the 20th century, stayed largely flat for a few decades, and has been increasing for the past few decades. The fall is explained by the two world wars, together with the period of high inflation that many countries experienced inbetween. Piketty argues that the flatlining of the next few decades occoured because the (after-tax) return on capital was lower than the economic growth rate, thus capital did not simply tend to accumulate when ‘left to itself’. This period of the (after-tax) return on capital being lower than the economic growth rate appears to be a historical anomaly, and has ceased to be the case in recent decades. As a result wealth inequality has begun to increase back towards its historical levels. There is one other major difference between post-war wealth inequality and historical wealth inequality, the part of the population not in the top decile actually holds a non-trivial fraction of the wealth (ie. many households own their houses).

 Income and Wealth Inequality:

  • The income rich and the wealth rich are not the same people. There is some overlap, but generally the people who make the top incomes and the people with the top wealth are not the same people. Retired people, with lots of wealth but little income, are one example of this.
  • Wealth is always and everywhere much more unequally distributed than income.
  • For most people income consists of wages, capital income is the most important form of income only for the very rich. Around 1930 capital income was the main source of income for the top 1% incomes, nowadays capital income is the main source of income for the top 0.1% incomes (US & France: F8.3, F8.4, F8.9, F8.10).
  • What does ‘low’ or ‘high’ inequality mean when talking about countries? Piketty gives some examples of countries that show us what such concepts might mean, for example Scandinavia in the 1970s provides a benchmark of low inequality, the US in 2010 a benchmark for high inequality. The following tables show what the shares of various groups are for labour income, capital ownership, and total income are for these cases, respectively: T7.1, T7.2, T7.3.

Income Inequality

  • There are two main trends currently occurring. One is that the top quintile (20%) or decile (10%) are leaving the average and poor behind. The second is that the top 1% or even 0.1% are leaving everyone else even further behind.
  • Income share of top decile in US and Europe: F9.7F9.8.
  • Income share of the top 1% in various countries: F9.2F9.3, F9.4.
  • Income share of the top 0.1% in various countries: F9.5F9.6.
  • That the top quintile or decile are leaving behind the median and poor seems mostly due to a combination of factors such as an increase demand for high-skill workers (due to technology such as telecommunications and computers that allow them to be more productive and reach larger audiences), a slowing supply of high-skill workers (since education levels appear to be levelling out; almost everyone already has high-school education, many people now have university education), and globalisation (which massively increased the supply of workers, and hence the competition in the non-university educated jobs).
  • The reasons why the top 1% of incomes have seen such a large increase in their share of earnings is not so clear. Is this a return to a more normal state of affairs?, as suggested by the observation that pre-WW2 they were much higher than now. Or is it due to their being more productive (thanks to technological improvements) like for the top decile, only even more so. Or is it due to their capturing the political process and manipulating the rules in their favour? Or is it because CEO pay is set by friends of CEOs and so they simply scratch each others backs? While there is some evidence for each of these arguments we do not yet know their relative importance. What we do know is just that the top 1% and 0.1% have been making an increasingly large share of income over the last decades, that this is true in all developed counties, and that it seems likely to continue. Interestingly their share is much higher in the US than in the other Anglo-Saxon countries (F9.2, F9.5).
  • Who are the top 1% of incomes in US? By vast majority CEOs, Managers, Finance, plus some Doctors and Lawyers. Who are not the top 1% of incomes in US? Film stars, Sports stars, and Small-Business Owners. Piketty mentions this point. The numbers can be found in Bakija, Cole, and Heim (2012WP).
  • Historically income inequality fell substantially around the period of the two world wars, and has been increasing since. A substantial part of this is due to the simultaneous fall and then rise in the importance of capital (F8.1, F8.2, F8.7, F8.8), and fall and rise is much greater within the top 1% than in the rest of the top decile (F8.6). One interpretation of this is that the post-war period was the exception, and presently rising inequality represent a return to the norm, this is the argument made by Piketty.

Wealth Inequality

  • The top decile and top 1% wealthiest hold very large shares of total wealth (F10.1, F10.3, F10.4, F10.5).
  • The bottom third (approximately) of the population holds around zero wealth.
  • The shares of wealthiest used to be much higher before the world wars, and have been increasing during the last few decades. Piketty argues this present increase likely represents a return to normal.
  • Part of his reason for arguing that increasing wealth inequality is likely to continue is that capital income is much larger than savings (F10.8) and so most wealth accumulation likely occurs from the reinvestment of capital income, tending to lead to higher concentrations of capital. This is made in combination with the observation that the return on capital (\(r\)) is higher than the growth rate of the economy (\(g\)), a so simply by saving a fraction of the ‘extra \(r-g\)’ part of capital income there will be a tendency to increased concentration of capital ownership (F10.10, Piketty provides a few other graphs arguing that \(r>g\) is very much the historical norm, and that the only exception has been the couple of decades post-WW2) .
  • This argument of Piketty’s, that \(r>g\) will lead to increasing wealth inequality, has been one of the most strongly criticised parts of the book. Disagreement is not so much that \(r>g\) is the normal state of affairs — which seems to have been widely accepted — but his conclusion that this naturally leads wealth inequality to increase involves some strong assumptions about how people decide how much to save. However Piketty’s assertion does not appear strongly at odds with the evidence, that generally suggests that the rich have higher savings rates. That Piketty does not present any evidence on what determines savings is though a major weak point in his arguments.
  • The shares of the wealthiest are higher in Europe than in US, this is likely explained by the higher population growth in the US which makes wealth accumulated in the past become more dispersed (this logic is reasonable and related to the case of capital/income ratios, but not watertight). (F10.6)
  • Superentrepreneurs, eg. Bill Gates, are very few in number and as such play no quantitative role in the increases in inequality of recent decades.

For more numbers on income and wealth inequality for a wider selection of countries, see the Chartbook of Economic Inequality.

Part 3: Inheritance of Capital Wealth

Summary of Piketty, Part 1: Capital/Income Ratio and the Capital Share of Income

[This is the second of five posts on Capital in the 21st Century. The first is here.]

The first part of Piketty’s Capital in the 21st Century is about the Capital/Income ratio and the split of Income between Capital Income and Labour Income. Piketty finds that Capital/Income ratios are increasing, and predicts they will continue to do say. Alongside this increase in Capital/Income ratios, and as a result of it, the share of income going to Capital appears to be increasing, and is also predicted to continue to do so.

Increasing Capital/Income ratios are the result of two forces. The first is a recovery to higher historical levels after the destruction of large amounts of capital in the first-half of the 20th century, mainly as a result of the World Wars. The second is decreasing income growth rates — due to both slowing technological progress and slower population growth — which mechanically means that the same rates of savings will result in higher Capital/Income ratios.

Increasing Capital/Income ratios automatically result in an increasing share of income going to Capital, unless they are fully offset by falling interest rates. The evidence suggests that interest rates do fall as Capital/Income ratios increase, but that they do not fall enough to fully offset the increasing importance of capital.

Capital/Income Ratios:

Main point: Capital/Income ratios are rising, and will continue to do so. There are two main reasons. The first is a return to historical norms after a massive fall in Capital/Incomes due to the destruction of capital in the World Wars. The second is a slowing growth rate of income (partly due to falling population growth), so that the same rate of savings leads to substantially higher Capital/Income ratios.

Return to historical norms after a massive fall in Capital/Incomes due to the destruction of capital in the World Wars: The focus here will be on France & Britain, simply because the data for these two countries goes back much further. The observations follow directly from

Capital in Britain , 1700-2010

Capital in France, 1700-2010

Here we see that the Capital/Income Ratio was high, until the two World Wars (and high inflation between them) substantially reduced the ratios. Since World War II they have been on an upward tendency. The first of the main points here is that Capital is currently becoming more important; and that this represents a return to historical norms after the destruction of the early 20th Century.1

The growth rate of national income is an important determinant of the levels at which the Capital/Income Ratio will settle: If a country saves a fraction \(s\) of income each year, and has per-capita income growth of \(g\), population growth of \(n\), and capital deprecates (wears-out) at rate \(\delta\) then the Capital/Income Ratio (\(K/Y\)) of that country will eventually stabilize at


(think of the Solow growth model; Piketty calls this relationship \(\beta=s/g\)). Population growth rates have fallen over recent decades, it is possible that per-capital income growth may be slowing as well. Thus we expect that the Capital/Income ratio will rise. As a rough guide, we might expect it to rise from levels historically experienced in countries such as the US that have had higher population growth (2.5 million people in 1776 to 300 million in 2006), to the levels historically experienced in countries such as France that have not seen so much population growth (25 million people in 1789 to 61 million in 2006). The US Capital/Income ratio has historically been about 4, while that for France has historically been around 7.

Capital in France, 1700-2010 (again)

Capital in the United States, 1770-2010

Some further points on the Capital/Income ratio:

  • Most capital is privately held: public (Government) holdings of wealth are small compared to private holdings, especially net public capital (assets-debt), and in many countries has been further decreasing in importance over recent decades (think privatization). (See F3.3, F3.4, F3.5, F3.6, F4.4, F5.1)
  • Some of the fall in the Capital/Income Ratio during the mid-20th reflects physical destruction of capital, some reflects falling prices. Piketty addresses this decomposition and finds that both play important roles. Thus, some of the rise since World War II simply reflects ‘price recovery’. (See Chapter 5)
  • Most capital is domestic: the difference between domestic wealth and national wealth, that is the importance of how much one country owns in foreign countries, is small. The only notable exceptions are from when countries, such as Britain and France, had large overseas Empires. While net foreign wealth remains small, gross holdings have increased over recent decades. (See F5.2, F5.7)
  • The only issue not covered in-depth is what determines the savings rate, \(s\). Since we expect that in the long-run the Capital/Income ratio will converge to \(K/Y=s/(g+n+\delta)\) the savings rate is important in determining where the Capital/Income ratio is going to. Piketty does discuss it briefly and provides some Tables (T5.1, T5.2, T5.3, T5.4) showing that it varies across countries. The question is why it varies across countries, and over time, and will it change in the future? This is a weakness in Piketty’s predictions for increasing Capital/Incomes, but given the history and current trends of Capital/Income ratios it is unlikely to be a major one (F3.1, F3.2, F4.6, F5.3).
  • Capital/Income ratios for some other rich countries, F5.3.
  • Interesting aside: Slaves were an important part of the ‘wealth’ of the US in the late eighteenth century, F4.10.

The Share of Income going to Capital

Main point: Increasing Capital/Income ratios automatically result in an increasing share of income going to Capital, unless they are fully offset by falling interest rates. The evidence suggests that interest rates do fall as Capital/Income ratios increase, but that they do not fall enough to fully offset the increasing importance of capital.

The income of capital is just the amount of capital times the income per unit of capital; the latter is called the return on capital or the interest rate. Thus the share of income going to capital, \( \alpha \) — the Capital Share of Income — is simply the Capital/Income ratio times the interest rate \( r  \), that is

$$\alpha=r \frac{K}{Y}$$

There is little to say here other than simply to give the graphs of the Capital Share of Income for Britain and France and simply observe that the capital share of income is not constant, and that it is higher when the Capital/Income ratio is higher.

The capital-labor split in Britain, 1770-2010

The capital-labor split in France, 1820-2010

Over the last decades the Capital/Income ratio has been rising, and the Capital Share of Income has risen along with it. The conclusion that the Capital/Income ratio will continue to rise leads us to conclude that the Capital Share of Income will continue to rise.

Some further points on the Capital Share of Income:

  • The return on capital (interest rate) does vary, but is comparatively stable. This fits with our earlier observation that, by accounting identity, the only way an increase in the Capital/Income ratio will not lead directly to an increase in the Capital Share of Income is if the return on capital falls enough to offset it. (F6.3, F6.4)
  • An increasing share of capital is seen in many countries, F6.5.2
  • Technical note I: The point about whether \(r\) falls enough when \(K/Y\) rises to keep \(\alpha\) constant is, in the language of Economics, a question of whether the elasticity of substitution between capital and labour is equal to one. The empirical evidence presented suggests that \(r\) falls a little, but not enough to keep \(\alpha\) constant; that the elasticity of substitution between capital and labour is greater than one.
  • Technical note II: Economists often use a ‘Cobb-Douglas production function’. This function assumes that the capital share of income is constant; that the elasticity of substitution between capital and labour is equal to one. One can easily fix this by using a ‘Constant Elasticity of Substitution (CES) production function’ which allows for an elasticity of substitution between capital and labour greater than one.


Part 2: Income Inequality and Wealth Inequality

  1. The observation about falling Capital/Income Ratios, and a return to ‘normal’ ratios since, is much more relevant to countries such as Britain and France that were devastated by the wars, than to countries such as US that were largely (physically) unaffected. This is evident comparing the graphs of Capital/Income Ratios for these countries. []
  2. For more, see Karabarbounis and Nieman (2014) – The Global Decline of the Labor Share. []

Summary of Piketty

I here provide a summary of Capital in the 21st Century by Thomas Piketty. The summary is broken into three parts by theme. The first part of the summary covers the Capital/Income ratio and the Capital Share of Income. The second part of the summary covers Income inequality and Wealth inequality. The third part of the summary is about Inherited Wealth. I also provided a “fourth” part discussing some of the main objections and criticisms that have been raised.

By my reading the book is largely a description of past trends, present trends, and probable future trends in income, capital, and inequality. This summary therefore concentrates on summarizing and describing those trends. I deliberately omit treatment of Piketty’s policy suggestions (largely Chapters 14 & 15).

I omit some other parts of Piketty’s book. Those describing historical and present trends in population growth rates (and ageing demographics), on the grounds they are well covered elsewhere. Those on global inequality as it is somewhat of a side-issue from his main topic; inequality in the developed countries in particular inequality in income and wealth of the top percentiles. Those on the differing size of governments (measured as a percentage of GDP) between countries and over the past century; as well as historical changes in top tax rates. Those on what tax rates on income and capital should be (Piketty’s policy prescriptions).

Much of Piketty’s book is about explaining how the data is put together: what are the sources?, what assumptions and definitions are made?, what is the uncertainty in the measurements?, if we used different measures would things change much? I ignore these important aspects here (go read the book!) and concentrate solely on describing some of the main findings. At this point massive kudos are due to Piketty for putting all of the graphs and data from his book online, without which this summary would not be possible in its existing form.

Some criticism of the book has been based on the grounds that the book contains a theory of inequality. The theory, such as it is, consists mostly of simple accounting equations. One has the feeling Piketty received the same advice Stephan Hawking got when writing A Brief History of Time: “Someone told me that each equation I included in the book would halve the sales. I therefore resolved not to have any equations at all. In the end, however, I did put in one equation, Einstein’s famous equation, \( E=mc^2 \). I hope that this will not scare off half of my potential readers.” For those who do think the book is about theory, allow Debraj Ray to clear things up. Those interested in Piketty’s theory will have to look at the technical appendixes of his book, or at his published papers.

Enough chat, here are the various parts of the summary.

Part 1: Capital/Income Ratio and the Capital Share of Income.
Part 2: Income Inequality and Wealth Inequality.
Part 3: Inheritance of Capital Wealth.
Part 4: Some Criticisms of Piketty.

Oddly enough almost all of the reviews seem to ignore Chapter 11 on the relative importance of inheritance in capital wealth. Odd since this seems to address one of the most contentious aspects of the book, I can only offer two possible reasons, either most reviewers didn’t reach chapter 11 before their deadlines, or the reviewers simply don’t like France (for reasons of data availability it is mostly about France, Britain and Germany get a mention, but the US and other countries are ignored simply as the needed historical data is non-existent).

For those who prefer to read a review instead of a summary, here are a few of the better ones.
Solow in New Republic
Shenk in The Nation (starts mid page 6))
Debraj Ray
Podcast interview on EconTalk

If your interest is in inequality at a global level, which has been falling, as well as a discussion of population and heath, a good book is Angus Deaton The Great Escape: Health, Wealth and the Origins of Inequality.