Life advice from Thomas Piketty

I am still working my way through Thomas Piketty’s Capital in the Twenty-First Century. I’m discovering that the page count can be explained to some extent by repetition and redundancy…

I have not reached the end of the book, but most of Piketty’s advice seems to be targeted at politicians, e.g., implement additional taxes on wealth (i.e., beyond existing wealth taxes such as real and personal property taxes). Aside from general edification is there any potential benefit to average readers from slogging through 696 pages?

A critical assumption behind the “crisis of inequality” that Piketty expects to develop is that world economic growth will be sluggish for the next 100 years, partly due to reduced population growth and partly due to the fact that we’re not bouncing back from any wars such as World War II that destroyed a lot of factories:

The median scenario I will present here is based on a long-term per capita output growth rate of 1.2 percent in the wealthy countries, which is relatively optimistic compared with Robert Gordon’s predictions (which I think are a little too dark). This level of growth cannot be achieved, however, unless new sources of energy are developed to replace hydrocarbons, which are rapidly being depleted.

[Piketty is not a believer in fracking, apparently.]

Suppose that growth slows to a crawl because world societies spend all of their money on social networking startups such as WhatsApp? How can an individual prosper in a depressed economy? Piketty writes about the Great Depression in France:

Within “the 9 percent,” midlevel civil servants and teachers fared particularly well. They had only recently been the beneficiaries of civil service raises granted in the period 1927–1931. (Recall that government workers, particularly those at the top of the pay scale, had suffered greatly during World War I and had been hit hard by the inflation of the early 1920s.) These midlevel employees were immune, too, from the risk of unemployment, so that the public sector’s wage bill remained constant in nominal terms until 1933 (and decreased only slightly in 1934–1935, when Prime Minister Pierre Laval sought to cut civil service pay). Meanwhile, private sector wages decreased by more than 50 percent between 1929 and 1935. The severe deflation France suffered in this period (prices fell by 25 percent between 1929 and 1935, as both trade and production collapsed) played a key role in the process: individuals lucky enough to hold on to their jobs and their nominal compensation—typically civil servants—enjoyed increased purchasing power in the midst of the Depression as falling prices raised their real wages. Furthermore, such capital income as “the 9 percent” enjoyed—typically in the form of rents, which were extremely rigid in nominal terms—also increased on account of the deflation, so that the real value of this income stream rose significantly, while the dividends paid to “the 1 percent” evaporated

In other words, this French reincarnation of Karl Marx who is so feared by the wealthy actually offers the same advice as the CATO Institute: work for the government.

Piketty assumes that an average person won’t be satisfied with being a government employee and Top 10% earner/wealther (my new word that will be needed if more people read Piketty!). It is not sufficient to be comfortable and to enjoy a better lifestyle than one’s parents. One must look enviously at the Top 0.1% (in the U.S., at the time Piketty wrote, this was apparently an income of more than $1.5 million per year). How to get closer to this elite group? Piketty quotes a Balzac character from Pere Goriot explaining why working for wages isn’t a viable strategy:

“Would Baron de Rastignac like to be a lawyer? Very well then! You will need to suffer ten years of misery, spend a thousand francs a month, acquire a library and an office, frequent society, kiss the hem of a clerk to get cases, and lick the courthouse floor with your tongue. If the profession led anywhere, I wouldn’t advise you against it. But can you name five lawyers in Paris who earn more than 50,000 francs a year at the age of fifty?” By contrast, the strategy for social success that Vautrin proposes to Rastignac is quite a bit more efficient. By marrying Mademoiselle Victorine, a shy young woman who lives in the boardinghouse and has eyes only for the handsome Eugène, he will immediately lay hands on a fortune of a million francs. This will enable him to draw at age twenty an annual income of 50,000 francs (5 percent of the capital) and thus immediately achieve ten times the level of comfort to which he could hope to aspire only years later on a royal prosecutor’s salary (and as much as the most prosperous Parisian lawyers of the day earned at age fifty after years of effort and intrigue).

What is most frightening about Vautrin’s lecture is that his brisk portrait of Restoration society contains such precise figures. As I will soon show, the structure of the income and wealth hierarchies in nineteenth-century France was such that the standard of living the wealthiest French people could attain greatly exceeded that to which one could aspire on the basis of income from labor alone. Under such conditions, why work? And why behave morally at all? Since social inequality was in itself immoral and unjustified, why not be thoroughly immoral and appropriate capital by whatever means are available? The detailed income figures Vautrin gives are unimportant (although quite realistic): the key fact is that in nineteenth-century France and, for that matter, into the early twentieth century, work and study alone were not enough to achieve the same level of comfort afforded by inherited wealth and the income derived from it. This was so obvious to everyone that Balzac needed no statistics to prove it, no detailed figures concerning the deciles and centiles of the income hierarchy. Conditions were similar, moreover, in eighteenth- and nineteenth-century Britain. For Jane Austen’s heroes, the question of work did not arise: all that mattered was the size of one’s fortune, whether acquired through inheritance or marriage.

Young people might be led astray by listening to advice from old people, who grew up in a unique time:

During the decades that followed World War II, inherited wealth lost much of its importance, and for the first time in history, perhaps, work and study became the surest routes to the top.

Should politicians fail to find the world’s wealth in its various offshore hideouts and tax it down to something that won’t inspire burning envy 24/7, Piketty essentially advocates that young people should hunt for rich partners to marry.

[Piketty is from a Civil Law jurisdiction like Denmark, and due to French child support maximums that correspond roughly to the actual cost of a child it is difficult to profit substantially from a one-night encounter that produces a child. An American reader would have to decide if it made more sense financially to try to have two or three out-of-wedlock children with two or three different high-income partners and thereby achieve a diversified portfolio of income streams (potentially $1 million/year or more for each child, entirely tax-free and therefore not exposed to the new much higher tax rates that Piketty proposes).]

Piketty points out that it is possible for a statistically insignificant number of workers to make real money:

The final and perhaps most important point in need of clarification is that the increase in very high incomes and very high salaries primarily reflects the advent of “supermanagers,” that is, top executives of large firms who have managed to obtain extremely high, historically unprecedented compensation packages for their labor. If we look only at the five highest paid executives in each company listed on the stock exchange (which are generally the only compensation packages that must be made public in annual corporate reports), we come to the paradoxical conclusion that there are not enough top corporate managers to explain the increase in very high US incomes, and it therefore becomes difficult to explain the evolutions we observe in incomes stated on federal income tax returns.41 But the fact is that in many large US firms, there are far more than five executives whose pay places them in the top 1 percent (above $352,000 in 2010) or even the top 0.1 percent (above $1.5 million).

Recent research, based on matching declared income on tax returns with corporate compensation records, allows me to state that the vast majority (60 to 70 percent, depending on what definitions one chooses) of the top 0.1 percent of the income hierarchy in 2000–2010 consists of top managers. By comparison, athletes, actors, and artists of all kinds make up less than 5 percent of this group.42 In this sense, the new US inequality has much more to do with the advent of “supermanagers” than with that of “superstars.”43 It is also interesting to note that the financial professions (including both managers of banks and other financial institutions and traders operating on the financial markets) are about twice as common in the very high income groups as in the economy overall (roughly 20 percent of top 0.1 percent, whereas finance accounts for less than 10 percent of GDP). Nevertheless, 80 percent of the top income groups are not in finance, and the increase in the proportion of high-earning Americans is explained primarily by the skyrocketing pay packages of top managers of large firms in the nonfinancial as well as financial sectors.

to the extent that certain job functions, especially in the upper management of large firms, become more difficult to replicate, the margin of error in estimating the productivity of any given job becomes larger. The explanatory power of the skills-technology logic then diminishes, and that of social norms increases. Only a small minority of employees are affected, a few percent at most and probably less than 1 percent, depending on the country and period.

It is also possible that the explosion of top incomes can be explained as a form of “meritocratic extremism,” by which I mean the apparent need of modern societies, and especially US society, to designate certain individuals as “winners” and to reward them all the more generously if they seem to have been selected on the basis of their intrinsic merits rather than birth or background.

In any case, the extremely generous rewards meted out to top managers can be a powerful force for divergence of the wealth distribution: if the best paid individuals set their own salaries, (at least to some extent), the result may be greater and greater inequality. It is very difficult to say in advance where such a process might end. Consider again the case of the CFO of a large firm with gross revenue of 10 billion euros a year. It is hard to imagine that the corporate compensation committee would suddenly decide that the CFO’s marginal productivity is 1 billion or even 100 million euros (if only because it would then be difficult to find enough money to pay the rest of the management team). By contrast, some people might think that a pay package of 1 million, 10 million, or even 50 million euros a year would be justified (uncertainty about individual marginal productivity being so large that no obvious limit is apparent). It is perfectly possible to imagine that the top centile’s share of total wages could reach 15–20 percent in the United States, or 25–30 percent, or even higher.

If executive pay were determined by marginal productivity, one would expect its variance to have little to do with external variances and to depend solely or primarily on nonexternal variances. In fact, we observe just the opposite: it is when sales and profits increase for external reasons that executive pay rises most rapidly.

In other words, try to be Bob Nardelli (check out Google Finance and click on the 10-year chart to see what a great value the Home Depot shareholders achieved in 2007 by paying Nardelli $210 million not to come into work anymore). But recognize that this is a statistical longshot so probably it is better to marry someone with rich parents.

[Separately, the deeper that I read into this book the more common themes are revealed. One is the general academic disbelief that people in other areas of society can be paid so much: “I am one of the smartest people in the world. If a comparatively stupid person is being paid more than I am it is a sign of market failure/market-rigging.” Here’s an example:

Among the members of these upper income groups are US academic economists, many of whom believe that the economy of the United States is working fairly well and, in particular, that it rewards talent and merit accurately and precisely. This is a very comprehensible human reaction. But the truth is that the social groups above them did even better: of the 15 additional points of national income going to the top decile, around 11 points, or nearly three-quarters of the total, went to “the 1 percent” (those making more than $352,000 a year in 2010), of which roughly half went to “the 0.1 percent” (those making more than $1.5 million a year).

Thus I am wondering how much of the book is driven by rage that apparently less-than-brilliant corporate CEOs get paid so much (in salaries set by their golfing buddies on the Board). One of my secret sources for this blog worked at Disney on a movie eventually titled Emperor’s New Groove. The working title was “Empire of the Sun”, a reference to the Inca worship of the sun god. Michael Eisner, the CEO who was in the process of looting $1 billion from Disney shareholders at the time, misunderstood the name and thought it was “Empire in the Sun”, as though the mountains of Peru were exceptionally sunny. The sycophants surrounding Eisner were paralyzed with fear that they’d have to tell the boss that he’d made a mistake so they changed the working title to “Empire in the Sun.” Check Google Finance to see how Disney shares have soared since Eisner’s 2005 departure.]