The Rise and Decline of General Laws of Capitalism
Massachusetts Institute of Technology (MIT) – Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)
Warren Buffett’s 2018 Activist Investment
Harvard University – Department of Government; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)
Thomas Piketty’s (2013) book, Capital in the 21st Century, follows in the tradition of the great classical economists, like Marx and Ricardo, in formulating general laws of capitalism to diagnose and predict the dynamics of inequality. We argue that general economic laws are unhelpful as a guide to understand the past or predict the future, because they ignore the central role of political and economic institutions, as well as the endogenous evolution of technology, in shaping the distribution of resources in society. We use regression evidence to show that the main economic force emphasized in Piketty’s book, the gap between the interest rate and the growth rate, does not appear to explain historical patterns of inequality (especially, the share of income accruing to the upper tail of the distribution). We then use the histories of inequality of South Africa and Sweden to illustrate that inequality dynamics cannot be understood without embedding economic factors in the context of economic and political institutions, and also that the focus on the share of top incomes can give a misleading characterization of the true nature of inequality.
The Rise and Decline of General Laws of Capitalism – Introduction
Economists have long been drawn to the ambitious quest of discovering the general laws of capitalism. David Ricardo, for example, predicted that capital accumulation would terminate in economic stagnation and inequality as a greater and greater share of national income accrued to landowners. Karl Marx followed him by forecasting the inevitable immizerization of the proletariat. Thomas Piketty?s (2013) tome, Capital in the 21st Century, emulates Marx in his title, his style of exposition, and his critique of the capitalist system. Piketty is after general laws which will demystify our modern economy and elucidate the inherent problems of the system? and point to solutions.
But the quest for general laws of capitalism is misguided because it ignores the key forces shaping how an economy functions: the endogenous evolution of technology and the institutions and the political equilibrium that influence not only technology but also how markets function and how the gains from various different economic arrangements are distributed. Despite his erudition, ambition, and creativity, Marx was led astray because of his disregard of these forces. The same is true of Piketty?’s sweeping account of inequality in capitalist economies. In the next section, we review Marx?s conceptualization of capitalism and some of his general laws. We then turn to Piketty?’s approach to capitalism and his version of the general laws. We will point to various problems in Piketty’?s interpretation of the economic relationships underpinning inequality, but the most important shortcoming is that, though he discusses the role of certain institutions and policies, he allows neither for a systematic role of institutions and political factors in the formation of inequality nor for the endogenous evolution of these institutional factors.
We illustrate this by regression using regression evidence to show that Piketty?’s central economic force, the relationship between the interest rate and the rate of economic growth, is not correlated with inequality (in particular, with the key variable he focuses on, the share of national income accruing to the richest 1 percent, henceforth, the top 1 percent share). We then use the examples of the South African and Swedish paths of inequality over the 20th century to demonstrate two things. First, that using the top 1 percent share may miss the big picture about inequality. Second, it is impossible to understand the dynamics of inequality in these societies without systematically bringing in institutions and politics, and their endogenous evolution. We conclude by outlining an alternative approach to inequality that eschews general laws in favor of a conceptualization in which both technology and factor prices are shaped by the evolution of institutions and political equilibria, and the institutions themselves are endogenous and are partly influenced by, among other things, the extent of inequality. We then apply this framework to the evolution of inequality and institutions in South Africa and Sweden.
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