N. Gregory Mankiw Tries to Discredit Piketty

In this paper, titled Yes, r > g. So What?. N. Gregory Mankiw tries to show that Thomas Piketty is wrong that if r > g wealth will accumulate in the hands of a tiny number of rich people. It’s short and easy on the math, perhaps because it was part of a symposium rather than a stand-alone paper. For comparison, take a look at this by Piketty and Gabriel Zucman, which requires more than a passing familiarity with math. It seems unlikely that Mankiw had read this paper before he cranked out his, because Piketty addresses the issues Mankiw raises.

Mankiw makes three arguments. First, he says we need to have r > g. Second, he claims that the generational changes and taxation will prevent dynastic wealth. Third, he disagrees with Piketty’s solution which is a wealth tax. Let’s take them in turn.

1. The idea that r, the rate of return to capital, is greater than g, the rate of growth of the economy, is common in mainstream economic theory.

If the rate of return is less than the growth rate, the economy has accumulated an excessive amount of capital. In this dynamically inefficient situation, all generations can be made better off by reducing the economy’s saving rate. From this perspective, we should be reassured that we live in a world in which r > g because it means we have not left any dynamic Pareto improvements unexploited.

Mankiw’s standard is whether the economy can produce Pareto Improvements, meaning an improvement in the wealth of one or more people that doesn’t reduce the wealth anyone else. Mankiw simply ignores the fact that fabulous wealth carries with it the ability to influence the political process to extract more wealth, which is what Piketty says. Surely Mankiw isn’t arguing that won’t happen, because it does. Take, for example, the pharmaceutical industry where the business model is to increase prices with no additional benefit to anyone.

Then look at his cure. How exactly will the bottom 60% benefit by saving less? They won’t, because they are barely saving. They cannot come up with $400 to fix a car. Most of the rest wouldn’t be able to save less; they need to save for retirement, and to pay what their kids can’t make in this rotten economy. What Mankiw means is that the very top, the .1%, would have to spend a lot more, But what are they going to buy? Expensive trips on private jets? Van Gogh paintings? That isn’t going to help the economy or make anyone’s life better. The fact is that this argument points directly to the need to hike taxes on the idle money of the rich.

2. Mankiw’s second argument is an effort to show that taxes and generational changes will decrease dynastic wealth. Mankiw doesn’t confront the detailed argument Piketty makes on those very points. I introduce it here, and link to the detailed argument for those interested. Instead, Mankiw offers a simple model that proves his point, and could be understood by anyone who read his introduction to economics textbook; for typographical reasons, subscripts are not used for cw and ck

To oversimplify a bit, let’s just focus on this economy’s steady state. Using mostly conventional notation, it is described by the following equations.

(1) cw = w + τ k

(2) ck = (r − τ − g)nk

(3) r = f ′(k)

(4) w = f(k) − rk

(5) g = σ(r − τ − ρ),

where cw is consumption of each worker, ck is the consumption of each capitalist, w is the wage, r is the (before-tax) rate of return on capital, k is the capital stock per worker, n is the number of workers per capitalist (so nk is the capital stock per capitalist), f(k) is the production function for output (net of depreciation), g is the rate of labor-augmenting technological change and thus the steady-state growth rate, σ is the capitalists’ intertemporal elasticity of substitution, and ρ is the capitalists’ rate of time preference. Equation (1) says that workers consume their wages plus what is transferred by the government. Equation (2) says that capitalists consume the return on their capital after paying taxes and saving enough to maintain the steady-state ratio of capital to effective workers. Equation (3) says that capital earns its marginal product. Equation (4) says that workers are paid what is left after capital is compensated. Equation (5) is derived from the capitalists’ Euler equation; it relates the growth rate of capitalist’s consumption (which is g in steady state) to the after-tax rate of return.

Note that we didn’t get a definition of the symbol τ, which in conventional notation means taxes. As we learn a couple of paragraphs down, Mankiw means not general taxes, but taxes on returns to capital. As he tells us, all the money from taxes is consumed by the workers (equation (1)), that is, the total amount of taxes on capital is transferred directly, in the form of grants or indirectly in the form of services, to wage-earners and none of it is consumed by the capitalists. in the real world, capitalists consume a great deal of the expenditure on taxes, whether the taxes are on capital or income or otherwise. Obviously we need to put a non-trivial number into equation (2) to show that capitalists consume a portion of the taxes, and make an appropriate modification to equation (1) if we want this model to make minimal contact with the real world.

Mankiw says that in this model, there is no steady increase in inequality.

In this economy, even though r > g, there is no “endless inegalitarian spiral.” Instead, there is a steady-state level of inequality. (Optimizing capitalists consume enough to prevent their wealth from growing faster than labor income.)

This outcome was baked into the model with equation (2). If instead, we assume the same equations, but add a non-trivial number to equation (2), then the capitalist accumulates that non-trivial amount each year, and wealth inequality increases naturally even in his steady-state economy.

Also baked into this model is the remarkable idea that “capital earns its marginal product” and the rest of the money is paid out in wages. That’s just so far from reality that it makes the whole exercise pointless. But it enables Mankiw to justify rejecting Piketty’s recommendation of high wealth taxes. Mankiw explains that if the government wants to protect capital, it pushes the tax on capital into negative numbers, and the capitalists will push wages to subsistence level. But,

Taxing capital and transferring the proceeds to workers reduces the steady-state consumption of both workers and capitalists, but it impoverishes the capitalists at a faster rate.

Taxing returns to capital hurts everyone in this model. Of course, if capitalists are taxed at the rate of their actual consumption of tax receipts, the non-trivial amount that should be added to equation (2), then you would get Mankiw’s desired outcome of a non-increasing inequality. Or you could go a bit higher, and start reducing inequality without resort to his suggestion of a consumption tax.

Mankiw’s sterile model doesn’t explain the facts documented by Piketty and his colleagues, but it does demonstrate nicely the state of mainstream economics. Obviously the American Economic Association wanted a paper from Mankiw challenging Piketty, no matter its quality. Mankiw is an established figure, and thus the beneficiary of the social structure of the field described by Marion Fourcade and her colleagues in the section of this paper headed Inequality Within, p. 96,

Second, we document the pronounced hierarchy that exists within the discipline, especially in comparison with other social sciences. The authority exerted by the field’s most powerful players, which fosters both intellectual cohesiveness and the active management of the discipline’s internal affairs, has few equivalents elsewhere.

Notre Dame undergrad (math); JD, Indiana University at Bloomington; 1st Lieutenant, US Army.; private practice in corporate and securities law; Assistant AG in Tennessee for consumer protection and securities; Blue Sky Securities Commissioner, Tennessee; private practice, bankruptcy and corporate law.

I have had a lifelong interest in economics. For most of my career, that interest was practical, focused on the problems in front of me. Lately I have been more interested in economics as a theory, especially its impact on the lives of people like those I met in my bankruptcy practice, and on the politics of money in the US. I also enjoy reading philosophers, starting in college and steadily expanding my reading ever since. I wrote at FireDogLake for a number of years.

Generally, I think the problem facing the US is the dominance of neoliberal discourse. I think it clouds the vision, and limits the kinds of problems that can be identified and solved. For example, the existence and danger of climate change can easily be identified in a scientific discussion. However, the problem does not fit the neoliberal discourse because science insists that the pursuit of individual and corporate self-interest will lead to devastation. In neoliberal discourse, the pursuit of self-interest always leads to Eden.

The neoliberal project has two prongs. One is the police function of crushing dissent and alternative views. The police function is provided by government agencies and private and institutional actors. The counterpart is the economic system , which is operated by government and by private and institutional actors. Some of these actors operate in both spheres. I focus on the second prong.

20 replies
  1. earlofhuntingdon says:

    “Second, he claims that the generational changes and taxation will prevent dynastic wealth.”

    Mankiw’s assertion will be news to the 1%, and to their legion of tax accountants, lawyers and advisers and virtually every secrecy jurisdiction/tax haven on the planet. He’s bonkers, as is the oversimplified equation he uses to “prove” his point. It is typical of economic models that ignore essential aspects of reality in order to prove another reality exists, at least theoretically; it’s just a reality in which no one is home. Except that he’s not bonkers. He knows that his claim has been false for over a hundred years. Which means his argument is faith-based, not rational, political, not “economic”.

    • blueba says:

      This is exactly correct. The field of economics is not even a social science much less a science dismal or not. It is, when reduced to its core, a myth making project for the justification of capitalism and dynastic wealth. This is true of Keynes and Stiglitz as much as it is true for Freedman.

      The analysis of these “formulas” makes that very clear.

  2. Alan says:

    I would work through this if I were able to take anything Mankiw writes seriously. His Principles of Microeconomics, 7th edition is listed as a best seller on Amazon (it is the #1 textbook on microeconomics). On page 10 he writes: “In his 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith made the most famous observation in all of economics: households and firms interacting in markets act as if they were guided by “an invisible hand” which leads them to desirable market outcomes. One of our goals in this book is to understand how this invisible hand works its magic.”
    *
    This is like someone in Harvard’s History of Science Department claiming that Galileo’s most famous observations provided evidence that the sun revolves round the earth. From this we must conclude that Mankiw (and presumably most of the economics professional if he’s right that this is “the most famous observation in all of economics”) either hasn’t read the book , has read it but hasn’t understood it, or is purposefully misrepresenting it. One has to ask: why do people pay good money to publishers and to Harvard for this nonsense?
    *
    For more see Michael Meeropol on Mankiw’s Mendacity about Adam Smith.

    • earlofhuntingdon says:

      Indeed. Smith’s description that beneficial economic outcomes appear as if they were guided by an invisible hand was a metaphor, not a literal description of how economics works, and one he highly qualified. He was also discussing “unintended” outcomes that were regarded as beneficial after the fact. He was not analyzing whether these represented an important or insignificant portion of total outcomes. It’s a bit like saying that because I won the lottery, or survived the asteroid strike, the invisible hand intended that I should. It’s a fallacy we are all prone to.

      Viewed through that lens (with no disrespect to Smith, who was much more nuanced than the neoliberals who misuse his work), his metaphor could be seen as an early version of “trickle down” economics: the false idea that self-interested, often rapacious economics of the elite will benefit in unintended ways those less fortunate. The idea never admits that once identified, elites move heaven and earth to remove such unintended beneficial outcomes for others because they are “inefficient”.

      • Alan says:

        The invisible hand wasn’t a metaphor about “how economics works”. It was a metaphor for the preference among some merchants for domestic over foreign investment and the unintended beneficial consequences of this preference for the domestic economy. It was not a general statement about how the economy works. There are numerous places in the book in which the self-interested actions of merchants and others have negative consequences for society and the broader economy. His argument is the opposite of trickle down. The whole point of the book is that the broader economy and the population as a whole generally suffers from the unrestrained self-interested actions, which involve collusion, monopoly, corruption and more, of the merchants, political elites, etc. 

  3. scribe says:

    “Second, he claims that the generational changes and taxation will prevent dynastic wealth.”

    That would be news to the people who used to put on Continuing Legal Education programs bearing titles like “Creating Dynasty Trusts”. See, about 25 years ago, before the big push to get rid of the Estate Tax really took hold, there was a bit of dipping toes in the water. Lawyers learned in law school about something called the “Rule Against Perpetuities”. That was a legal rule which, in its shortest version, said that a trust or other devise under a will or trust had to terminate (i.e., disburse the principal to designated beneficiaries) no later than 21 years after the end of a “life in being” at the time of the instrument’s creation. (The ins and outs of the Rule Against Perpetuities made the “in a nutshell” version over 20 pages long.) Thus, for example, there were trusts drafted to terminate 21 years after the death of the last of Queen Victoria’s grandchildren to pass away.
    The basic purpose of this Rule was to ensure that wealth and money circulated and did not get tied up in few, and fewer, hands, forever.
    Very few lawyers actually had to use, or get deep acquaintance with, the Rule Against Perpetuities – other than as a drafting trap to be avoided – because few lawyers dealth with people rich enough to have long-term trusts like that.
    Well, since it was complicated and very few people dealt with it, and even fewer understood it, the “reformers” said, “let’s get rid of it”. And so, off the books it went with barely a notice.
    Of course, that means that now rich bastards of all persuasions can have their lawyers create eternal trusts which tie up wealth, property and money forever, to the exclusion of all others, and which will continue to grow and metastatize.
    I’m sure Mankiw just forgot about that.

    • earlofhuntingdon says:

      Good thing Lawrence Kasdan made Body Heat before Florida revised its rule against perpetuities.

      Even when it existed in full force, the rule was only a speed bump in the maneuvering of the elite’s courtiers in maintaining their patrons’ wealth. Among the many things Mankiw ignores in his blithe comment is that we are living in a world of dynastic wealth, made possible, in part (as PBS used to say), by the invention and evolution of the corporation. Family estates of the wealthy are now family businesses. This has been true for several generations. A thoroughly useless statistic is the amount of money left in a once wealthy decedent’s estate. With any sort of planning at all, all but a theatrical amount of the money would have been siphoned off before death and preserved for future generations.

      • Ed Walker says:

        In his book Piketty gives a marvelous example of this: the wealth of Liliane Bettancourt of France, the heir to the L’Oreal fortune. There are plenty of others. And, as you point out, it’s basic estate planning to move money away from the founding company and into safe places, while retaining control of the enterprise directly or through a foundation.

        • earlofhuntingdon says:

          Neoliberalism’s exceptionalism is most American. It would have us believe that our economic (and hence political, social and cultural) fate rests on the unintended consequences of the behavior of businesses acting in competition with each other. Tied to that is the fabulous claim that no better set of beneficial outcomes is possible, even through the most rigorous planning, trial, error, and renewed effort.

          Those claims do not reflect reality. They are designed to eliminate from the market – jargon for the aggregate behavior of economic actors – the one actor able to restrict the excesses of the most powerful private firms: government. The catechism is designed to eliminate competition, and indirectly, those beneficial outcomes.

          Economic theory’s adoration of competition also ignores one small thing. It’s absence. Bidnessmen hate it; they work tirelessly to destroy it. A hundred years ago it was tobacco, beef, steel, and oil trusts. Then it was uranium cartels. Today, it’s expressed in the monopolies of cable and telecoms companies, health insurers and health care providers.
          That ought to give neoliberals a problem. For Smith, those unintended beneficial outcomes arose from the discipline of competition. The less competition, the fewer unintended inefficiencies known as beneficial outcomes.

          Most importantly, the idea that it is impossible to plan for better beneficial outcomes applies only to governments. Businesses devote vast resources to it. In reality, businesses are not uniquely capable of planning, implementing, assessing, revising and rededicating themselves to their plans. Often, they are horrible at it, or just mediocre. The catechism simply endlessly repeats the desire that businesses — dependent on governments to organize and maintain their “markets”, and to provide lucrative subsidies and immunities — be unrestricted in how they extract profits. And they should be able to ignore costs when imposed on others outside their businesses. That’s good for the monopolist. Dead ones have given us Duke and Chicago universities and small libraries in every corner of the eastern United States. Is it good for everyone else? Not so much.

          • jonf says:

            Nice comment. To emphasize:
            .
            “Tied to that is the fabulous claim that no better set of beneficial outcomes is possible, even through the most rigorous planning, trial, error, and renewed effort.”
            ,

            And of course, as you note, government is uniquely unable to accomplish it. And that is in no small part due to the elite’s vassals in congress who block all efforts, or sidetrack them. We see a little of it every day. Obamacare and its actors in congress were a good example in 2010. And that catechism you speak of includes appropriate notes on the evils of socialism and other unwanted efforts, all supported by nicely funded foundations and think tanks and economists to perpetuate the myths.
            .

            I have a particular tick arising from the constant hammering about the evils of deficit spending and our impending bankruptcy as a nation if we continue with our profligate spending and proposals like those from one Bernie Sanders who will lead us all to the poor house. It seems no one even thinks of the benefits that may far exceed any cost. It is accepted as faith: government simply can’t do it. Taxes would be too high you know.

  4. blueba says:

    Separately, the myth makers leave out entirely the dynastic (and new tech) wealth already accumulated and its corrosive effects going forward. As should have been learned from FDR’s efforts to “save capitalism” higher taxes on the rich and weak social programs can be simply wiped away in the blink of an eye by the great fortunes which are allowed to remain.

    I was deeply disappointed in Piketty’s higher tax solution whey surly he could see from the data that every time higher taxes on the rich and/or social programs are implemented the great fortunes lickety split bribe and blackmail their way back to full power and control of the economy.

    I think it is understood by at least a few that there can be no future equitable economy as long as the great fortunes are never mentioned, their influence not accounted for, or the reason for their continued existence examined. Just because the Porsche family (owner of VW) has had vast wealth for generations is no justification for them to keep it, and the power it affords them, into the future, especislly considering the fraud and racketeering they used to make huge profits (a billion dollars in profit this year alone after revenues were +/- 20% lower due to the emissions “scandal.”

    As long as the extreme power of the owners of corporations have the privilege of the Porsche family – that is to own and benefit from the operation of their business without any liability or accountability why would they not encourage such behavior – they have nothing to loose. No one is going to demand the Porsche family give back the profits it extracted from criminal activity just on the emissions issue – there are no doubt others about which we do not know – they are held above the law and protected by the myth making of economists.

    Piketty’s “solution” of higher taxes on capital has failed over and over as he should well know. To have proposed it undermines all his work.

    Until and unless the great fortunes of the Porsche or Brin or Page fortunes are dismantled and their power neutralized nothing is going to change.

    • Ed Walker says:

      Piketty’s proposal requires that all wealth be recorded so that the true wealth of individuals and other entities can be calculated and taxed. It’s pretty well thought out, it seems to me. Of course, transparency is the enemy of wealth, so that makes the proposals even harder to enact.

      • blueba says:

        I suppose some kind of register so it would be public information, each persons wealth, could be part of a wealth taxation scheme. But it says nothing about how it would be used. Bribery would surly still be possible. The Dutch? or is it Norway publishes everyone in the country’s tax returns on the internet for anyone to see – the rule however is that in order to look you must disclose that you are the one looking. Systems of that nature, but getting to the real owner after the shell companies and all that would be daunting. It would surly take a powerful revolution to demand the opening of the tax shelter books around the world. But that way you wouldn’t have to take it from them but you would still have to fined a way to deal with bribery and blackmail.

        The Great Wall of China is/was a monumental feat of human engineering and effort millions of man hours, millions of stones years of work. Yet, it fell rather quickly, all it took were a few coins and the doors opened wide for the invaders.

        Maybe declaring all the existing money worthless and issuing new money according to some formula that kept anyone from acquiring vast amounts of it, that provided money for commerce but not for individual wealth might work.

        Or the radical idea that the owners of corporations have personal liability for the acts of those working on their behalf.

        But, the dynastic fortunes are the ones most insidious they must surly be dismantled if any progress is to be made, The Porsche family, Cargill, Bectel, Jonhson (drugs) European royal fortunes the Queen of England’s fortune and of course and especially the Saud family fortune these and the others must have their power neutralized – doing that without dismantling them does not seem realistic.

        Actually when you think about it neutralizing the power of dynastic wealth seems like a pipe dream. But even in its state of improbability the truth must be said.

        One thing is certain taxing the rich but letting them keep what they now have has failed over and over. For FDR it was under 50 years – his work wiped away and now an economy far better for the wealthy than ever in history.

        The mythology of capitalism/Calvinism which grew into favor hand in hand is deeply seeded in the West’s psyche the uber rich are looked on and afforded positions of royalty and thought closer to god by society.

        It’s a lot to overcome.

  5. Alan says:

    Ed, wondering if you are going to write on Brexit? At this stage the vote appears to be capable of going either way. The cat will be among the pigeons if there is a yes vote for Brexit. If the UK exits it will be on a wave of English nationalism in response to the failings of English neoliberalism. That will be doubling down on the problem as the UK government will likely become even more right-wing and neoliberal as a result. The knock-on effects on the EU and the make-up of the UK could also be very significant.

    • masaccio says:

      I hardly know what to say about Brexit. The movement is led by the foul UKIP and apparently the more rightist Tories, so I assume they think it will help the City and the British elites. The tactic of stirring up a pointless patriotism is typical of their operations, and it seems to be working. On the other hand, the elites of the EU have proven unable to cope with the problems of the Great Crash, and the neoliberalism of its institutions is killing people all over the southern countries.
      .
      This has to come to a head somehow. I just hope for the best.

  6. Rayne says:

    Need changes to the equations reflecting:

    — Degree of ease with which regulatory capture related to taxes may be effected; this subset should also include a time period over which changes are likely to take place based on the degree of so-called freedom to effect regulatory capture.

    — Degree of social transparency in financial reporting (This may be a subset of the rate of regulatory capture equation.)

    — Rate of change to commons which benefit most those with least capital, undermining their ability to halt regulatory capture.

    — Suppressive factor related to regulatory capture which isn’t taxes, encouraging tendency toward too-big-too-fail because of economies of scale. Factor ensures stickiness of capital among the TBTF while discouraging competitive entrants.

    Without these and a few more corrective tweaks, economic models still don’t reflect reality. Mankiw’s assumption that taxes are both inevitable AND absolutely a deterent to inequality is incredibly naive or blind. The model must show what we know to be the truth: those with more capital can buy the economic system that prefers them.

    • Ed Walker says:

      I really despise Mankiw with his smarmy attitudes and his pointless models. As I say, it’s a sad testament to the state of economic theory that he is not only allowed into the club, he’s a member of the Board of Directors.

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