Inequality and Piketty

May 9, 2014·Alasdair Macleod

It is a sign of the times that a 700-page book by an obscure French economist turns out to be a surprise best-seller. Thomas Piketty has been feted by heavyweight Nobel prize-winning economists, such as Paul Krugman, Robert Stiglitz and Robert Solow. These names give us a clue to his thesis, that capitalism is responsible for inequality and this must be corrected by governments through 80% marginal income tax on high earners and a global tax on wealth.

This book will appeal to people who feel let down by avaricious bankers and by the super-rich who have not shared in everyone's economic sacrifices. It provides a superficial explanation for why the rich have become rich, playing into the anger that many feel, and promotes government as the agent of retribution and redistribution. But before we go charging down this route we must stop and think whether or not Piketty is right.

At the least sophisticated level we should draw a distinction between those who become rich supplying products the rest of us actually want, and those that don't. While we can all agree that crony-capitalists who get rich by ripping society off should be penalised, very few of us would want to stand in the way of entrepreneurs and businessmen who improve our lives. Piketty demonises the lot including the good guys.

We should abhor crony-capitalists, who use their power and influence over government to secure advantage and profits instead of placing the customer first. It is this that makes bankers so unpopular. At the same time that governments bail them out, they say no to honest customers seeking finance, and make fortunes doing deals few understand. And it's not just the banks: all big businesses use political influence and many of them game the system as well.

So what is the answer? It is not Piketty's retribution and redistribution. For a start, he ignores the fact that government is a very bad agent for transferring wealth, ending up destroying most of it. Furthermore, by reallocating resources from being used productively to satisfy political preferences, transferred wealth ends up being used much less productively.

Above all Piketty ignores the role of monetary inflation. Ironically it was a Paris-based economist and businessman Richard Cantillon, who in his Essai sur la Nature du Commerce en Général 270 years ago explained the mechanism whereby monetary inflation benefited the first recipients of the money at the expense of later recipients. A bank gets newly-issued currency first and even augments it by creating extra credit out of thin air. By the time this new money is fully in circulation, the low-paid and small savers find its purchasing power has fallen with no corresponding rise in their income. This is known as the Cantillon effect to this day.

Piketty, in his haste to give government his approval to tax the rich in the pursuit of equality, seems completely unaware that it is government itself that is the problem. By embracing crony-capitalism and inflationary monetary policies, the state enriches the rich and impoverishes the poor. This is the exact opposite of the effect intended.

Unfortunately Piketty's thesis will only encourage western governments to continue to tax, print and spend, deepening the crisis instead of facing up to economic reality.