Twelve problems with Piketty’s capital

Piketty’s thesis is that the rate of return on capital exceeds the general rate of growth (r > g). So, barring wars, capital owners accumulate a larger and larger share of the world’s wealth.

1. This theory does not fit the facts. In the modern economy, it is not the rich who are getting richer, but the poor. The failure of communism and the spread of trade has lifted perhaps 2 billion people off dollar-a-day- poverty.

2. Capital is not like a tree that drops fruit into the owner’s lap. Capital has to be created, accumulated, applied, managed and safeguarded if it is to produce any income at all. Capital owners can and do fail at any one of those points.

3. Capital is certainly destroyed by war from time to time. But it is destroyed every day by folly, misfortune, miscalculation or being outperformed by competitors. The difficult thing is keeping wealth. Losing it is easy.

4. Capital carries risk, not a word that features much in Piketty. Utility-type capital with more predictable returns produces higher returns, entrepreneurs making risky investments demand higher returns. There is no one ‘r’.

5. Even a small amount of risk undermines Piketty’s belief that capital owners will get richer for ever. Stuff happens: it is hard to predict what returns will be next year, never mind in ten years or a hundred.

6. The risk-adjusted rate of return on capital is modest, and falling, as it has been doing for decades. Adjusted for risk, Piketty’s thesis does not fit the facts.

7. Capital is only one factor of production. You need labour and brains too. If capital took a larger and larger share, wages would soon be bid up. The 19th Century saw huge capital accumulation – but huge rises in living standards too.

8. The most important form of capital in our service economy is human capital. That’s not confined to a few rich people, but owned by all of us. Investing in it delivers a far bigger payback than the returns on financial or physical capital.

9. The success and rapid rise of poor immigrant groups, from Ellis Island to modern Europe, shows that you do not need to own financial or physical capital to generate income and accumulate wealth fast.

10. Capital-owning societies are actually more equal. Pre-tax, not greatly; but post-tax, with their health, education and welfare programmes, they are very much more equal. And it’s better to be poor in a rich capitalist country.

11. Piketty’s savage global redistribution would destroy capital, and sacrifice its productive power for society. Massive capital taxes create instability (Cyprus) or ruin (Zaire). High taxes also cut people’s investment in their own human capital.

12. If you want to make the world more equal, try open immigration. The world’s poorest live where capital is sparse and unprotected by the rule of law. Let them become participants in the productive, capitalist, wealth-creating process.

HMRC and the rule of law

Plans to allow Britain’s tax authorities, HMRC, to take money directly from the accounts of tax delinquents have been criticised by a Committee of MPs on the grounds that HMRC ‘sometimes makes mistakes’.

A sharper criticism would be that the plan is a fundamental assault on the rule of law.

Next year is the 800th anniversary of Magna Carta, but the basic civil protections it gave citizens against arbitrary power are being systematically eroded. Governments have become elected dictatorships.

Magna Carta laid down that there could be no taxation without the ‘common consent’ of the people. It also insisted that no official can take anything from a person – nor fine them, nor imprison them, nor ‘in any way destroy’ them – without due process of law. Right now, the tax authorities would have to apply to the courts before they could take cash or other assets from a citizen.

But the new HMRC plans flout both these Magna Carta principles. HMRC can already decide that someone owes tax that they have deliberately ‘avoided’ – even if they have complied with every tax law. This is arbitrary power that we cannot safely entrust to any official. Reinforcing that power with further powers of confiscation – in the absence of any magistrate or court decision – is even more dangerous.

The MPs are right that even fair-minded officials make mistakes. Worse, the new plan passes the burden of proof – and the costs of proving it – from the authorities to the citizen. That again is contrary to the fundamental principle that people are innocent until proven guilty.

HMRC says that the new powers would be used only in extremis. But then they say that they expect perhaps 17,000 people will be affected each year. Many of them will, of course, be people who are completely innocent and the subject of official mistakes. Some will see their businesses ruined, and their employees losing their jobs, because of officials arbitrarily raiding their accounts. Others, worryingly will be people who the authorities decide to bully and make an ‘example’ of just because they are well known.

Recent history – like people being arrested under terrorism legislation for heckling the Home Secretary or walking down a cycle path – shows that when you give officials sweeping powers, they will be used. And when you exempt them from the rule of law, those powers will be abused.

Subsidy is not the way to export success

UK Chancellor of the Exchequer, George Osborne, says he wants to see more ‘Made in Britain’ stickers appearing around the world. So would I. But we have to create the right conditions for that to happen.

We certainly don’t want ‘Made in Britain’ stickers to appear round the world only because we are subsidising our production. We tried that in the 1970s with shipbuilding, steelmaking and volume car manufacturing. It just loaded cost on taxpayers and created vast monopolies that grew inefficient because they faced no effective competition. But in fact, other emerging economies such as Korea could do all these things better and cheaper than we did.

Adam Smith pointed out 250 years ago that by means of glasshouses and hotbeds you can grow good grapes in Scotland, and make wine out of them – but at around 30 times what it costs to make wine in France. So we should stick with what we are better at than others – design, fashion, finance, tourism, education and luxury goods such as Scotch Whisky.

What we certainly should not be doing is subsidising industries such as renewable energy. If these are potentially money-making industries for the future (as the government say, to justify the subsidies), then private investors would be well ahead of any government investment bureaucracy, that is for sure.

Perhaps Mr Osborne is riled by the fact that Germany, even though its economy is flatlining, has expanded its exports to China, while the UK, even with its devalued pound, hasn’t. But the solution to that is a proper growth agenda. Roll back the acres of regulation on employment and manufacturing, making it easier for people to hire workers and less risky to invest. Then stand back and watch the ‘Made in Britain’ stickers streaming out.

The conscience of the constitution

The Conscience of the Constitution by Timothy Sandefur, is a new Cato book that can be read with profit by anyone interested in classical liberalism, not just Americans. Some regard the US Constitution as a great bastion of democracy, yet the word, says Sandefur, appears nowhere in it. What the Constitution actually enshrines is liberty.

This liberal purpose and foundation is expressed in very plain terms by the Declaration of Independence, which is, in Sandefur's term, 'the conscience of the Constitution'. Where the Constitution says how the power of government should be limited, the Declaration explains why. Not to empower majorities and their representatives, but to restrain them.

Sandefur's thesis is that over a long period of usurpations, the liberty role of the Constitution has been eclipsed by its democracy rule. Its principles go back to Magna Carta, which declared that rulers and officials themselves had were subject to the 'law of the land' – the deep sense of justice and fairness that grows up through the voluntary interactions of free people. Governments cannot pass any rule they like, no matter how arbitrary, irrational, unfair, unclear or contradictory, and properly call it 'law'. It is this that 'due process' is all about – laws and their execution must be substantively fair and just. Americans do not simply enjoy a list of 'rights' but are protected (or should be) by a general rule against exploitation and unfairness.

In any particular case, that general rule might of course outrage the majority. And in recent years, says Sandefur, the courts have come to place the majority decisions in the legislature above the principle of safeguarding liberty, hardly ever striking down official powers. It is called 'judicial activism' but actually it is a baleful inactivity. Justices claim that legislators are nearer to the public and therefore better equipped to know what is in the 'public interest'. But that, says Sandefur, gives legislators carte blanche to pass almost any law, covering it with some or other 'public interest' fig-leaf. Also, majority decisions are actually made through the rent-seeking of interest groups, pressuring politicians, as described so well by the Public Choice economists. And much law today is made by unelected regulators anyway, so the 'nearer to the public' argument is plainly a sham.

Deliberately upholding unjust laws, concludes Sandefur, is no less damaging than accidentally striking down just ones. The courts should be in no doubt that, as the Constitution and Declaration specify, liberty is the primary object of their actions. However much democracy we have, our rulers have no right to go beyond the Constitution and thereby put the liberty of individuals at risk.

Pensions: Chancellor has taken the first step on a long road to reform

The Chancellor's Budget decision to treat pension savers as responsible adults and let them choose how to spend or invest their own pension pots on retirement – instead of being forced to convert them into annuities (or follow hugely complicated drawdown rules) – is surely welcome. But our pension system is such a mess that there is a lot more work to do.
On private pensions, for example, we need to stop fretting about 'tax relief'. The use of the phrase 'tax relief' suggests that somehow the great taxpaying public is subsidising pension savers, and it has been used to make the case that upper-rate taxpayers should not get upper-rate relief on their contributions. This is a complete misconception. When the rules were introduced decades ago, the principle was clear. If you actually drew your income, you paid tax on it. But if you did not draw your income at the time, but 'deferred' taking it until you retired, it was thought fair that you should only pay tax on it then. So it's not a subsidy – simply deferring the tax until the income is actually enjoyed.
Second, the contribution rules must be much simpler. Right now, how much you can contribute to a pension fund depends on your age and status. And thanks to Gordon Brown, there are limits on how much you can have in your pension pot before you start getting clobbered with a huge tax. The argument is that the special tax treatment is there just to make sure that pension savers have enough to live on, without having to fall back on welfare – not to help millionaires build up millions more in pensions pots. But in fact it is just a way of the Treasury saving money – money it regards as its own, rather than belonging to taxpayers like you and me. Scrap the lot and forget it.
Third, Gordon Brown (again) effectively killed off workplace pensions by over-regulating them. Sure, you need some regulation to make sure that company pension plans are well managed, but Before Brown the UK had more private pension savings than the rest of the EU put together. Now, workplace pensions are almost non-existent. The new 'people's pension' arrangement is an attempt to re-build that. Too little too late – and just another layer of rules and complexity on an already densely-stratified set of regulations.
Then there are state pensions. Current (tax) contributions go straight out to current beneficiaries. It's a pure Ponzi scheme – you just have to hope that some even bigger mug will be willing to pay in when you get to the drawing-out stage. If private-sector rules applied, Iain Duncan Smith and George Osborne would be in the slammer. When the system was introduced, the government was supposed to build up a proper fund to pay out future pensions, but (like America's too) it was never more than a fig-leaf for the fraud.
It's tough, but at some point we need to move to properly funded personal pension accounts, as Chile did in the 1980s (with many other countries following suit). Oblige people to earmark some of their earnings for pensions, by all means – but let them put it into an account that they control, rather than the Treasury black hole. Few young people today think they will ever get a meaningful pension from the state, and they are right. Again, maybe the Chancellor should do the right thing, and trust the people.
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