Reviewing Lawrence H. Summers’s Review of Piketty V: Secular Stagnation and the High-Pressure Economy: Tuesday Focus: June 32014

Mark Thoma sends us to Larry Summers at Michael Tomasky’s Democracy Journal:

Lawrence H. Summers: The Inequality Puzzle: “His policy recommendations are unworldly….

Success in combating inequality will require addressing the myriad devices that enable those with great wealth to avoid paying income and estate taxes…. If, as I believe, envy is a much less important reason for concern than lost opportunity, great emphasis should shift to policies that promote bottom-up growth. At a moment when secular stagnation is a real risk, such policies may include substantially increased public investment and better training for young people and retraining for displaced workers, as well as measures to reduce barriers to private investment in spheres like energy production, where substantial job creation is possible. Look at Kennedy airport… if a moment when the United States can borrow at lower than 3 percent in a currency we print ourselves, and when the unemployment rate for construction workers hovers above 10 percent, is not the right moment to do it, when will that moment come?

The relationship between the PikettyWorld, in which increases in the wealth-to-annual-income ratio do not see any substantial reduction in rates of profit, either because rich dominance of politics puts the state’s thumb on the scale or because the rise of the robots means that capital and labor are no longer complements, and the SummersWorld, in which there is a very low real interest rate, is complex.

You would think that they would be opposites. Where the rate of profit is high, the fact that savers can invest in high-return private investments as an alternative to buying government bonds would keep the government’s borrowing costs high. Thus you would think that we can be either in the PikettyWorld or in the SummersWorld, but not in both: one of them must be very wrong about how the North Atlantic will look over the next two generations.

I am not sure that that is correct. The rate of profit that matters for Piketty’s argument is the average rate of profit earned by plutocratic wealthholders. That is a risky rate of profit. The rate of interest that matters for Summers’s argument is the safe rate of interest at which the government can borrow. The difference between these two–between the risky average rate of profit and the safe government rate of interest–is the economy’s risk premium. And an economy that is short of risk-bearing capacity relative to the demand for safe assets might well wind up having the rate of profit be high enough for Piketty’s arguments to go through while the government’s borrowing costs remain low enough for Summers’s arguments to be correct as well.

In my view, the issues raised by Piketty and the issues raised by Summers are largely orthogonal. The major market failure in the PikettyWorld is one of maldistribution: the market system does its job of maximizing wealth and letting those with the gold makes the rules, but that is not the job that we want to market system to accomplish–that is not the social welfare function we want maximized. The major market failure in the Summers world is the inability of private financial intermediaries to create trusted safe assets to satisfy the demand. The solution to the market failure in the PikettyWorld is for the government to redistribute wealth and income. The solution to the market failure in the SummersWorld is for the government to create the safe assets, the safe stores of value that it can so cheaply create, that the private sector cannot create, and that are so highly-valued. These are largely independent policy agenda.

But focus on “lost opportunity”. What does Summers mean?

First, there is the lost opportunity from maldistribution: a dollar of income creates more human well-being in the hands of the relatively poor than in those of the superrich. As we trade off dessert, incentive, and utility in our assessment of what the distribution of income should be, there is potentially a huge lost opportunity from maldistribution that blocks both egalitarian division and upward mobility.

Second, there is both the loss of opportunity directly to those whose ability to move up is blocked by the sociological, Cultural, and economic consequences of plutocracy; and the indirect loss of opportunity for others because blockages to upward mobility keep a great deal of the potential talent of the society from being appropriately utilized.

Third, there is the fact that in the PikettyWorld most institutions are run and most societal decisions of note are made by those whose principal qualification is to have chosen the right parents. They for the most part lacks the meritocratic chops to would have been able to potentially acquire even 1/100 of their fortunes on their own. In such a society institutions are unlikely to function well. This is a third, enormous loss of opportunity.

And, fourth, there is, in the SummersWorld, the lost opportunity to mobilize the potential savings power of the world for economic growth and development––unless, of course, the government provides the risk-bearing capacity that the private sector cannot mobilize on its own.

Both sets of opportunities are with seizing. Summers appears to have spent a considerable amount of time thinking about how to grasp opportunities in SummersWorld. It is a flaw in Piketty’s book, I think, that Piketty takes a relatively narrow focus on policies. Here is a place where I think a great deal of thought and work could productively be concentrated.