Afternoon Must-Read: Thomas Piketty: On the Elasticity of Capital-Labor Substitution
As I have said before in Very Rough: Exploding Wealth Inequality and Its Rent-Seeking Society Consequences (backed up by the numbers here) and elsewhere, in my view Thomas because he really needed a rent seeking society chapter in his Capital in the 21st Century. The underlying logic of his argument seems to be that wealth can take two forms: investments in capital-embodied technological wealth that boost wages in the economy, or investments in rent-seeking wealth that erode wages in the economy. And, I think, his argument is that we are headed for a society with a higher wealth-to-income ratio, and in such a society a greater share of wealth will find its way into the second channel.
Maybe that is not what Pikitty’s argument is. But I at least think that it is what Piketty’s argument should be–because I think it is highly likely to be true…
On the Elasticity of Capital-Labor Substitution:
“I do not believe in the basic neoclassical model…
…But I think it is a language that is important to use in order to respond to those who believe that if the world worked that way everything would be fine. And one of the messages of my book is, first, it does not work that way, and second, even if it did, things would still be almost as bad….
My response to Summers and others is… what we observe… [is] a rise in the capital/income ratio and a rise in the capital share… [in] the standard neoclassical model… the only possible logical… expla[nation]… would be an elasticity of substitution somewhat bigger than 1… that there are more and more different uses for capital over time and maybe in the future robots will make substitution even more…. Now, does this mean that it is the right explanation for what we have seen in recent decades? Certainly not….
All I am saying to neoclassical economists is this: if you really want to stick to your standard model, very small departures from it like an elasticity of substitution slightly above 1 will be enough to generate what we observe in recent decades. But there are many other, and in my view more plausible, ways to explain it…. It is perfectly clear to me that the decline of labor unions, globalization, and the possibility of international investors to put different countries in competition… have contributed to the rise in the capital share…
Cf.:
Capital Eats the World, and The Slack Wire: Notes from Capital in the 21st Century Panel; and me: The Hourly Piketty: Paul Krugman, “Gattopardo Economics”, and Economic Modelling, and The Honest Broker: Mr. Piketty and the “Neoclassicists”: A Suggested Interpretation: For the Week of May 17, 2014.