Allister Heath in The Telegraph
Given that today’s fashionable economic ideas tend to become tomorrow’s government policies, it’s not looking good for the future of free-market capitalism. Consider the current bestselling book in America, Capital in the Twenty-First Century, a hugely important work that has already become the defining post-crisis manifesto. Its ground-breaking research on historic patterns of wealth ownership is second to none, but its conclusions are horrendously flawed.
Its author, the French economist Thomas Piketty, advocates an 80pc income tax rate for those earning more than £300,000 a year. For good measure, he also floats a range of other even worse ideas, including an internationally coordinated progressive wealth tax, hitting anybody with at least £165,000 in assets and peaking at a crippling 10pc a year on billionaires, a windfall tax on private capital, a dose of inflation and a war on inherited wealth. It’s the kind of hardcore message to warm the hearts of your average British socialist, circa 1976 – and yet it is being embraced as the latest, cutting-edge thinking.
Even more fantastically, this assault on private property and wages would supposedly have no meaningful negative side-effects. Piketty writes that “the evidence suggests that a rate [of tax] of the order of 80pc on incomes over $500,000 or $1m a year would not reduce the growth of the US economy but would, in fact, distribute the fruits of growth more widely while imposing reasonable limits on economically useless behaviour”. Instead of being laughed out of town, Piketty is being treated with the sort of adulation usually reserved for a rock star.
At this point, I could cite some of the many peer-reviewed studies that show — unlike the author’s own research — how high marginal tax rates reduce work and effort, remind readers that eating capital is the best way to impoverish a nation, reduce productivity growth and keep wages down, or point out that societies where the most successful entrepreneurs are rewarded by the state seizing their assets don’t prosper.
Instead, let me consider Piketty’s big idea, which he believes justifies his policies of “confiscatory” taxation – to him, a positive term. He believes that in a peacetime free-market economy, the returns on capital — dividends, interest, rents and capital gains — inevitably grow faster than the overall economy. The owners of capital will therefore end up grabbing an ever-greater slice of the pie, leaving workers with less and less.
I buy neither the prediction nor the proposed solution. For a start, João Paulo Pessoa and John Van Reenen from the LSE have shown that the share of UK income going to labour is largely the same now as it was 40 years ago, unlike in America. And if the returns to capital do go up, more money will eventually be invested to reap the rewards — and that, in turn, will increase productivity and hence wages, and keep down capital’s share of GDP.
There are other problems. Try telling pensioners that “rentiers” always end up ahead. The rate of interest on many bank accounts is close to zero, and therefore negative after inflation, and returns on gilts have been awful over the past couple of years. Of course, share prices have shot up — but risky assets come with a premium, and total returns on UK equity markets haven’t exactly been stellar over the past 15 years.
Capital is an amorphous concept; it keeps changing, as does its ownership. Entire industries are being decimated by technological progress; the whole point of capitalism is creative destruction, which means that old capital becomes obsolete, wiping out its owners, and is replaced by new capital, enriching its creators. It is also easy to destroy assets by consuming them — and that is what happens, in most cases, when money is passed down generations.
The fact that Piketty’s book is selling so well busts several myths.
The first is about American intellectual exceptionalism: the idea that US Left and Right differ only marginally in their support of capitalism, unlike in Europe. That certainly isn’t the case today. Parts of the US intelligentsia now advocate the same ideas that are to be found on Europe’s Left-wing fringes; Piketty and his adoring fans would go much further even than Ed Miliband.
The second incorrect idea is that the recent episode of banker-bashing from Occupy Wall Street et al was merely a reaction to the bail-outs, or to the financial sector’s role in the crisis. It was perfectly possible, we were told, to slam bankers but to embrace entrepreneurs. It was a case of Wall Street bad, Silicon Valley good; money accrued through finance was supposedly “undeserved” and that accrued by building a business wasn’t.
The truth, as I long suspected and as the almost delirious reception that this book has received confirms, is altogether different. Envy is back, disguised as a concern about “inequality”, and the bail-outs and QE were merely a convenient excuse to bash the rich. It is shocking how many intelligent people now support seizing most of the wealth created by entrepreneurs, including the founders of the great software companies (which is what a 10pc annual tax on the assets of billionaires would soon achieve).
The third myth is that there is such a thing as the “1pc”. This was always nonsense: someone earning £150,000 a year (the threshold at which a UK income taxpayer joins the club) has nothing in common with a billionaire. The Left now has another enemy, the top 0.1pc or even 0.01pc, which is just as well given that plenty of those waxing lyrical about Piketty are in the lower reaches of the top 1pc themselves. It is a case of the rich waging war on the extremely rich.
One reason why many believe Piketty’s claim that returns to capital will continue to outpace GDP is the experience of the past three to four years. Share prices have bounced back, and house prices have outperformed; meanwhile, wages are down in real terms. Yet that doesn’t mean this will continue indefinitely.
Regardless of whether Piketty’s key prediction is true — and I’m sure it isn’t — a much better solution is to encourage an ownership society so all can enjoy returns from capital. In the UK, auto-enrolment means that nearly everybody will begin to accumulate financial assets in pension pots.
Housing policy needs to change. In London, New York and San Francisco, house prices have rocketed because of planning rules that limit supply growth, pricing many out of the market. The best way to refute Piketty’s law in this area is to make it much easier to build new homes.
We also need a normalised monetary policy, not one designed to keep the price of capital assets as high as possible, thus artificially (but temporarily) boosting the wealthy.
Last but not least, supporters of capitalism need to get their act together. They are being slaughtered on the intellectual battlefield by opponents who are finding sexy new justifications for their old arguments. We need more and better defences of the free enterprise system, and we need them now.
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