It’s a pleasure to be here.
Let me begin by talking about the key puzzles and questions that I want to talk about.
And it really begins with, is there an equilibrium distribution of wealth and, if so, what determines it?
And how do we account for the increase in wealth output ratio
and the fact that a return to capital which does not seem to be declining?
Average wage rates which in many countries seem to be stagnating or declining?
And a share of wages which seems to be decreasing, at least in many countries?
The context of these remarks is Thomas Piketty’s book which deservedly has gotten a lot of attention recently.
It suggests an ever-increasing concentration of wealth.
What is quite important about the book is that it also emphasises the period that I was growing up in.
The period after World War 2 was the golden age of capitalism.
When I was growing up I didn’t realise that this was the best that capitalism ever got.
Because as I was growing up I saw unemployment, discrimination, labour strife - lots of things that weren’t so golden.
But then I was told by Piketty’s book that’s the best capitalism ever gets.
And that, in fact, inequality in the post-1980 era has soared in a way
that was bringing us back to the inequality that had marked the 19th century.
Actually, as I’m going to try to explain in a few minutes, there is a fundamental difference though,
between inequality in the post-1980 world and inequality in the world
that existed in say the 19th century until World War 1 or World War 2.
And that is that during the 19th century wages increased enormously.
Standards of living of most citizens increased enormously.
And what’s been happening since 1980 is real stagnation.
So we have a puzzle.
We have a puzzle that is why is the post-1980 world different from the earlier world.
We have a puzzle that’s related to these movements in wages and returns to capital.
Standard theory suggests that increasing the capital labour ratio should lead
to a decrease in the return to capital and an increase in average wages.
And that’s true even in models with many types of capital.
So if there’s skilled biased technical change it will change the relative wages but not the average wage.
The fact that the average wage should be increasing.
There’s some important aggregation problems that are swept under the rug in almost all macroeconomics which are really first order.
Important issues that used to be discussed and really limit the applicability of standard macroeconomic models.
But this is a fairly general result.
Technological change, or an increase in efficiency as a result of globalisation,
would be expected in fact to increase average wages even more.
And studies of elasticity of substitution suggest that the elasticity is less than unity,
so an increase in the capital labour ratio, or the effect of capital labour ratio, would lead to a diminished share of capital.
So let me just review very quickly some of the data that Piketty was talking about
and some of the problems that I’ve just highlighted.
And I’ll do this very quickly.
So the standard chart is that inequality at the top - and this is just one aspect of inequality,
because there’s also a weakening in the middle and increase in poverty at the bottom –
has reached levels that haven’t been seen since before the Great Depression.
The second is to show that trickle-down economics, as usually meant, isn’t working.
You know in some ways trickle-down economics never worked,
the idea that if you throw enough money at the top everybody would benefit.
I wish it were true because if it were true - we’ve thrown so much money at the top everybody would be doing well.
But, in fact, as this chart shows for the United States median income is at the level that it was a quarter of a century ago.
Of course, different demographic groups are affected differently.
This is an average or a median.
An important demographic group that I feel very empathetic with is males.
And if we look at the median wages of a full-time male worker in the United States, it’s lower than it was 40 years ago.
So when I say that capitalism is failing -
any economic system that doesn’t deliver for very large groups in the population,
doesn’t deliver for a majority of citizens, is an economic system that is failing.
And certainly capitalism in America, and its true in many other countries, is in these terms failing, and failing very badly.
It’s not because productivity hasn’t increased.
In fact, productivity has increased significantly.
This chart shows that over the last 40 years there’s been 100% increase in productivity.
It’s just that most citizens haven’t participated.
Here’s a chart that shows the average wages in the United States over the last 40 years –
this is the pay per hour - has actually gone down by about 7%.
All the increase in productivity has gone elsewhere.
Now, one thing I’m not going to be able to talk about very much.
And a dimension of inequality that is very important.
Particularly those on the right talk about it all the time.
And say we don’t care about inequality of outcomes, what we care about is equality of opportunity.
But that’s also not very good.
Inequality of opportunity varies from country to country.
In the United States, which thinks of itself as the American dream, the land of opportunity,
the fact is that a young American's life prospects are more dependent
on the income and education of his parents than in other advanced countries.
So the idea that America is a land of opportunity is really a myth.
We ought to call it not the American dream, but the Danish dream or the Scandinavian dream.
And one sees that there’s a clear relationship.
And this is a really important research topic to try to understand why this is so.
But it’s been well documented - not only across countries but across counties in the United States –
that what you see is that countries with more inequality of outcomes have more inequality of opportunity.
There are many other dimensions of inequality that I could talk about but I’ve been told I only have 21.41 minutes.
So let me move on very quickly.
What I want to do is spend the time this morning trying to explain some of these anomalous facts.
What is going on?
The basic problem in Piketty’s work and the easy resolution of the quandaries that, from a theoretical perspective,
his analysis throws up is, that there’s a fundamental confusion between 2 variables, wealth and capital.
He talks about wealth going up - wealth output ratio going up, wealth labour ratio going up –
but that doesn’t mean that capital is going up.
Now, if you use a very simple model, W and K are the same thing.
But, in general, they are not.
Most of the increase in the value of wealth is an increase in the value of land.
It’s not that there’s more land.
But the price of land has gone up.
The data on K, the value of capital, actually shows a decline in the capital labour ratios in many countries.
In Piketty’s own country, in France, the capital - according to data that I’ve been able to get from the OECD –
the capital stock has actually been going down.
There are other important measurement problems.
And I emphasise that because too many people, in macroeconomics particularly, just take the data
that come out of the national accounts without asking, what does the data mean?
And this is particularly true when it comes to capital data.
So for instance, the value of capital could go up because of an increase in monopoly power.
Increase in monopoly power means that monopoly rents will go up.
The capitalised value of those monopoly rents will show up in stock market values.
There are reasons for us to not be surprised that monopoly rents might be going up
because of an increase in network effects that have been identified in areas like computerisation and telecommunication.
The second thing is there could be a shifting of resources to the private sector from the government,
exemplified in the value of the government bailouts.
In each of these cases there’s a negative, but the negative doesn’t get reflected in our accounting framework the way it should.
In the first case, when there’s an increase in monopoly power, there’s a decrease in the value of human capital.
But when we talk about wealth we don’t include the decrease in the value of human capital.
In the case of the shifting of resources from the government to the private sector,
we don’t talk about the decrease in the value of taxpayer wealth in the data.
Now, the next question we need to ask is how do we think of or how do we explain the increase in the value of land?
Important to emphasise that an increase in the value of land doesn’t mean that there’s more productive land.
An example of why the value of land might go up is that if some Russian oligarchs, who have been able to steal money
from their country and become very wealthy, decide they want to buy more land in the Riviera, in the south of France.
This is the one example where trickle-down economics works.
It trickles down from the Russian oligarchs to the rich people in France. (Laughter)
So the price of land in the Riviera goes up.
The same views of the ocean, the same water is there.
In fact, fewer people will be enjoying it.
But in terms of the value wealth is going up.
With the next slide - which I can’t talk about because Peter has restricted my time –
is that we can try to explain the value of these kinds of positional goods.
And we can show that, in fact, when there is an increase in wealth, there can be an increase in these positional goods
in such a way as actually to lead to a decrease in the value of K, of capital stock.
There’s another explanation of what might be going on.
And that’s related to dynamic instability that’s been well explored in theories of heterogeneous capital goods.
In the theories of heterogeneous capital goods, where there are multiple capital goods,
one can show that the equilibrium is a saddle point.
And without futures markets extending infinitely far into the future, or infinite foresight,
there is no reason to believe that the boundary value, the transversality conditions, will be satisfied.
Now you can translate these kinds of ideas directly:
2 kinds of capital, physical capital, the kind that’s productive and the value of land.
And the dynamic instability shows up in the amount of capital goods and the value of land.
There’s a dynamic instability.
The suggestion is that it may be that we are in one of these unstable paths with the value of land going up.
And, eventually, there will be a correction of this trajectory.
But unfortunately, even when there’s a correction, it can go to creating another land bubble of the kind
that we’ve seen repeatedly in capitalist economies.
The next issue is putting aside this problem, which helps explain the anomalous behaviour of the increase in wealth,
at the same time that the rate of interest has not gone down.
This says they’re not surprised their interested rate hasn’t gone down because the capital stock hasn’t gone up.
What’s really happened is just the value of land has increased.
But there’s another aspect of Piketty’s work that’s really interesting.
It's that he suggests that there is going to be ever-increasing inequality in the distribution of wealth.
And this is a really important research agenda which has not being studied intensively for a very long time.
And one can formulate very simple models, for instance with dynastic families leaving bequests among their children.
Right down simple differential equations describing the wealth distribution that results.
In the simplest kind of models, where for instance savings is described by a simple solo model,
where savings is a constant fraction of income, you get some striking results.
Which is: regardless of the initial distribution of income, there will eventually be equality of wealth.
Very different from the results that Piketty got.
If the savings rate, returns on capital, rates of growth of families are all the same but wages differ,
then, his studies say, the wealth distribution will correspond precisely to the wage distribution.
It’s easy to, or I shouldn’t say 'easy' - it’s possible to extend this to stochastic models.
For instance where wages of families are determined by a simple stochastic process with regression towards the mean.
That is to say if the parent is of unusual ability, it’s more likely that his children will be of some less ability.
One can formulate models of this kind with a lower bound on wealth –
that is to say individuals can’t borrow more than a certain amount - and assume the families optimise intergenerational utility.
And out of that one can derive simple theories of equilibrium wealth distributions
in which the inequality of wealth is related to the nature of the stochastic process of wages and intertemporal discount factors.
A third model that one can focus on is a savings function
where all the saving is done by the capitalist, by those who have capital.
It’s not a bad approximation to what has been happening today.
And it's really the model that is implicit in Piketty’s analysis.
In that kind of case, for instance again an implicit assumption of a lot of what he talks about
is the savings rate of capitalism is unity.
Then, in the long-run equilibrium, you get the rate of growth is equal to the rate of interest.
The important point here is that the interest rate is an endogenous variable.
So in his analysis some of you who looked at it noted that he made a big point
that you get increasing inequality as a result of the fact that the rate of interest exceed the rate of growth.
But that’s not consistent with long-run equilibrium.
In a long-run equilibrium the 2 will be equal.
And in that case you get the rather striking result that in the long run the road to wealth of all families would remain the same.
And the initial inequality of wealth would be perpetuated.
Really, what I’m trying to highlight here is that there is an important research agenda,
something that’s not really been researched as much as it should - on the determinants of the distribution of wealth over time.
In some of the work I’ve been engaged in,
it's been focusing on trying to identify what you might call the centrifugal and centripetal forces.
What are the forces at play that lead to increasing inequality of wealth?
And what are the forces that lead to reduced inequality of wealth?
And we’ve been able to identify a lot of the factors.
Analytic questions that arise are: Can we interpret the increase in inequality that we’ve observed?
Very strong increases in inequality since 1980.
Are we moving from one equilibrium to another?
Is it possible for inequality to increase without bound?
Or are we temporarily off an equilibrium path?
As I say I don’t have time to identify all the forces that are at play, either the centrifugal or the centripetal forces.
One of the aspects that I will have a chance to talk about is that if the very rich can use their position to get higher returns –
more investment in information, more extraction of rents - and if the very rich have equal or higher savings rate,
then wealth will become more concentrated.
Although there will be again, typically, an equilibrium distribution of wealth.
So that comes to the question: Can we identify factors that are currently at play,
that are contributing to this increase in wealth income, the increasing inequality in wealth and income?
And there are a couple of things that I want to try to identify
that go beyond some of the standard models that have been talked about.
The most important aspect of this is trying to go beyond the boundaries of economics.
And to realise that economic inequality inevitably gets translated.
Economic inequality of the magnitude of the United States, and some of the European countries,
inevitably gets translated into political inequality.
And political inequality gets translated into more economic inequality.
The basic and really important idea here is that markets don’t exist in a vacuum.
That market economies operate according to certain rules, certain regulations that specify how they work.
And those affect the efficiency of those markets.
But they also affect how the fruits or the benefits of those markets are distributed.
And the result of that is that there are a large number of aspects of our basic economic framework
that in recent years have worked to increase the inequality of wealth and income in our society.
An obvious one is how we provide education to different groups in our populations.
If we provide more education in rich districts, in rich parts of the country, then we help perpetuate wealth inequality.
If we have systems of public transportation that make it more difficult for poor people to get access to jobs,
we will get more inequality.
If we have systems of taxation that lower the taxes on capital, which has happened in the United States since 1980,
we get more inequality.
And if we have legal frameworks like bankruptcy laws, systems of corporate governance, inadequate enforcement of anti-trust laws,
we wind up getting more inequality.
So, in fact, if you look closely at what has been going on, it’s not a surprise what we’ve been seeing.
Empirically one of the striking things that’s been going on is an increased role of inherited capital.
The question is: What is the role of inherited capital versus life cycle savings, savings that people do on their own?
And the evidence is overwhelming: significant increases of the relative importance of inherited capital.
Well, I don’t really have time to talk about this, except to note
that it’s easy and important to try to construct models which answer that question.
And which try to identify how policy changes of the kind that I described above
lead to increases in the importance of inherited capital.
Leading to a society which can better be described increasingly as an inherited plutocracy.
The final part of my talk.
I want to talk about the notions of credit, wealth, and inequality.
And actually, in some ways, linking up macroeconomics to microeconomics.
I observed in the beginning that the aspect of the increase in wealth
that really characterised capitalist economies is really about the value of land.
And I’ve put forward 2 possible explanations of this increase in the value of land.
One is the value of position of goods.
The second being of equilibrium paths, the saddle-point nature of markets with heterogeneous capital goods.
There’s a third explanation which sees the growing wealth inequality as a result of misguided monetary policy.
It should be very clear that monetary policy in the years before 2008 did not lead to economic stability.
It led to the Great Recession.
I think it was a pivotal role in that.
But what I want to suggest is the nature of monetary policy, credit creation, actually it’s related to the increase in inequality.
So the basic idea is a fairly simple one.
It's credit not money that is central to macroeconomic behaviour.
Normally they move together.
In crisis monetary base may increase without an increase in credit.
So we need really a theory of credit creation.
And as we focus on credit creation, what we need to emphasise is that what matters is not the interest rate, the T-bill rate,
as has been standard in DSGE models but credit availability, the spread between the T-bill rates and the lending rates.
Well, what is credit?
Credit is what enables individuals to spend more than the resources they have available at that moment.
And one has to realise that credit is different from ordinary commodities.
Credit can be created out of thin air.
What gives rise to credit?
Why can banks, for instance, create this kind of credit that allows people to spend more money than they’ve already earned?
Credit economy is based on trust.
Trust that the money that is borrowed will be repaid.
Trust that the money that is received will be honoured by others.
If a financial institution is trusted it can effectively create money or credit on its own,
issuing IOUs that will be honoured by others and thereby can increase effective demand.
Today trust in the financial system is the belief that the government will come to the rescue.
And we saw that so clearly in 2008 where the US government and European governments basically said to the banks:
Here are a few trillion dollars - we’ll back you up even though you’ve misallocated credit and mismanaged risk.
What’s actually happened, if we look underneath the surface, is that the government has de facto delegated responsibility
for the creation and allocation of credit to private banks.
These private banks are effectively making use of its trust.
So we’ve privatised a key national asset.
Now, the central banks have only limited control of the quantity and, especially, the allocation.
And much of the credit has gone to the purchase of existing assets, leading to asset price inflation.
At the same time that the central banks were focusing on CPI, on commodity price inflation.
This controlled the credit creation process - credit creation activity is a major source of inequality in our societies.
Wealth not only going to those in the financial sector and to those that allocate credit,
but to those that own the pre-existing asset whose prices are increasing.
And it’s most evident in the creation of inequality in economies in transition,
who went from a high level of equality to one of the highest levels of inequality in a short span of less than a quarter century.
That brings me to the key policy issues.
Central banks, on this particular issue - the regulators could have circumscribed the flow of purchase of existing assets,
which is a form of macro-prudential regulation, but it was not part of the doctrine of central monetary policy of the DSGE models.
Government could have taken a more direct role in the provision of credit, of making use of this scarce resource, their own trust.
The crisis has shown that private markets were not good either in allocating credit or managing risk.
Relatively little of the credit goes to productive investment.
And that’s why the capital stock, the K, has actually been going down.
And it emphasises the importance of significant macroeconomic externalities
which were not taken into account by the private sector - a line of work that has now become very central to that at the IMF.
So this leads me, very quickly, to both policy agenda and the research agenda, which is:
Understanding the determinants of wealth inequality provides a framework for understanding policy reforms
that will lead to lower level of inequality.
And there’s a whole set of factors that I haven’t had a chance to talk about.
Both public policies, polices that affect the extent of rent seeking, wealth appropriation that goes on,
and social factors like discrimination and the role of unions.
Before concluding there are just 2 comments I want to make.
The first is there’s been a major change in perspectives on inequality in the last 10 years.
The first is that the distribution of income does matter.
In contrast with the prevalent macroeconomic models, particularly those that were prevalent before 2008,
most of which assumed the distribution of income was of no relevance.
It’s important to know what aspects of inequality of income and wealth are relevant, but it is very clear that they are.
The second thing is that traditionally economists have talked about there being a trade-off between inequality and wealth.
Yes, inequality is bad, but the view in many quarters is, if we were to do anything about inequality
it would slow growth, introduce distortions in the economy and lead to less economic efficiency.
We now realise that, at least given the extent of inequality in the United States and in many other advanced countries,
and given the way inequality is created, the sources of inequality that I’ve talked about –
actually we could have lower inequality and greater efficiency, greater stability, greater economic growth.
In short, equality and efficiency should be viewed as complements.
And this of course is the central theme of my book, The Price of Inequality,
but it’s also now become a mainstream view that’s emphasised by research at the IMF.
Again, an important research agenda is to understand the channels through which the effects get exercised.
The final remark I want to make is that we can’t be sure that in the next 50 years, the trends of the last 30 will continue.
We should hope not.
But it’s not just a question of economic forces.
Economic forces are the same on both sides of the Atlantic, both sides of the Pacific.
But the outcomes, including the structure of opportunity are markedly different.
And that says it’s not just economic laws, it's political forces.
And so what’s at issue here is not just economic capitalism in the 21st century, as Piketty said.
It’s really about democracy in the 21st century.
There are, in fact, as I’ve hinted in this talk, many instruments at our disposal to create a more equal society.
And many of these instruments would at the same time create a more efficient and better performing economy.
Understanding the drivers of this growing inequality and the consequence will, and hope should be,
a major area of research in the coming decades.
Thank you.
(Applause)