Piketty and the elasticity of substitution

23 oktober, 2014 kl. 22:39 | Publicerat i Economics | 4 kommentarer

When “Capital in the 21st Century” was published in English earlier this year, Thomas Piketty’s book was met with rapt attention and constant conversation. The book was lauded but also faced criticism, particularly from other economists who wanted to fit Piketty’s work into the models they knew well …

whereswaldo1A particularly technical and effective critique of Piketty is from Matt Rognlie, a graduate student in economics at the Massachusetts Institute of Technology. Rognlie points out that for capital returns to be consistently higher than the overall growth of the economy—or “r > g” as framed by Piketty—an economy needs to be able to easily substitute capital such as machinery or robots for labor. In the terminology of economics this is called the elasticity of substitution between capital and labor, which needs to be greater than 1 for r to be consistently higher than g. Rognlie argues that most studies looking at this particular elasticity find that it is below 1, meaning a drop in economic growth would result in a larger drop in the rate of return and then g being larger than r. In turn, this means capital won’t earn an increasing share of income and the dynamics laid out by Piketty won’t arise …

Enter the new paper by economists Loukas Karabarbounis and Brent Neiman … Their new paper investigates how depreciation affects the measurement of labor share and the elasticity between capital and labor. Using their data set of labor shares income and a model, Karabarnounis and Neiman show that the gross labor share and the net labor share move in the same direction when the shift is caused by a technological shock—as has been the case, they argue, in recent decades. More importantly for this conversation, they point out that the gross and net elasticities are on the same side of 1 if that shock is technological. In the case of a declining labor share, this means they would both be above 1.

This means Rognlie’s point about these two elasticities being lower than 1 doesn’t hold up if capital is gaining due to a new technology that makes capital cheaper …

In short, this new paper gives credence to one of the key dynamics in Piketty’s “Capital in the 21st Century”—that the returns on capital can be higher than growth in the economy, or r > g.

Nick Bunker

To me this is only a confirmation of what I wrote earlier this autumn on the issue:

Being able to show that you can get the Piketty results using one or another of the available standard neoclassical growth models is of course — from a realist point of view — of limited value. As usual — the really interesting thing is how in accord with reality are the assumptions you make and the numerical values you put into the model specification.

4 kommentarer

  1. A particularly silly critique
    Comment on Nick Bunker’s ‘Piketty and the elasticity of substitution’
    .
    “A particularly technical and effective critique of Piketty is … that for capital returns to be consistently higher than the overall growth of the economy — or “r > g” as framed by Piketty — … the elasticity of substitution between capital and labor, which needs to be greater than 1 for r to be consistently higher than g.” (quote from above)

    In order to buy this argument one has to buy its premises and these premises are known to be false. The first rule of scientific inquiry has been aptly put by Davidson:

    “…, before accepting the conclusions of any economist’s model as applicable to the real world, the careful student should always examine and be prepared to criticize the applicability of the fundamental postulates of the model; for, in the absence of any mistake in logic, the axioms of the model determine its conclusions.” (2002, p. 41), see also (Keynes, 1973, p. xxi)

    The elasticity argument presupposes the existence of of production function with convenient properties. There is no such thing. And any graduate student could know this.

    “Orthodox economists operate with concepts like continuous substitutability in consumption and production, positively sloped industry supply curves, and well-behaved aggregate production functions, for which there is little or no empirical support, because they are wedded to a political myth of the market as a self-regulating mechanism.” (Blaug, 1984, p. 973)

    Not only that there is empirical support lacking, any undergraduate student of physics laughs out loud when confronted with an economist’s production function.

    “The idea of a path-independent transformation of one set of physical objects into another violates so many physical laws that one can only marvel at the audacity of those who wrap themselves in the banner of physics before marching off to do battle with the opponents of production functions.” (Mirowski, 1995, p. 327)

    An effective critique does not waste time with the green cheese assumptionism economists are famous for.

    Suffice it to mention that capital, profit maximization, decreasing returns, equilibrium and many other notions of marginalism are nonentities.

    The worst thing of all, though, is that economists are talking about distribution without knowing what profit is.

    “A satisfactory theory of profits is still elusive.” (Desai, 2008, p. 10), for the correct approach see (2014a; 2014b)

    The discussion about the elasticity of substitution is in no way different from the discussion about how many angels can dance on the point of a pin.

    That the graduate students at MIT are not aware of this is small surprise. They even accept supply-demand-equilibrium as an explanation. What is a real surprise is that this shallow argumentation is taken seriously on this blog.

    To be as clear as possible: Marginalism is Zombie-Economics (Quiggin, 2010).
    .
    Egmont Kakarot-Handtke
    .
    References
    Blaug, M. (1984). Review: Why Economics is not Yet a Science. Economic Journal,
    94(376): 972–973. URL http://www.jstor.org/stable/2232317.

    Davidson, P. (2002). Financial Markets, Money and the Real World. Cheltenham,
    Northampton, MA: Edward Elgar.

    Desai, M. (2008). Profit and Profit Theory. In S. N. Durlauf, and L. E. Blume
    (Eds.), The New Palgrave Dictionary of Economics Online, pages 1–11. Palgrave
    Macmillan, 2nd edition. URL http://www.dictionaryofeconomics.com/article?id=
    pde2008_P000213.

    Kakarot-Handtke, E. (2014a). The Profit Theory is False Since Adam Smith. What
    About the True Distribution Theory? SSRN Working Paper Series, 2511741:
    1–23. URL http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2511741.

    Kakarot-Handtke, E. (2014b). The Three Fatal Mistakes of Yesterday Economics:
    Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2489792.

    Keynes, J. M. (1973). The General Theory of Employment Interest and Money.
    The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke:
    Macmillan. (1936).

    Mirowski, P. (1995). More Heat than Light. Cambridge: Cambridge University
    Press.

    Quiggin, J. (2010). Zombie Economics. How Dead Ideas Still Walk Among Us.
    Princeton, NJ, Oxford: Princeton University Press.

    • It is a good statement to base economic theory in profit, but it’s not enough to explain variability in economic reality. Ricardo did obtain is profit from lends to british govern and to East Indies Co. and Samuel Bailey a critic of Ricardo, make his profit in commerce between England and USA. Both make his profits not representable in a wage rate multipied by labor hours but in state politics-war and in international cultural-economic differences.
      Is it possible to create an axiomatic economy base to represent this variability?

      • The one and only Profit Law and the multitude of unique historical circumstances
        Reply to robertoviera1

        .

        The crucial point is to distinguish between total profit for the (world) economy as a whole and the distribution of profit among firms. The theoretical point of departure is conventional profit theory which asserts that total profit is zero.

        “The consensus to date has been that it is mathematically impossible for capitalists in the aggregate to make profits.” (Keen, 2010, p. 2)

        This assertion is fully accepted by methodologists.

        “But, from the macro perspective of Walrasian general equilibrium, the total profits in this case cannot be other that zero (otherwise, we would need a Santa Claus to provide the aggregated positive profit) but this does not preclude the possibility of short-run profits and losses of individual firms canceling each other out.” (Boland, 2003, p. 150)

        The curious thing is that aggregate profit has been greater than zero for most of the time in most of the known market economies up to the present. This is an empirical fact. Hence there is something wrong with conventional profit theory (Desai, 2008). And, clearly, when the profit theory is wrong then distribution theory is also wrong (2014a). This is the main argument against Piketty.

        Now for the constructive part.

        First of all it is necessary to show how positive overall profit comes into existence and how it can be maintained over any stretch of time. The structural axiomatic paradigm achieves this in a formally rigorous way (2013; 2011). For total profit there exists a testable Profit Law.

        Now, the second point is the distribution of total profit among the firms which constitute the economy. Here additional factors come into play. For example: firm A increases productivity, firm B slashes wages, firm C gets a big contract to build weapons etc. All these historical events effect a redistribution of total profit which is given by the Profit Law. It is quite clear that there is no such thing as a historical law of the distribution of profits among firms.

        “That is why Descartes said that history was not a science — because there were no general laws which could be applied to history.” (Berlin, 2002, p. 76)

        How Ricardo or Bailey made their individual profits is a historically unique story that unfolds within the framework of structural axiomatic laws. How universal economic laws and unique historical events play together has been shown exemplarily in (2014b).

        From the Law of Gravity does not follow how a feather flies. Likewise: it does not follows from the structural axiomatic Profit Law how Ricardo got rich. Vice versa: from the fact that Ricardo got rich does not follow that he understood the Law of Profit. In fact, he got it completely wrong (for details see the web page http://www.axec.org/#!profit-w/cmlw).

        .

        Egmont Kakarot-Handtke

        .
        References
        Berlin, I. (2002). Freedom and Its Betrayal. London: Chatto Windus.

        Boland, L. A. (2003). The Foundations of Economic Method. A Popperian Perspective. London, New York, NY: Routledge, 2nd edition.

        Desai, M. (2008). Profit and Profit Theory. In S. N. Durlauf, and L. E. Blume
        (Eds.), The New Palgrave Dictionary of Economics Online, pages 1–11. Palgrave Macmillan, 2nd edition. URL http://www.dictionaryofeconomics.com/article?id=pde2008_P000213.

        Kakarot-Handtke, E. (2011). The Emergence of Profit and Interest in the Monetary Circuit. SSRN Working Paper Series, 1973952: 1–23. URL http://ssrn.com/abstract=1973952.

        Kakarot-Handtke, E. (2013). Debunking Squared. SSRN Working Paper Series, 2357902: 1–5. URL
        http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2357902.

        Kakarot-Handtke, E. (2014a). The Profit Theory is False Since Adam Smith. What About the True Distribution Theory? SSRN Working Paper Series, 2511741: 1–23. URL
        http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2511741.

        Kakarot-Handtke, E. (2014b). The Synthesis of Economic Law, Evolution, and History. SSRN Working Paper Series, 2500696: 1–22. URL http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2500696.

        Keen, S. (2010). Solving the Paradox of Monetary Profits. Economics E-Journal, 4(2010-31). URL
        http://dx.doi.org/10.5018/economics-ejournal.ja.2010-31.

  2. To Egmont Kakarot-Handtke
    You say ”“The consensus to date has been that it is mathematically impossible for capitalists in the aggregate to make profits.”(Keen, 2010, p. 2)

    This assertion is fully accepted by methodologists.”
    Problem is that this asertion is false, that is asserted for Adam smith, David ricardo and a series of East Indies associated persons. In some point of history in XVIII siecle, in England some theoricists or philosophos begin to negate profits in international and colonial trade. Adam Smith make long dissertations negating any profits for England in colonial commerce. All this to maintain profit fluxes from colonies and from all the world.
    Ricardo put as a law the specialization in manufacture for England and in prime matter in everywhere.
    But this is distant in time. See just now.
    China and India and some ”emergent” countries are world workshop. In commerce and internal firms transport profit appears that I think is not recognized for ”methodologists”.
    Origin of profit is
    1. Cultural level of work force and administrative personal, this includes long work hours and 7 days labour week
    2. No paying for environment rules
    3. No paying for health rules with cancer, respiratory deseases in labor and in general public.
    All important firms appreciate politics, economists, health personnel, journalists that are blind to reality that produces big profits.
    It is difficult to generate an axiomatic system that represents this reality. It is understandable that if you want to be accepted or recognized you dont must to see this.
    An example of this is oil bubble. In 2000 oil companies have income for 1.6 % of Global GDP (data from Global Fortune 500) and after bubble grow, incomes was 3.6% of WGDP.
    What is profit from firm’s workshop moved from Pittsburg to China?
    this is a good data to begin to think.


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