Karl Fitzgerald: Sweeping the world have been glowing reviews of the new book by Thomas Piketty, Capital in the 21st Century. I’ve been pounding on the bookshop doors asking when it’s arriving, this 700-page opus. It hasn’t hit here yet but I’ve read many book reviews. Have you had a chance to grab a hold of this must-read document?
Michael Hudson: No, but I have worked on the statistics that he uses for the last 50 years, so I know the problems with the statistics and what they can do and what they can’t do. And I’ve read what he’s been publishing all along with his colleague in California, Emanuel Saez, about the concentration of wealth and income at the top of the pyramid.
Question: And that’s the big point is that he’s renowned, along with Saez, for working on income inequality, but this book really looks at wealth inequality.
Answer: The problem with Piketty’s statistics are that it vastly understates how unequal the world really is and that’s because – you may know in Australia that our Queen of Mean, the hotel lady Leona Helmsley said “Only the little people pay taxes”. What she means is only the little people earn income. Rich people in America don’t earn income, they make capital gains and capital gains are not in everybody’s income statistics, they’re not in the statistics basically that are reported. And the IRS, the Internal Revenue Service of the United States, only conducts a study of capital gains once every ten years or so, and countries like England and many European countries don’t even have a tax on capital gains, so they’re not going to appear in the statistics.
So one of important results of Piketty’s work, if you know what you’re reading, is that the disparity in wealth is much greater than the disparity of income, and that’s because of tax avoidance by the rich. They don’t earn an income. And the same is true of corporations. The largest American corporations I think in the world are Google and Apple. Apple takes all of its income in Ireland, not in the United States, so how are you going to treat all of this? That’s the element that’s left out of this, that rich people don’t earn an income.
The other thing that is left out of the income tax statistics is of course how fortunes are really made, and that’s crime and fraud. The good thing about Piketty is he points out, why is it that French novelists and English novelists tell you much more about wealth than economics? And he points out that in the 19th century novels by Jane Austen and Balzac, the way to make a fortune is to marry into it. That’s true, but what Balzac also said is that behind every fortune is a great theft.
Now, let’s look at Forbes’ list of the richest people in Russia, China, the Ukraine or the post-Soviet economies. I can guarantee you that they didn’t make this wealth by saving up income, they didn’t earn a higher income; they stole the property by fraud and internal bribery, the same way that the great fortunes were made in the United States. The History of Really Great American Fortunes by Gustavus Myers shows how the railroad land grants made fortunes by bribing congressmen and by privatising the land. The great fortunes are made by privatising natural resources, land and the public domain, and since 1980, when the concentration of wealth and income have really taken off, as Piketty shows, this is the age of privatisation, of Margaret Thatcher, of Ronald Reagan, and Boris Yeltsin in Russia.
Q: But that’s been the interesting point is even with these limited statistics, he’s had to delve into the tax records to try and find this incredible wealth that’s come through privatisation, that’s come through this rent-seeking. That even with all those limitations you’ve pointed out, he has still come up with some incredibly strong statistics that people like Paul Krugman are just floored by. And it seems like it’s slapped the economics profession in the face to say look, we’ve got to get beyond income inequality and really focus on this wealth issue and have a look at how this wealth is created and what we can do to redirect economics, to look at the distributive side of the equation.
A: You’re right. He’s started the discussion by showing the fact of vast inequality. What needs to be done now is to explain how did this inequality come about and what do you do about it? And as you and I have talked on this show before, the solution of simply taxing fortunes, which is very hard to do, is a very broad hammer. And you and I have spoken about particular kinds of wealth and particular kinds of making fortunes are predatory, and that’s namely economic rent, whether it’s land rent, natural resource rent, monopoly rent or the kind of money that the financial sector makes. So Piketty’s book, large as it is, didn’t discuss this except at the end to say “Well, you need to somehow tax the wealth away”. Well, that’s true, but that’s for another book in the future. How do you tax it away? What’s the best kind of tax to make economies grow?
One of the things that Piketty does not discuss when it comes to making fortunes is the role of debt, that most of these fortunes that have taken off since 1980 have taken off because of the increased debt leverage. As interest rates have fallen since 1980, you’ve had more and more bank credit going in to just bid up real estate prices, stock prices, bond prices, every kind of price, not to mention fine arts trophies that have gone with this. So, just as you’ve had the rising ratio of wealth to income of the 1%, you also have a rising ratio of debt to income. And so this indebtedness and the net worth again is very unequally distributed. Most peoples’ families, the major asset they have is in their home but these homes are also very heavily mortgaged and the mortgage payments they make, basically the 99% makes interest payments to the 1%.
And what to me really has been accelerating wealth at the very top is the financial sector, is the ability of the 1% to get the other 99% in debt to them by saying “Look, we’re controlling the access point to buying a home, to buying basic needs, in America to getting an education, and you can’t afford to buy a home or get an education or even a car without borrowing money. And we’re going to charge you enough interest so that everything you earn in effect you’re going to be paying us for interest”. And that’s the same thing that is leading the corporate raiders and the activist shareholders to try to raid corporations and say “Pay up more of your money as dividends”.
So you’ve actually had a dismantling of tangible wealth and an increase in what used to be called fictitious capital or fictitious wealth, which is all basically debt leveraged wealth.
Q: Now one of the things Thomas Piketty goes into great detail and has earned him quite a few plaudits is looking at the difference between economic growth rates and the return on investments. And his general thesis is that when the economic growth rate falls below the long term average of 5% that the wealth gap accelerates because the wealthy, who own all this land, the mines, the privatised utilities, they can claim a greater return than what the rest of the people who actually have to rely on earning income when there’s low growth rates. And the thesis is that with an ageing demographic we have a period of low growth coming and from that we’re going to see an increased inequality in wealth. So this Gilded Age has really only just begun. What did you think of that thesis?
A: I think his conclusion, the gilded age is just beginning, is correct but the logic is not the logic that I’m following in my exposition. He’s saying the exact opposite of Adam Smith. Adam Smith said that the rate of interest is often highest in countries going fastest to ruin. So the fact is you can go to ruin for high interest or low interest.
When he talks about the rate of return the largest sector in the United States, and other countries also, is the real estate sector. If you look at from 1945 to today, the real estate sector doesn’t make an income. As you know, real estate by the billionaires is run as a personal charity. They don’t pay any income – if they made an income, of course, they would pay an income tax and declare it, but they don’t make any income. Almost all the rent they make is paid out either as interest or they charge depreciation as a cost. So what Piketty is referring to is not earnings before interest, taxes, depreciation and amortisation, but one portion of declared earnings excluding taxes, excluding interest, excluding depreciation and amortisation. The next highest wealth industry is oil and gas, they don’t declare any income because either they have a depletion allowance that makes them tax-exempt or they make all their income offshore in the flags of convenience countries. So the actual returns that are made, including the capital gains and total returns, simply are not available in the statistics that he looks at.
Secondly, what is growth? If you look at the American National Income & Product Accounts, for instance, 40% of all corporate profits in America a year ago when the statistics came out were made by the banks, by the financial sector. Now, these returns are basically a transfer payment. They don’t really add to growth. Financial services are not a service, unless you believe that a hold-up man that comes up to you in front of an ATM machine and says “Your money or your life” is giving you the service of giving you your life; it’s actually a transfer payment. He’s taking your money.
So there’s a question about whether all this financial activity and the real estate speculation and all this money paid to Wall Street and to bank managers and corporate managers really is growth or is it just a kind of fictitious growth to go hand-in-hand with the fictitious capital formation? You’re having the statistics take on an increasingly fictitious element, to the degree that they’re made by corporate tax accountants that pay enormous sums to the government not to tax the income they have. I think you have that in Australia in the mining sector where the richest lady in Australia pays a lot of money to make sure that she doesn’t earn a penny. Although she obtains for herself billions per year, none of this is really earned.
Q: So Michael, what you’re saying there is that, shocking as Piketty’s statistics are, they’re drastically understated and part of the reason that people such as Paul Krugman – you know, he’s written a book review where he says here “Even if the surge in US inequality to-date has been driven mainly by wage income, capital has nonetheless been significant too”. So why does Paul Krugman continue to ignore this incredible wealth advantage that some people have by owning the Earth and the rest of us struggle to keep up with good old wages?
A: The simple answer is that Krugman is a neoclassical economist. Neoclassical means anti-classical. He does not recognise that there is such a thing as economic rent. He also got in a big argument with your Australian Steve Keen two years ago saying that banks don’t create credit. “All banks do,” Krugman said, “is lend out savings.” He said it’s inconceivable that a bank can actually create credit or inflate asset prices.
So Krugman is applauded by the right-wing to be their liberal of choice not because he understands the economy, but because he doesn’t understand the economy. If he understood how the economy worked he wouldn’t have won the Nobel Price, because that’s a prize for people pretending that there’s no such thing as economic rent; there’s no such thing as unearned income. And that’s why Krugman’s focus is on, well, the real problem is that these managers of companies are paid so much more and they earn so much more income. But he’s even wrong as to his statistics and, remember, he’s a professional bank lobbyist. He’s paid by the banks. He went to Iceland to support the banks against the government trying to rein them in. So, of course the bankers love Krugman because he’s their lobbyist.
Take the Wall Street incomes that he’s pointing to. In the United States, under US Tax Law the income they make is not really an earned income; they make most of their money through stock options and trading gains, speculation. These are countered as capital gains and not taxed as normal income, but taxed much lower. So once again we have this fictitious accountant’s view of the world of what is income and what isn’t income. And looking at the tax returns one’s obliged to use, the categories that these tax accountants who’ve paid enormous sums to governments to distort content of and to make it appear as if the wealth really doesn’t exist. That’s why they call financial wealth “invisible wealth” in comparison to real estate, which is visible wealth. The whole idea of wealthy people is to make their wealth invisible because if it’s seen it will be taxed and it’ll be resented.
Well, what Piketty has done is make this wealth seen. So at least by his wealth statistics he says “Look, we see it there and we can measure it and we can see how unequal it is. What we can’t see is really how they got this wealth. All we have to show is the income tax statements that reflect the degree to which this wealth finds its counterpart in income”. But it’s sort of like looking – if you drop your keys you look where the light is instead of where you dropped the keys. All he has to go on statistically are the income tax records and he’s done an enormous technical job there, and that’s the only job that one can do as a starting point.
But one would really have to spend even more time reworking the statistics to untangle them to find out what is the actual reality behind this. You’d have to say “What are the capital gains that have enabled these Wall Street and financial managers to make an income?” And their contracts are very clear as to what makes it. To the extent that a corporate manager’s income is tied to the stock price, they get either a bonus or they get a stock option. Well, if they get a bonus based on the stock price what are they going to do with corporate earnings? They’re going to take the corporate income and instead of investing in new equipment and plant, instead of developing a new market, instead of producing more, they’re going to use the money simply to buy up their own stock instead of capital investment. So by buying up the stock, the stock price goes up and they can say “Look at how my management of the company has increased the price of the stock, give me my higher compensation and my stock options and my bonuses”.
So the failure to tax these capital gains away, the sort of free lunch, is leading to the warping of the economy that produces the statistics that Piketty’s come up with.