Seattle just voted in a new $15/hour minimum wage, although it doesn’t take full effect until 2021. So we’ll have to wait a bit to see the impact.  But what sort of impact are we looking for?

The usual debate pits liberals who see little or no job loss and very little extra unemployment, against conservatives who see lots of job loss and extra unemployment.  But there are other possibilities as well:

1.  Lots of job loss but not much unemployment.  Perhaps low wage firms move across the border to the suburbs.  Seattle itself has only 634,000 people in a metro area of 3.5 million.  Perhaps low wage workers move out with the jobs, as the city itself gentrifies.  For remaining low wage jobs in Seattle, unskilled Hispanic workers are replaced with college-educated millennials.  The Hispanics move elsewhere.

2.  Or maybe there is lots of unemployment but almost no job loss.  Suppose fast food companies view their existing facilities as a sunk cost, and swallow the wage increase.  Or suppose there is lots of monopsony power.  Then very little job loss.  But there might be lots of unemployment.  In development economics there are models where unskilled peasants move to the city and try to find the (scarce) well-paying jobs in the formal sector.  While they look for those good jobs they are unemployed, although that term might also involve some work in the informal sector.  Even the US has a big informal sector; I used to work in it when I was very young.

I’d like to argue that outcome #1 (low unemployment) has a conservative vibe, and outcome #2 (high unemployment) has a liberal vibe.  Outcome #1 assumes markets are very creative at getting around obstacles.  It doesn’t mean there aren’t any welfare costs from the policy, just that there won’t be much unemployment.

Outcome #2 is more interesting.  Liberals tend to argue that low wages are a huge problem for the poor.  Thus a $15 dollar wage would offer significant improvements in living standards (BTW, I agree with this, although I’d prefer the government paid the bill.)  Let’s say liberals are correct, and that the Seattle policy is a huge boon to the poor.  In that case low wage workers from other cities should flood into Seattle looking for one of those precious jobs.  Yes, the cost of living is high, but no higher than some other bigger affluent cities with minimum wage rates that are far lower.  The low-skilled workers will park themselves in the informal economy, or live off welfare, until they find one of those jobs.  Thus we have the odd situation where the law will be a boom to low wage workers if and only if it leads to a large rise in Seattle’s unemployment rate.

Of course this is just the tip of the iceberg.  Other possibilities are possible, such as reductions in non-wage benefits.  But with Obamacare coming on board I’m not sure how much firms will be able to cut costs in that area.  The underground (or informal) economy might also expand. Because the law doesn’t take full effect until 2021, the effects might be smaller than first advertised.  A wage of $15/hour in 2012 might be closer to $12 today.  Still high, but not absurdly high relative to the Seattle economy.  (This sort of law would probably have a bigger impact in the southern US, which is why many southern Congressmen oppose higher minimum wages, whereas former Massachusetts governor Romney is in favor.)

Now consider the impact of a wage-subsidy scheme, in a world with lots of migration and a fairly elastic supply of low-skilled labor at a wage rate of $7.25/hour.  The wage subsidy policy would mostly depress net wages to firms (more money for the 1%!), with only a small increase in gross wages to low-skilled workers. Migrants flood in. In contrast, a very high minimum wage and tight immigration enforcement would lead to much higher low skilled wages, and illegals from Mexico would return home as their jobs are taken over by better educated American born workers (back to the 50s–less for the 1%.)  The first policy mostly transfers money from American taxpayers to foreigners moving to the US.  The second policy produces an outcome that “looks” much better to most liberals.  But it’s the first policy that is actually superior from a liberal/egalitarian perspective.

In welfare economics, as in other areas of econ, nothing is as it seems.  It’s cognitive illusions all the way down.  Indeed I have doubts about whether money actually makes people happier (and no, those studies do not show causation.)

I’ve started Piketty’s new book, but just finished the first chapter (intro.)  Here are a few initial observations:

1.  He has a fairly left-wing worldview (albeit certainly not Marxist.)

2.  He says that “all the historical data” shows that real wages in Britain did poorly in the first 1/2 to 2/3rds of the 19th century.  I’m no expert here, but that’s not what I was taught.  I was taught (at both Wisconsin and Chicago) that the data conflicted. Some data showed what Piketty claims, and some data suggested that real wages rose, that British workers did better than peasants, and also better than people on the continent.  Does anyone know whether all the data supports Piketty’s claim?

3.  He is rather dismissive of those he disagrees with.  At Econlog I extensively discuss his mischaracterization of Simon Kuznets’ views.  That’s the post to read if you are a visitor from MR and only have time for one.

4.  He says the wealth/income ratio in the late 19th century was 600%, “which is a lot.”  That doesn’t seem like a lot to me.  It will be interesting to see if he later explains why it is a lot.

5. I’m not quite sure what motivated him to write the book.  Is it a study of capital, of wealth, or of economic inequality?  The title suggests capital, the intro suggests he’s more interested in wealth and income inequality.

6.  He says that two key graphs motivate his study.  One shows the U-shaped pattern in income inequality over time, and the other shows a U-shaped pattern in the ratio of private “capital” and income. The second graph has been challenged by Chris Giles.  Then he gets to the model.

If, moreover, the rate of return on capital remains significantly above the growth rate for an extended period of time (which is more likely when the growth rate is low, though not automatic), then the risk of divergence in the distribution of wealth is very high.

This fundamental inequality, which I will write as r > g  (where r stands for the average annual rate of return on capital, including profits, dividends, interest, rents, and other income from capital, expressed as a percentage of its total value, and g stands for the rate of growth of the economy, that is the annual increase in income or output), will play a crucial role in this book. In a sense, it sums up the overall logic of my conclusions.

I had read numerous reviews of the book, pro and con, before I started reading it, so I was well aware of the importance Piketty placed on the r > g relationship. When I first heard about this model it struck me as absurd. I started reading the book, thinking Piketty would provide some sort of persuasive explanation for the model. After all, the book is been very well reviewed, for the most part. And yet right after these two paragraphs, here’s what I found:

When the rate of return on capital significantly exceeds the growth rate of the economy (as it did through much of history until the nineteenth century and as is likely to be the case again in the twenty-first century), then it logically follows that inherited wealth grows faster than output and income.

This is even more absurd than I expected. It does not logically follow that inherited wealth grows faster than output and income. It just doesn’t. It’s wrong. I really don’t know what else to say, other than it’s wrong. At some level the Piketty probably understands his claim was incorrect, as he contradicts himself in the very next sentence:

People with inherited wealth need save only a portion of their income from capital to see the capital grow more quickly than the economy as a whole.

OK, so doesn’t logically follow, you need to make assumptions about savings. Does that help? Not really, because the model is still absurd. And that’s because the assumptions that you’d need to make about savings are utterly implausible. To see what’s wrong with Piketty’s model all you have to do is rewrite the “logically follows” sentence, replacing “inherited wealth” with specific families. Here is what Piketty claims is the “logical” model that lies at the very core of the book, rewritten by me:

When the rate of return on capital significantly exceeds the growth rate of the economy (as it did through much of history until the 19th century and as is likely to be the case again in the 21st century), then it logically follows that the wealth of the grandchildren of Bill Gates, Warren Buffet, Larry Ellison and all the other billionaires, will exceed their wealth.  Indeed the wealth of the grandchildren will exceed their wealth by more that (1 + g) to the n power, where n is the number of years between now and when these billionaire’s grandchildren reach the same age. That’s about 60 years.

Using plausible growth rates, Piketty is saying that the grandchildren of these super-billionaires will “logically” be at least 4 times wealthier on average, or even more, even in real terms.  He thinks that is the implication of r > g.  Now to be fair, that may well be true in a few cases.  But is that the expected result?  Obviously not.  Do you expect Bill Gates’ grandkids to eventually have $200 billion in 2014 dollars?

And the reason is obvious.  Billionaires accumulate vast fortunes for a reason.  They want to do something with the money.  They want to do lots of things with their money.  They have grand plans for a billionaire lifestyle.  They have grand philanthropic interests.  And yes, they also want to give some money to their children.  Piketty continues:

Under such conditions, it is almost inevitable that inherited wealth will dominate wealth amassed from a lifetime’s labor by a wide margin, and the concentration of capital will  attain extremely high levels–levels potentially incompatible with the meritocratic values and principles of social justice fundamental to modern democratic societies.

No it isn’t.  What more can I say?

So why did Piketty make this mistake?  Perhaps he was too influenced by European culture.  In most European countries it is illegal for billionaires to give more than 1/2 of their fortunes to charity.  So although Piketty’s model won’t even be true for Europe, it will be closer to the truth in Sweden than in the US.  As an analogy, Keynes model was wrong, but most people think it was “less wrong” for depression-type periods with near zero rates, such as Keynes was familiar with in the 1930s, than for the economy at full employment.

How big of a problem is this?  That depends.  For the policy issues of interest to progressives, it may not be much of a problem at all. Even though Piketty’s model is wrong, his predictions may well be correct.  Wealth may grow increasingly unequal.  Perhaps wealth redistribution is needed.

However I do think it’s a big problem for Piketty’s book. If the book is a model plus data plus policy advocacy, then in my view he’s lost one third of the book in the opening chapter. In later posts I’ll let you know whether he collects the data that is most relevant to the issue of economic inequality, and whether he has good arguments for or against the standard remedy of a progressive consumption tax, with zero taxes on capital.

PS.  After writing this I noticed a book edited by Joel Mokyr has a article by Deirdre McCloskey that claims British real incomes rose by two and a half times between 1780 and 1860, but that’s an average, and doesn’t account for changes in income distribution.  Another article by Clark Nardinelli suggests that real incomes doubled between 1760 and 1860 and the share of income going to the bottom 65% fell from 29% to 25%.  But even that suggest a substantial gain for average people.  So I’m not sure that “all the historical data” shows what Piketty claims it shows.

This headline caught my attention:

Romney Wants GOP to Be the Party of Jobs and a Minimum Wage Hike

Just imagine how much higher the minimum wage would be if the GOP had won the election in 2012.  Thank God for Mr. Obama.

Of course the right did win the German election, and in addition to instituting a minimum wage in the world’s only non-dysfunctional big country labor market, they’ve decided to cut the retirement age:

Individually, these proposals may seem noble-minded. But as a package, the plan is “short-sighted and one-sided,” thinks Axel Börsch-Supan, a pension adviser at the Munich Centre for the Economics of Ageing. It benefits the older generation, which is already well looked after, at the expense of younger people who will have to pay higher contributions or taxes. “The financial and psychological costs of the pension at 63 are disastrous,” Mr Börsch-Supan says. There will no longer be any incentive to keep working longer. In some cases, people may, in effect, retire at 61, register as unemployed for two years, and then draw their full pensions.

Criticism of the pension changes straddles German politics. Social Democrats who were involved in previous reforms, such as Franz Müntefering, a former party boss, are against. So are members of the business-friendly wing of Mrs Merkel’s own party. Employers are opposed, because they face labour shortages and are trying to persuade older workers to stay in their jobs longer, not leave sooner. Even the churches are critical, on the grounds that the plan violates “generational justice”. Germany’s EU partners are especially upset. Olli Rehn, the European economics commissioner, has said that the commission may even sue Germany if it goes ahead with the plans.

Love that part about opposition from the Social Democrats.  And the cardinals seem to have elected a Peronist pope:

The Peronist pope?

The political landscape of Francis’s homeland, however, offers a more accurate, and nuanced, understanding of his views. For most of his life Argentina has plotted a kind of third way between Marxism and liberalism””albeit one with disastrous political and economic results. “[Francis] only knows one style of politics,” says a diplomat accredited to the Holy See. “And that is Peronism.”

The creed bequeathed by Argentina’s former dictator, General Juan Perón, with its “three flags” of social justice, economic independence and political sovereignty, has been endlessly reinterpreted since. Conservatives and revolutionaries alike have been proud to call themselves Peronist. But at its heart it is corporatist, assigning to the state the job of resolving conflicts between interest groups, including workers and employers. In that respect it resembles fascism and Nazism””and also Catholic social doctrine.

Peronism combines the things I hate most about the left, with the things I hate most about the right.  And yet at least Pope Francis has empathy for the world’s “true victims:”

“He has changed the topic from abuse without doing anything about it,” says Anne Barrett Doyle of the American watchdog group bishopaccountability.org. “I would never have predicted that a whole year would go by without the new pope reaching out in a meaningful way to the victims.” In his most recent interview, with Corriere della Sera, Francis appeared to suggest that the church was the true victim: it was “perhaps the only public institution to have acted with transparency and responsibility…And yet the church is the only one to have been attacked.”

Just when the news seems bleak, I can always count on the Chinese commies to cheer me up:

Mr Li also said the amount of energy consumed per unit of GDP growth would be cut this year by 3.9%, after a 3.7% drop last year. He omitted to mention that coal consumption, China’s biggest source of energy and a major cause of smog, is expected to continue rising. But he did say that emissions of sulphur dioxide (which result from burning coal and contribute to smog) fell by 3.5% last year and would drop another 2% this year. Smog notwithstanding, researchers at Harvard University last year said China’s cuts in sulphur-dioxide emissions in recent years may have been “one of the most swiftly effective air-pollution policies ever implemented anywhere”.

Over the next 30 years China’s air and water will get dramatically cleaner, partly due to tough regulations, and partly due to China’s ongoing switch to a service economy, once the physical infrastructure appropriate for a developed economy is built out.  And say what you will about the Chinese, they are building a modern economy at blinding speed.  (Pretty soon I need to do another “apocalypse later” post.)  Long term I’m much more worried about global warming than I am about Chinese air and water pollution.

And don’t forget we are coming up on the 25th anniversary of May 35th.