Friday, June 13, 2014

Sly, Brad. Very sly

For weeks Berkeley's J. Bradford DeLong has been in denial over a fundamental little error made by Thomas Piketty in his best seller, Capital in the Twenty-First Century. Stridently claiming that the profession's most respected members who pointed out the flawed logic in that book were wrong, wrong wrong!

Today, he quietly concedes he was wrong and they were right;
Matt Rognlie has a first-rate exposition of his critique of Piketty:
Matt Rognlie: A note on Piketty and diminishing returns to capital: “Capital in the Twenty-First Century predicts…
…a rise in capital’s share of income and the gap r – g between capital returns and growth…. Neither outcome is likely given realistically diminishing returns to capital accumulation. Instead–all else equal–more capital will erode the economywide return on capital…. Piketty (2014)’s inference of a high elasticity from time series is unsound, assuming a constant real price of capital despite the dominant role of rising prices in pushing up the capital/income ratio. Recent trends in both capital wealth and income are driven almost entirely by housing, with underlying mechanisms quite different from those emphasized in Capital….
If Rognlie's analysis is a first-rate exposition of Piketty's Capital, and it comes to the same conclusion as Per Krusell, Tony Smith, and James Hamilton (as well as Sala y Martin and others). Then these from DeLong earlier must be inoperative;

Depreciation Rates on Wealth in Thomas Piketty’s Database: Monday Focus: June 9, 2014Thomas Piketty emails: We do provide long run series on capital depreciation in the "Capital is back" paper with Gabriel [Zucman] (see, appendix country tables US.8, JP.8, etc.). The series are imperfect and incomplete, but they show that in pretty much every country capital depreciation has risen from 5-8% of GDP in the 19th… More >

1 comment:

  1. "Capital" is an abstract and summary concept. It is the market value of the resources used to prepare for making something or for delivering a service. It is abstract because those preparations are merely valued in money. It is summary because there is no information about all the details of the preparation.

    Some of the preparation is to build machines and install them, and some is to find locations and negotiate with officials for permissions. Some cash has to be saved away to hire lawyers to defend against lawsuits. These preparations are wildly different and equally necessary, but they are summed up abstractly as "capital".

    Another level of summary and abstraction is to average the profits of many companies and compare them to the capital of the companies to get an average rate of return. This is an abstract way of understanding if the overall profit is enough to pay back the costs of preparing to run the businesses.

    I haven't read Piketty's book. From reviews, it seems that he has drawn some graphs, investigated many of these averages, and done some arbitrary extrapolation into the future. He considers the highly abstracted and summarized concept of capital and none of the detail. How could he see the detail? The detail is millions of decisions and preparations with highly different costs and purposes.

    This is as fanciful as looking at the Dow Jones Industrial Average in the past and predicting what it will be in 10 or 50 years. He would be laughed at for predicting the stock market. Why isn't he laughed at for predicting what the influence and cost of "capital" will be in the future?

    No detailed evaluation of his equations and assumptions is needed.