Economic progress tends to increase insofar as the savings result in a larger supply of capital goods, which serves to increase production, including the further production of capital goods. The rate of return on capital tends to fall because the larger expenditure for capital goods (and labor) shows up both as larger accumulations of capital and as an increase in the aggregate amount of costs of production in the economic system, which serves to reduce the aggregate amount of profit. Our problems today result largely from government policies that serve to hold down saving and the demand for capital goods. Among these policies are the corporate and progressive personal income taxes, the estate tax, chronic budget deficits, the social security system, and inflation of the money supply. To the extent that these policies can be reduced, the demand for and production and supply of capital goods will increase, thereby restoring economic progress, and the aggregate amount and average rate of profit will fall.
– Reisman is dealing with Piketty and his assertion that because returns on capital can outpace economic growth in general, that this is some sort of bad thing, to be stopped, banned and generally supressed. Perry Metzger of this blog has already done a lot to demonstrate the economically insane nature of Piketty’s analysis.
In summation, if you want to increase incomes, then an essential step is to stop attacking capitalists (not to be confused with crony capitalists tapping the public sector for privileges, etc).
Reisman has another devastating take-down on Piketty and his ideas on capital, at the Ludwig Von Mises blog. (Thanks to Paul Marks, frequent Samizdata commenter, for the pointer.)
“The rate of return on capital tends to fall because the larger expenditure for capital goods (and labor) shows up both as larger accumulations of capital and as an increase in the aggregate amount of costs of production in the economic system, which serves to reduce the aggregate amount of profit.”
It’s because of passages like this that Reisman’s “Austro-Classical” economics hasn’t become popular. I assume that when he talks about “larger accumulations of capital” Reisman is talking about the competition between existing capital and new capital. So, if there’s a lot of existing capital then the return on new capital becomes lower. That’s not necessarily true, nor is it true that an increase in the “aggregate amount of costs of production” reduces aggregate profit. That’s because capital goods can be complementary as well as competing. New capital goods can make old capital goods worth more. Suppose a widget is made by a production line of machines. Another machine is added that adds an extra component to the widget making each widget more useful to the customer and worth more. That new machine raises the value of all the other machines in the production line, because collectively they can produce a more valuable. Hayek wrote a paper on this in the 30s called something like “Investment that raises the value of Capital”. The best modern example of this is Airbnb which has raised the value of tens of thousands of spare rooms across the world. It’s because of things like this that the “tendency of the rate of profit to fall” that’s mentions in Adam Smith and Marx hasn’t panned out over the subsequent centuries.
That doesn’t mean he’s wrong. The real reason though is to do with supply & demand for investments.
I want to second Current in
We saw that in the beginning of the computer revolution. Adding computer controls to a machine (replacing relays) made the machine more productive, lowered costs, or both. And these days? Relay logic is gone. Transistors at less than a penny per thousand have made relays for logic mostly uneconomical and machines much more reliable.
I am not a fan of Scott Sumner, but I enjoyed his take on Piketty – recommended.
I also agree with Current’s comment, especially the last sentence. That’s really the crux of the matter.
I am sure I have already sent George Reisman’s article (with a comment upon it).
But then nothing I send ever appears here.
What matters is that it has appeared – and that most of Dr Reisman’s article is correct.
I agree that a lot of what Riesman writes is correct. But, still he leans too heavily on capital competition. The more important issue is that there are two sides to the savings-investment market. Suppliers of savings and demanders who invest. That can take many forms, but two are most common. Firstly, the bank deposit and loan of fractional reserve banking (arguments against FRB aren’t related here AFAICT). Secondly, the share and dividend structure of limited companies. Most of what Piketty discusses is about the internal-rate of return, the profit earned inside companies on the assets they own. The issue though is the returns to the final customers, to savings account holders and shareholders. He basically assumes that these external rates of return are the same as the internal ones. That can’t be true. Suppose that a Foo PLC starts earning 20% on it’s capital. Does that mean each shareholder gets 20%? No, what happens is the share rise in value until their return isn’t much different to the market average. The original shareholders who owned shares in Foo before that make a one-off gain, that’s from investing wisely, from entrepreneurship. Everyone else doesn’t get anything spectacular. Even if the rate of return of all investments rises even then every investor doesn’t gain proportionally, because it attracts new savers to the market. Jevons, Menger and Bohm-Bawerk figured all this out more than a century ago. Piketty purports to show that external rates of return have been steady over a long period of time, that’s something I very much doubt. Unlike his other statistics these haven’t been investigated in detail.
Scott Sumner’s post on the tax-incidence problems with Piketty is also good:
http://econlog.econlib.org/archives/2014/06/unpersuaded.html