On Pikkety and the future of capital

Thomas Pikkety has dropped a bomb on the economics community with his painstaking exposition of the fact that, over reasonably long periods of time, the return to capital has exceeded the growth in the economy. The result is an increasingly polarized world, where the rich get richer, even if the poor don’t get poorer, but then, it is all relative, isn’t it? Very well, then, if we accept as a proven fact, that the return to capital is greater than economic growth, we should pause to ask – why is it so? Only then will we be able to say whether this is an accidental many-time phenomenon, a fatal flow in the capitalist system, or simply something will inexorably ground down by the law of diminishing returns. I offer two arguments: 1. The ‘return’ on financial assets, as they teach us in Finance 101, is partly a reward for taking risk – remember the good old CAPM? In that case, the average return to capital (let us say, the equity market), is necessarily greater than the riskless rate – and the growth in the economy is just one component of the riskless rate (inflation and risk-aversion are the other two). Then there is nothing surprising or evil about capital earning more than the ‘economy growth rate’. The higher average rate is offset by the wild fluctuations in the return, which means there are periods when financial assets yield highly negative returns too – the economy as a whole doesn’t usually crash by 40% in a day – the stock market can, and often does. 2. Financial assets, by definition, reflect and ‘price in’ the future – imagine a company whose earnings are growing fast and is expected (by the market, that is) to keep growing fast – its share price will reflect the expected high growth while its earnings reflect the current growth (like the growth rate in the economy). We can easily imagine such a company having a rapidly increasing P/E ration – which is the equivalent of what Pikkety says is happening in the economy as a whole. Extrapolating to the economy as a whole, if the market forecast of the economy continues to look better and better, the value of financial assets will keep rising – faster than the economy itself, because financial assets price in the future, while the growth rate reflects only the current situation. Will this necessarily result in a crash, sooner or later? Some day, the economy will indeed stop growing, perhaps because of a war, global warming, or even another 2008-style meltdown – in which case financial returns will go abruptly negative while the growth numbers in the economy may turn only mildly negative. In short, there are very good reasons why the return to capital can exceed the growth rate in the economy, and no guarantee that it will either continue forever or, for that matter, that it will inevitably stop – after all, wars and disasters are not inevitable – not even global warming is! So, what should we do about it? The only way to deal with the root causes is by abolishing risk-aversion (good luck with that! It is a deep-seated human instinct) or by forcing the economy to stall, which, of course, our politicians around the world are trying their best to do every day! Denying climate change? That is a good way, too – then the catastrophe will be upon us and there will not future, so financial assets will stop growing.. again, something all worthy politicians are working hard at anyway.

The 98% syndrome

how interesting. I thought, when my newest client told me they achieved 98% of their target this year.. that is what ALL my clients are telling me! it doesnt seem to matter what the target actually is, 98% of it is what they achieve.. sounds familiar? Reinforces the thinking I was exploring in my earlier post on targets.. if you want to set targets (which is debatable), set them high - you will achieve 98% anyway!