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PeakTrader:

The rate of return on capital (r) doesn’t necessarily rise at the expense of the rate of economic growth (g).

For example, in the U.S., both r and g have been higher than in Western Europe.

Also, at the height of the U.S. Information Revolution, from 1982-07, both r and g rose substantially.

Moreover, when the U.S. is in a recession or depression, r is high and g is low. The high r didn’t cause the low g. The high r raises g, e.g. through monetary policy. When the economy recovers, r falls, or slows, and g rises, or accelerates.

Furthermore, the U.S. offshored old industries, imported those goods at lower prices and higher profits, and shifted resources into high-end manufacturing and emerging industries. Increasingly larger trade deficits subtract from g and globalization adds to r, although U.S. living standards improved faster. The U.S. has been a “Black Hole” in the global economy attracting imports and capital, and even attracting the owners of that capital themselves.

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Capital creation results from efficiencies in production, where more output is produced with fewer inputs.

Output = GDP = income; and income = consumption + saving.

Using fewer inputs (or limited resources) to produce more output allows the economy to expand.

So, both capital and output rise.

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Competition tends to reduce r and raise g.

Less risk taking (for whatever reason) and barriers to entry are examples that can cause r to exceed g.

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When an asset, e.g. land, is sold for a gain, there’s no capital creation.

There’s just a capital exchange.

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Paul Krugman wrote a related article:

Profits Without Production
June 20, 2013

“Economies do change over time, and sometimes in fundamental ways.

“…the growing importance of monopoly rents: profits that don’t represent returns on investment, but instead reflect the value of market dominance.

…consider the differences between the iconic companies of two different eras: General Motors in the 1950s and 1960s, and Apple today.

G.M. in its heyday had a lot of market power. Nonetheless, the company’s value came largely from its productive capacity: it owned hundreds of factories and employed around 1 percent of the total nonfarm work force.

Apple, by contrast…employs less than 0.05 percent of our workers. To some extent, that’s because it has outsourced almost all its production overseas. But the truth is that the Chinese aren’t making that much money from Apple sales either. To a large extent, the price you pay for an iWhatever is disconnected from the cost of producing the gadget. Apple simply charges what the traffic will bear, and given the strength of its market position, the traffic will bear a lot.

…the economy is affected…when profits increasingly reflect market power rather than production.

Since around 2000, the big story has been one of a sharp shift in the distribution of income away from wages in general, and toward profits. But here’s the puzzle: Since profits are high while borrowing costs are low, why aren’t we seeing a boom in business investment?

Well, there’s no puzzle here if rising profits reflect rents, not returns on investment. A monopolist can, after all, be highly profitable yet see no good reason to expand its productive capacity.

And Apple again provides a case in point: It is hugely profitable, yet it’s sitting on a giant pile of cash, which it evidently sees no need to reinvest in its business.

Or to put it differently, rising monopoly rents can and arguably have had the effect of simultaneously depressing both wages and the perceived return on investment.

If household income and hence household spending is held down because labor gets an ever-smaller share of national income, while corporations, despite soaring profits, have little incentive to invest, you have a recipe for persistently depressed demand. I don’t think this is the only reason our recovery has been so weak — but it’s probably a contributory factor.”

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http://econbrowser.com/archives/2014/05/criticisms-of-piketty#comments

http://econbrowser.com/archives/2014/05/more-on-piketty#comments

http://econbrowser.com/archives/2014/06/educating-brad-delong#comments

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Professor Hamilton:

Piketty’s second law is not mathematically incorrect, but it relies on assumptions– as do all economic theories. The central assumption concerns how the economy saves. Piketty assumes that the ‘net’ saving rate is constant and positive, i.e. the economy increases its capital stock from year to year by an amount that is a constant fraction of (net) national income.

This assumption may sound standard but actually it is not– precisely because it is expressed in net terms. In particular:

•With zero growth in population or technology, the assumption that the capital stock is always growing (because net saving is positive) implies that more and more output must be diverted away from consumption towards investment.

•Eventually, because capital needs to keep rising, it is necessary to devote 100% of GDP to capital formation!

His assumption of a constant net saving rate implies that capitalists always try to increase the capital stock if they have any level of positive net income whatever. That mathematically and necessarily implies that the economy’s total depreciation expense has to be higher every year.

The necessary implication of Piketty’s assumed saving behavior is that as the growth rate becomes smaller and smaller, the capital stock would tend to an arbitrarily large multiple of net income (tending to infinity as the growth rate goes to zero) and the net income of capitalists after paying the depreciation bill would become arbitrarily small (tending to zero as the growth rate goes to zero).

To summarize: Piketty’s assumption that the ratio of net saving to net income remains constant as the economy’s growth rate falls is incompatible with any coherent model of saving behavior.

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