This is the first of a three part series.
It has been six years since the financial crisis engulfed the global economy. In 2014, a bestselling book -- French economist Thomas Piketty's Capital in the Twenty-First Century -- brings yet another round of agitation to the stagnant West that some have called the "Piketty panic."
Mr. Piketty's book reveals a 300-year-old macro trend of capitalism -- the widening gap of inequality -- that reminds one of the first line of The Communist Manifesto about a spectre haunting the West. This time the spectre may not be communism per se, but nonetheless a deep appreciation of the flaws of utopian capitalism.
Piketty's concerns are also relevant to the growing inequality in China that has resulted from adopting the neo-liberal capitalist model from the West.
Piketty criticizes neoclassical economic theories, such as Simon Kuznets' inverted U curve of income inequality and Robert Solow's exogenous growth theory, which are the very foundation of the campaign by Chinese neoliberal economists against China's independent industrial policies and a Chinese economic model in favor of the Anglo-Saxon model. Hence, Piketty's reflection on mainstream Western economics indirectly treads a delicate ground in China. It fits right into the current raging debate over which path China's reformers should take in the next stage of "structural reform."
THREE REASONS CHINA SHOULD LISTEN
Many Chinese economists follow the mainstream doctrines of textbook economics from the United States. This time, ironically, a non-mainstream French economist lectures mainstream Anglo-Saxons. There are three reasons China should listen.
First, Piketty suggests that in order to study the historical trend of inequality in advanced Western economies, France instead of Britain or the United States, is a more appropriate benchmark country. English aristocracy has remained intact since the Glorious Revolution of 1688. The absence of a thorough capitalist revolution and the unbroken lineage of wealth thus make England an unrepresentative case in the study of inequality.
The U.S. case is one of a kind. By the eve of its independence, the U.S. only had a population of 3 million and an area of 800 thousand square kilometers. Now the U.S. population is near 300 million -- a continent of 9 million square kilometers. Naturally, as the country expanded massively in population and territory, the effects of inequality were to some extent neutralized.
In 1789, the French population was around 30 million; 300 years later, the figure had only doubled -- a growth pattern commonly observed in many other European nations. Most crucially, the French Revolution had brought all inherited prerogatives to nought, and established the principle of égalité devant la loi (equality before the law).
If even here the trend shows the French wealth gap continuously widening, the implication for economics are profound: even equality before the law could not safeguard economic equality in capitalist societies. This is the revolutionary finding of Piketty's empirical analysis, and it poses a great challenge to the Anglo-Saxon model as the normative model in assessing world economies.
Secondly, Adam Smith did not specify any means to measure national wealth in The Wealth of Nations. In Piketty's analysis of the inequality trend, instead of employing the dubious Gini coefficient, he quantifies the Marxian dichotomy between capital and labor in income distribution, and thereby reveals a shocking truth: throughout the history of capitalism, capital gains has always exceeded by far labor gains. This shatters the myth of "market general equilibrium" and "optimal income distribution" theory of neoclassical economics.
Piketty excludes governmental debts from the capital structure, because treasury bills purchased domestically have zero net value. He defines the composition of national capital as the sum of farmland, housing, other domestic capital, and net foreign capital; and then he looks into the historical evolution of their values respectively.
Oddly, Chinese neoliberal economists did not learn from the financial crash. Turning a blind eye to the American real sector squeezed out by the financial sector, they are still in denial that the poorly regulated financial market has been the main culprit in creating an ever larger wealth gap. They continue to defend speculation with old fairy tales from the Wall Street, and advocate the idea that a free market could still "leave wealth with the people" in the face of the global financial calamity.
In direct opposition to their logic, Piketty finds that even with the proper rule of law in place, the most affluent 1 percent in the West still gets the lion's share of wealth; and in countries without progressive income tax and property tax, such as India and Russia, national wealth is highly concentrated within a small circle of clans and business magnates.
Thirdly, Piketty employs an impressive range of historical data such as income, capital, population and growth rate, etc. that date back to the Industrial Revolution in the 18th century. He also investigates the causes of global evolution of inequality in the 21st century, including public debts in France and Britain, property tax in Europe, capital expansion in China, immigration reform in the U.S., multinational trade protection, debt management, social capital accumulation and the degeneration of natural capital.
Piketty's empirical study negates the income distribution theory of neoclassical economics dominated by the Anglo-Saxon school and shows that the development of the market economy has exacerbated -- instead of reduced -- inequality.
This refutes Simon Kuznets' bell curve, also known as Kuznets' inverted U curve, which claims to show that as technology progresses, the income inequality gap will first widen but eventually narrow -- and thus government should wait for inequality to run its course without intervening. In other words, Piketty's study undermines the idea that a "perfect market" will ensure fairness in income distribution.
Piketty also looks into why Robert Solow's exogenous growth theory has failed to lead the world's economic growth to convergence and narrow the gap between rich and poor. He also shows how "human capital," the favorite term of endogenous, or internal growth, theorists has turned education into a tool to entrench privileges instead of a ladder out of poverty.
WHAT IT MEANS FOR CHINA
Piketty's criticism of Kuznets and Solow bears significance for China's present economic transition. Those who dismiss China's growth as "extensive" frivolously attribute the economic success of East Asia solely to high rates of savings and investments, ignoring substantive advancement in technology due to state interventionist policies.
Following Solow, some prominent Chinese economists advocate structural reform in the direction of liberalizing the "factor markets "such as labor and land to free them from any regulation and subject them only to the unfettered law of supply and demand. This will supposedly lead greater prosperity and equality because lack of state controls will let the market create wealth unhindered.
I once consulted a strong believer in perfect market son the existence (if any) of an undistorted factor market in advanced Western economies. It could not be more obvious that such a thing doesn't exist. In the West, work permits and immigration rules distort the labor market; minimum wage laws distort the price of labor land-use zoning distorts the land market; benchmark interest rate and tax policies distort the capital market. America's laissez-faire policy on financial oligarchs distorts the commodities market. Military actions, including dominance of the seas, by Western powers distort foreign exchange markets and capital flows. One could go on.
In an era characterized by intense global and regional competition, where can one possibly find this perfect market idealized by utopian capitalism? Yet, Western economics textbooks enthusiastically digested by mainstream Chinese economists paint just such a rosy picture despite the reality.
Instead of asking how to utilize market rules and strategies to defend China's interests in the game of big powers, they recommend building a deregulated arena for "fair market competition" hoping that the invisible hand will do the rest of the job and eventually achieve prosperity.
Sadly, throughout the colonial history of the West and even the entire history of economics, this utopian capitalist fantasy never had any semblance to the real world. My friend, Nobel laureate Joseph Stiglitz, often advises me "do what Americans do, don't do what Americans say"-- a sincere remark from one of the greatest Western economists.
WHERE DID A FREE MARKET EVER LEAD TO DEVELOPMENT?
As I have commented in my book, Solow depicted technological advancement as a cumulative process of random shocks, instead of a metabolic process with a wavelet pattern, and predicted that all nations would move along a convergent path in which disparity in development would eventually disappear.
Because of its neoliberal ideology, Solow's exogenous growth theory rooted in the idea of marketizing factors of growth, ignored the role of interventionist industrial and technological policies. Yet, reality shows that state policies, not free markets, have been critical to unleashing technological advance and building the foundations for growth.
This reality raises a number of doubts about neoliberal claims.
Does private ownership and free market have anything to do with America's aeronautical projects, Internet, GPS system, global presence of the U.S. Navy, and the extensive information-monitoring network? All were initially funded by the state.
Without its independent scientific and industrial systems -- a solid foundation laid in the first three decades (1949-1978) of the People's Republic -- could China's rapid industrial upgrading have taken place at all?
Why have emerging powers such as India, Turkey, and the Philippines -- all countries that established private ownership and parliamentary governments -- not been able to cut their economic dependence on the West and develop their own modern industries, build their own spacecraft, satellites, high-speed rail and information systems?
Fourthly, according to Piketty's observation, there were but two periods in history during which inequality in income distribution had improved. The first time in the 1870s, and the second period was from the end of World War II to 1970s -- soon afterwards inequality had worsened again. The overall historical trend is that the rate of return on capital has almost always been several times the rate of economic growth.
What is the lesson here? It is that no market mechanism has ever substantively improved income distribution; the adjusting force came from political intervention in the form of war, revolution or independence movements which shrunk the size of total assets in developed countries. Income distribution also only occurred as a result of economic interventions such as rent control, state ownership, regulations on securities exchange and capital flow measures that impact asset prices in the market.
The free economy and efficient market hypothesized in neoclassical economics are nothing more than a hypothetical utopia of mathematical economics; they have nothing to do with real world capitalism. Piketty's discovery delivers a heavy blow to China's neoliberal camp in academia and media.
It would be a big mistake for China not to heed Piketty's skewering of mainstream Western economics as it charts its own path forward. Only a hybrid model that mixes the state and the market along with technological independence will enable China not only to prosper but also to build the socialist aspect of greater equality.