At the beginning of the year, French economist Thomas Piketty’s “Capital in the Twenty-First Century” generated a mighty storm.
Unlike Karl Marx, Mr. Piketty believes he has detected a structural advantage of profits before wages – and thus posits an inherent tendency toward growing inequality in income and wealth in all market economies.
His “law,” based on capital usually being greater than the growth of the economy and wages in all capitalist countries, is not borne out despite Mr. Piketty’s impressive collection of data.
Nevertheless, his theory has the potential to change reality. To this end, a small, epistemological note: Frameworks of statements in which objects of inquiry are actually existing phenomena are different in the formal sciences than in the cultural and social sciences. Progress in the field does not only occur from a logical consistency of statements, but must also withstand an empirical check, the falsification test.
An important difference exists between the natural sciences and the social sciences in general, especially with economics. The phenomena and observations that a natural scientist makes and wants to explain can never be influenced by the theoretical, underlying understanding of the researcher. The course of the stars will not be changed whether the observer adheres to the world view of Copernicus, Newton or Einstein.
The change of the object of inquiry through a scientific theory and its social impact is possible in economics and was not unusual to observe. After the 19th century, laissez-faire ideas of Adam Smith or Jean-Baptiste Say had prevailed in the heads of politicians, general conditions were liberalized, and the economy no longer functioned according to the rules of mercantilism, but rather according to the laws of the free market. A theory had changed the economic reality.
Following the market crash of 1929, the economic crisis shook up the prevailing market-liberal theory of that time. It was replaced by the contemporaneously developed ideas of Keynes, whose ideas in turn changed the world of business again.
This demand-oriented theory failed to combat supply-side shocks during the oil crises of the 1970s. The neoliberal paradigm of the Chicago school developed by Milton Friedman replaced demand-oriented management.
The consequences: Financial markets were liberalized, job markets became more flexible, and high welfare state standards as well as income and property taxes were lowered in the interest of growth-friendly conditions. Economic reality changed with the spread of free market-fulfilling points of view.
Video: Thomas Piketty presents the data set that led him to his theory at TED.
Part of this doctrine was the theory of efficient capital markets. It was dependent on the assumption that all economic actors always processed available information rationally. The financial crisis of 2007-2008, however, shook the belief in this concept. Then began – once again – a search for a new theoretical paradigm under the headings of “nudging” or “animal spirits,” with the goal to be able to draw new economic-political conclusions – so far without particular success.
Something, however, has already changed. The International Monetary Fund and the Organization for Economic Co-operation and Development, OECD, which until recently took rather orthodox positions, have been pleading for some time for more redistribution in favor of poorer populations.
Empirical observations have shown that a widening income gap would lead to loss of growth. Mr. Piketty’s thesis of growing inequality could further influence policies in many countries even if his book just collects dust in libraries.
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