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Opinion, commentary and analysis on everything that makes the U.S. housing economy tick -- not to mention the ghosts in the machine, too. Written by HW's team of editors and reporters each business day.
Investments

Piketty’s Folly: Wrong on inequality, wronger on homeownership

Turns out housing the best way to build wealth

March 26, 2015

Turns out that homeownership is, by and large, the best vehicle for the creation of generational wealth.

Who would have thunk it?

The Economist has a story that hits on this proven truism, even if it buries the lead.

Of all things, it hits on Thomas Piketty’s book, "Capital in the Twenty-First Century," which continues to delight American economic dilettantes who partake of the Keynsian Kool-Aid.

Last April, grad student Matthew Rognlie wrote a 459-word blog post that hit center-mass on “rock star economist” Piketty’s thesis that inequality has increased because the return to capital has been greater than general growth in the economy. (For short, it’s “r > g.”). The basic idea – not exactly original, we’ve been dealing with this antibiotic-resistant strain of disease since 1867 – is that the share of income going to those who own capital rises, while the portion going to labor falls.

As the Economist notes:

Mr Rognlie mounts three main criticisms of these arguments. First, he argues that the rate of return from capital probably declines over the long run, rather than remaining high as Mr Piketty suggests, due to the law of diminishing marginal returns. Modern forms of capital, such as software, depreciate faster in value than equipment did in the past: a giant metal press might have a working life of decades while a new piece of database-management software will be obsolete in a few years at most…

Second, Mr Rognlie’s research suggests that Mr Piketty has overestimated how high the returns on wealth are likely to be in the future. These should also decline over time, he reckons, unless it is very easy for the economy to substitute capital (like robots) for workers. Yet the historical evidence suggests that this is far harder than he suggests.

And third, Mr Rognlie finds that the growing share of national income deriving from capital income has not been distributed equally across all sectors. The return on non-housing wealth, in fact, has been remarkably stable since 1970. Instead, surging house prices are almost entirely responsible for growing returns on capital.

But his observation that it is homeowners in particular—rather than rentiers generally—who are grabbing a larger share of the pie is important for policy. Mr Piketty used the historical evidence in his book to argue that a global tax of up to 2% a year on individual wealth should be introduced in order to prevent capital concentrating in the hands of the few. But if housing wealth is the biggest source of rising wealth then a more focused approach is called for. Policy-makers should deal with the planning regulations and NIMBYism that inhibit housebuilding and which allow homeowners to capture super-normal returns on their investments.

Last summer, a critical paper by four economists at l’Institut d’Etudes Politiques de Paris challenged Mr. Piketty’s claims, likewise invoking the role of housing as a wealth creator for a broader range than just those who are traditional, top-hat wearing fatcats.

The pointed out that the higher growth of capital rests entirely on returns to housing.

Since Piketty’s argument depends on housing, it doesn’t match his basic story about the ongoing ascendancy of the evil capitalists.

That paper, which is available in English, concludes the following:

First, the author’s result is based on the rise of only one of the components of capital, namely housing capital, and due to housing prices. In fact, housing prices have risen faster than rent and income in many countries. It is worth noting that “productive” capital, excluding housing, has only risen weakly relative to income over the last few decades. Over the longer run, the “productive” capital/income ratio has not increased at all.

Second, rent, not housing prices, should matter for the dynamics of wealth inequality, because rent represents both the actual income of housing capital for landlords and the dwelling costs saved by “owner-occupiers” (people living in their own houses). Logically, to properly measure capital, the value of housing capital must be corrected by measuring it on actual rental price, and not housing prices.

Third, when we apply this change, we find that the capital/income ratio is actually stable or only mildly higher in the countries analyzed (France, the US, the UK, and Canada) except for Germany where it rose. These conclusions are exactly opposite to those found by Thomas Piketty.

Piketty isn’t just wrong on economics, he’s wrong on housing. Wronger, even.

Now, I don’t accept the position that income inequality is a bad thing to begin with. People have unequal talent, ambition, and goals.

Income inequality is a consequence and outcome of economic freedom. One person earning more doesn’t mean they’re taking away from someone who earns less – it’s not zero sum. Income equality is a far more ominous concept.

 Nothing is static in economics, but despite the cry of those who yell at the clouds and preach the gospel of rootless, urban renting – homeownership has consistently created generational wealth more reliably, and more “democratically,” than any other asset class. And it does so in a manner entirely ancillary to its primary purpose of giving you a place to lay your head and keep your stuff.  

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