Dutch Inequality Theory

Last night I dreamt of Nick van Rowe again. I asked my Dutch ancestor what he thought would happen to the distribution of wealth in the future.

According to Dutch Capital Theory, "capital" is just the name we give to land that we have made ourselves in the past. The rent on an acre of land equals the value marginal product of that acre of land. But the price of land depends on both the rent (and expected future rents) and the rate of interest. And (one plus) the rate of interest equals people's marginal willingness to trade-off future consumption for present consumption.

We can imagine an economy where the aggregate stock of land, population, technology, preferences, output, wages, and land rents, are all constant over time, but where the price of land and inequality of wealth will grow over time.

"How can that be?" I asked my ancestor. He explained it to me:

With the stock of land staying constant by assumption (because the sea is too deep to drain more land), investment is zero, and so saving must be zero too. But it is only aggregate saving that must be zero; one individual can save, by buying more land, if another individual dissaves, by selling land. And if different people have different preferences, and face the same rate of interest, some will save and some will dissave. So inequality in ownership in land will grow over time. And as the more patient accumulate more and more land, and have a higher and higher share of the same aggregate income, their preferences will have a bigger and bigger influence on the rate of interest, and so the rate of interest will fall over time, and so the price of land will rise over time, so the wealthy get even wealthier. They own more and more land, and each acre of land is worth more and more.

"But that sounds terrible!" I said. "Is there nothing that could prevent this continuing forever, until one person owns all the land, and each acre of land is infinitely valuable?". He said it depends:

What happens to people's marginal time preference as they get richer? They might get either more or less willing to trade-off future for present consumption at the margin, as both their present and future consumption rises. If they foresee future satiation, they will become less patient; if not, they won't. We don't have to assume homothetic preferences, where everything scales up in proportion.

And people do not live forever. They die and leave their land to their children. Will they leave it equally to their children? Will they practise primogeniture? Or will they give a bigger share of their land to their weaker children? And how many children will the wealthy have compared to the poor? And will the rich always marry the rich, or will they sometimes marry the poor? And will the children of the rich be as patient as their parents, or will they regress to the mean?

And stuff happens. Taxation, theft, fraud, war, illness, charitable impulses, weather, gambling, alcohol, a love of horses or crackpot religions: the sum total of unlucky events and foolish decisions that reduce the value or quantity of one person's land (and raise that of another's). When you've got something you've got something to lose; and many things can make you lose it. All stones eventually roll.

He shrugged his shoulders, and I woke from my dream.

I never got the chance to ask if he had read Piketty.

Comments

[Market Fiscalist]

Nick,

Have you ever thought of turning this stuff into a 700 page book, and adopting a French accent ?

[Market Fiscalist]

Nick,

Have you ever thought of turning this into a 700 page book and adopting a French accent ?

[Livio Di Matteo]

Nick:
Speaking of Piketty, I attended the Purvis Lunch at the CEA meetings last week and one of the interesting points made by the speaker - Paul Romer- on Piketty's book is that much of the result of the rising wealth to income ratio over the last forty years is due to the rise in housing wealth rather than financial assets or agricultural land. Thus, Piketty's result is capturing the housing bubble.

[Nick Rowe]

MF: I would never get past page 7. I really do admire those people who have the, er, patience (and self-discipline) to invest in reading, let alone writing, 700 pages. But I am reconciled to my comparative disadvantages.

OK, who can spot the two literary(?) allusions in my post?

[Nick Rowe]

Livio: yep! Stefan Homburg noted the same thing. That was partly what was driving this post. But according to Dutch Capital Theory, housing land and agricultural land are theoretically equivalent.

[Market Fiscalist]

"OK, who can spot the two literary(?) allusions in my post?"

Are they Bob Dylan and Daphne DeMaurier , by any chance ?

[Nick Rowe]

MF: you are too good at this, or I am too easy.

[Achim]

"Thus, Piketty's result is capturing the housing bubble."

Was there a housing bubble in France as well?

[Joseph S]

This post reminds me of Krussell and Smith's 1998 paper where, in one section, they model an economy with aggregate uncertainty and with dynastic infinite horizon agents with a discount factor that that can change slightly over the dynasty. When the agents are patient they build up capital and when they're inpatient it gets wound down.

http://www.econ.yale.edu/smith/250034.pdf

[Nick Rowe]

Achim: I don't know if it was a "bubble", but IIRC house land prices did rise in the cities. Stefan Homburg's paper (follow the links in my above comment) has some graphs which break down wealth into capital and land.

Joseph: good find. But I think I would put my emphasis on the "stuff happens" mechanism. If you've got something/nothing you've got something/nothing to lose when stuff happens. That stuff can be almost anything.

[ianlee]

Nick - not only are you getting better and better but you must also have Austrian ancestry for you seem to be channeling your inner Schumpeter:)

Schumpeter had to stand Marx on his feet - who was standing on his head because he argued inequality was going to become larger and bigger and wider until the - we now call it the 99% - would not have enough to eat and would rise up in violent revolution and kill the capitalists (whose capital per Marx is merely "congealed labour" - contra Nick and the heathen Dutch), so that as Marx said, "at the end of history we can go hunting in the morning, fishing in the afternoon and do philosophy in the evening ... without ever becoming hunter, fisherman, shepherd or critic.” [not clear whether he is describing u/g students or NGO activists].

Except that the opposite happened as Schumpeter argued in Capitalism, Socialism and Democracy and the 99% became fabulously wealthy (McCloskey) - and wanted to buy a house in the burbs instead of joining the revolution. (but kudos to those professors who broke free to become radical chic and hired "revolutionaries" in the classroom similar to Leonard Bernstein inviting a convicted Black Panther to a soiree on the upper west side – see Tom Wolfe).

So our society becomes wealthier and wealthier, safer and safer, cleaner and cleaner while intellectuals and NGO activists cry out that it is becoming worse and worse. Schumpeter provided the analysis and the answer in "Growing hostility - The Sociology of the Intellectual" Ch 13, C,S&D) and the fetish for "the end is nigh".

Could we characterize it as "fetishizing the eschaton"? [OK - I confess to plagiarism - Eric Voegelin called it the "immanetization of the eschaton].

Piketty is merely the latest incarnation - and he had to use market pretax, pre tax redistribution & pre govt program redistribution measures to pull it off - see Chris Giles deconstruction at FT.

[W. Peden]

Ian Lee,

Well-put, although Schumpeter's "Capitalism, Socialism and Democracy" is a more prescient book in your mind than in mine...

The tendency in intellectual life will tend to focus on the negative aspects about society for the same reason that newstories in the press and on TV tend to be negative. I find that it takes an extreme and regular act of conscious will to focus on the good things about modern life. Patrick R. Sullivan recently posted a link to a video that reminded me of how much things have improved in my lifetime-

https://www.youtube.com/watch?v=PF7EpEnglgk#t=129

I remember using computers like those as a kids and thinking that they were basically Star Wars-magic machines. Typing and printing could fascinate me for hours when I was a very young child.

I suspect that if we could re-wire the human brain to be better at comparing the present and the past, we would all be a lot happier.

[Lord]

And a lot of times, stones just roll back. Until we can fix the dying part. Britain attempted it with entailments, but we can probably come up something better eventually.

[Herbert]

@Achim: "Was there a housing bubble in France as well?"

p.6 of this paper shows the drastic French increase in land prices:

http://ideas.repec.org/p/han/dpaper/dp-530.html

I strongly agree with Nick's view that Piketty's "increase in wealth" largely reflects the global land price rally.

@Nick: Did your ancestor publish his views? I find them interesting because some authors treat land as non-reproducible which contradicts Dutch ijsselmeer accomplishments.

[Kevin Donoghue]

"I never got the chance to ask [Nick van Rowe] if he had read Piketty."

He may have read the closing section of Chapter 5, The Mystery of Land Values. Or perhaps Piketty lifted his ideas without acknowledgement?

[Nick Rowe]

Kevin: I *think* there is nothing here that would be theoretically unfamiliar to Austrians (Bohm Bawerk?) 100 years ago. (Can any Austrians chime in on that?)

But it is well-known that the Austrians stole their best ideas from the Dutch.

All the discussion I have seen around Piketty is about investment and growth. I wanted to talk about wealth inequality in a world with no investment and no growth - to leave out everything that discussion focusses on, and bring in all the things it leaves out.

The idea that differences in time-preference create a "natural tendency" towards increasing wealth inequality over time has always interested me. And the next obvious question to ask is: "OK, but what might stop that natural tendency?" I think those are the big questions.

Herbert: unfortunately, all his writings were lost in a devastating flood. Land can depreciate, too. All we have left is what I can remember him telling me, like this post on Dutch Capital Theory

But yes, my guess is that the mechanisms I am talking about here (land ownership and prices) are empirically as or more important than mechanisms that rely on investment and growth.

Lord: "Britain attempted it with entailments..."

Sounds interesting. Could you explain? Thanks.

Ian and W Peden: thanks. I remember reading both Marx and Schumpeter in the 1970's, when it did seem like capitalism would eventually disappear and be replaced by socialism. Schumpeter struck me then as having a more plausible explanation of why it would disappear. Looking back, of course, the world didn't turn out the way most of us thought it would back then. At least, not yet!

[Kevin Donoghue]

Nick, I'm reminded of the apocryphal Fitzgerald-Hemingway exchange: "The very rich are different from you and me.” "Yes, they have more money." Basically, Piketty is with Hemingway. He assumes that the poor, too, would like to leave large bequests. What makes the rich different is that they can. It's the initial endowments that matter, not time-preference. But of course rapid economic growth opens up the game dramatically. Then the enterprising and thrifty have a vastly better chance of founding a dynasty of plutocrats.

When it comes to the literary references, it's a pity that Piketty didn't make use of Oscar Wilde:

Lady Bracknell: What is your income?
Jack: Between seven and eight thousand a year.
Lady Bracknell: In land, or in investments?
Jack: In investments, chiefly.
Lady Bracknell: That is satisfactory. What between the duties expected of one during one’s lifetime, and the duties exacted from one after one’s death, land has ceased to be either a profit or a pleasure. It gives one position, and prevents one from keeping it up. That’s all that can be said about land.

[Lord]

The greatest threat to perpetual wealth is dying and leaving everything to spendthrift heirs, so between primogeniture and entailments one could deprive one's heirs of any right to alienate the property, granting them only life estates in it that would pass along to their heir. Originating in the 13th century for the landed nobility and normally created by will, upon failure of the line, the land would revert to the living descendant of nearest relative of the original maker. Various fictions were generated to circumvent them but perpetuities were abolished in 1925.

[Wonks Anonymous]

It kind of sounds like you're describing Raymond Crotty's Ireland. After studying economics he thought he could be a more modern farmer by investing in capital, which didn't work out very well. All the unschooled Irish farmers poured their money into buying more land instead. And with that Crotty independently rediscovered Georgism.

In (the likely) case you've never heard of Crotty, he has an interesting (and unfortunately posthumously published) book titled "When Histories Collide", and he's also responsible for the legal case which resulted in the requirement that Ireland pass a referendum before adopting a more integrated EU treaty.

[JW Mason]

Yes.

here's another way of thinking about it -- probably this has been mentioned here, but I missed it.

Start from a constant capital share of income. This could come out of a production function, or from a constant markup over labor costs (as in Kalecki), or from some kind of bargaining process, or by political fiat. It doesn't matter, all that matters is that the capital share is stable over time. Now suppose shares in "capital" (whatever that may be) are traded, what will they be worth? Presumably, the present value of the associated flow of profit income. Since the profit share is constant, the flow of profits grows at the same growth rate g as the economy as a whole. Let r be the discount factor. Then the value of the capital stock will be the sum from t=0 to infinity of (1+g)^t/(1+r)^t, or approximately 1/(r-g). In other words, the discount factor r must be greater than the growth rate g for the present value of the capital stock to be finite.

Obviously when r greater than g is derived this way, it doesn't have any implications for distribution or any other substantive outcome. It is just a logical consequence of a constant capital share when capital values are equal to the present value of future capital income.

[Nick Rowe]

JW: when I first read your comment, I agreed with it. But on thinking about it, I don't think this bit is exactly right:

"Then the value of the capital stock will be the sum from t=0 to infinity of (1+g)^t/(1+r)^t, or approximately 1/(r-g)."

because it ignores physical depreciation. If capital depreciates at rate d, it becomes 1/(r+d-g), and we could still get a finite value of capital even if r < g.

Not sure if this matters though.

[JW Mason]

Piketty's r is net of depreciation.

[Nathanael]

This is a truly excellent piece, Mr. Rowe. I've been working from the understanding that capital is pretty much land that was created at some point in the past... and returns on capital are basically rents.

The result works out as you say. There are certainly ways for the accumulating fortune to be broken up... these are essentially political decisions.

It's not going to happen on its own right now, because *our particular wealthy elite* fetishizes the numbers on their "net worth" statement. Those are the points that they keep score with. (Think _Theory of the Leisure Class_, only instead of conspicuous consumption, it's conspicuous possession.)

As long as this psychology remains the social tendency in the elite, we have a terrible problem. If we can change that psychology, hey, we can probably get the fortunes redistributed.