On Piketty and definitions. ‘Financial capital’ is not the same thing as ‘physical capital’ (two graphs)

The discussion about Piketty is getting messed up. The vagueness of economic parlance allows people to accuse him of mistakes he doesn’t make. The meaning of the word ‘capital’ is a case in point. Financial capital (like bonds, cash, receivables (which are included in the estimates of financial wealth in the national accounts and which have the same magnitude as cash, deposit money and money in savings account combined)) are not the same thing as physical capital (houses, cars, buildings, machinery and the like). Financial capital is to quite some extent owned by old, retired women. Physical capital is used by people at work. The Piketty book, ‘Capital in the 21st century’, is about the inexorable rise of financial capital, not about the increase of physical capital, as Clive Crook rightly notes (below).

Over the course of history, capital accumulation [physical capital, M.K.] has yielded growth in living standards that people in earlier centuries could not have imagined, let alone predicted — and it wasn’t just the owners of capital [financial capital, M.K.] who benefited. Future capital accumulation may or may not increase the capital share of output; it may or may not widen inequality. If it does, that’s a bad thing, and governments should act. But even if it does, it won’t matter as much as whether and how quickly wages and living standards rise.

That is, or ought to be, the defining issue of our era, and it’s one on which “Capital in the 21st Century” has almost nothing to say.

That’s right. But the english word ‘capital’ can mean financial capital as well as physical capital.  It’s a bad thing that economics as a science did not come up with more precise phrases and definitions – but that’s the way it is. Piketty does talk about physical capital – as financial capital is always some kind of ownership of physical or other financial capital and increases in physical capital can give rise to an increase in financial capital, like bonds (when the government uses bonds to finance bridges) or stock – but in his book he does not try to explain economic growth, as Crook rightly mentions. He points out and explains the inexorable, endogenous rise of financial capital (graph 1). And it’s sad to see that Crook mixes up both meanings of the phrase ‘capital’ in one sentence. And to see Tyler Cowen approvingly albeit somewhat cunningly quoting this statement.

Financial capital is of course another kind of technology – a market economy without ‘payables’ and ‘receivables’ is inconceivable. Piketty however shows that the increase of financial capital does not come without risks – he does not give enough attention to pension funds, but these are some of the largest owners of financial capital (graph 2). And the fickle character of financial markets does mean that the increase of financial markets and the increasing importance of returns and the value of financial market is, in fact and alas, a defining issue of my financial future. This will still take a while and today the sun is shining. But in my country at least part of the retired experience ridiculous swings in pensions – while the stock of physical capital is steadily increasing!

For some idea about the different growth rates of financial and physical capital see below, source: Centraal Bureau voor de Statistiek. Sadly, and tellingly, the physical series has been discontinued – we’re decreasingly interested in baking pies and increasingly in slicing them.

Update: The sun was shining. Now it rains.