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

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.

real capital


Update: The sun was shining. Now it rains.

  1. April 21, 2014 at 8:38 am

    If we had have stuck strictly with the classical economics definition of Captial, as discussed by Henry George (http://www.henrygeorge.org/cap.htm), we would have saved ourselves 150 years of brain-dead economic analysis.

  2. April 21, 2014 at 11:59 am

    Many valid points but do you not think that pensions wouldn’t be worth nearly as much were it not for out-of-control asset prices. It seems to me that a very large component of the redistribution that is taking place in financialised economies is from the young to the old.

  3. April 21, 2014 at 1:48 pm

    I’m glad we are starting to talk about definitions. Much of economic discussion is pointless and confusing due to the lack of definitions. Voltaire famously said, “If you want to converse with me, define your terms”.

    It is really possible to define “financial capital” or “physical capital”, by the way. If you or anyone else try, then you will find yourself in a knot. For example, take intellectual property, such as a patent, is that “financial capital” or “physical capital”?

    You cannot define capital properly without defining other economic terms. Otherwise, you create confusion when you discuss other economic issues. Below is a sample of provisional definitions, which I have tentatively created to build a science of economics.

    1. Capital is the means of production including resources, technology, knowledge, goods and services which are useful for production.

    2. Resources include energy, materials, water, land and other property.

    3. Knowledge or know-how is human capital useful for production.

    4. Money is a recognized claim on capital, goods and services and is useful for exchange, accounting and storage of value.

    5. Asset includes capital, money and other rights of financial claims, such as stocks, bonds and other financial instruments.

    6. Liability consists of obligations of financial claims such as stocks, bonds and other financial instruments.

    7. Financial investment is the ownership of financial assets, which are rights of financial claims, such as stocks, bonds and other financial instruments.

    8. Investment or real investment is the allocation and use of capital for economic production.

    9. Wealth or net wealth is asset minus liability.

    From my definition, money, stocks, bonds and other financial instruments are not capital at all, but merely claims on capital and what it may produce. For other definitions see


    You cannot possibly think clearly if you don’t have a clear idea what you are talking about. Feedback is welcome on the website.

    • April 21, 2014 at 2:16 pm

      Perhaps, maybe capital is the “M” of E= M C sqrd ?
      However the world was created, there us enough “capital” for all mankind to survive.
      It depends apun how we use it.

  4. Bruce E. Woych
    April 21, 2014 at 9:35 pm

    http://www.peri.umass.edu/236/hash/63df950a3baddaae16a073f377e21073/publication/599/ Capitalism, Crisis and Class: The U.S. Economy after the 2007-2008 Financial Crisis Mathieu Dufour | Özgür Orhangazi | 1/31/2014
    Abstract: [partial]
    “The post-1980 era witnessed an increase in the frequency and severity of financial crises around the globe, a majority of which took place in low- and middle-income countries. Studies of the impacts of these crises have identified three broad sets of consequences. First, the burden of crises falls disproportionately on labor in general and low-income segments of society in particular. …”
    “Capital as a whole, on the other hand, usually recovers quickly and most of the time gains more ground. Second, the consequences of crises are visible not only through asset and income distribution, but also in government policies. Government policies in most cases favor capital, especially financial capital, at the expense of large masses. In addition, many crises have presented opportunities for further deregulation and liberalization, not only in financial markets but in the rest of the economy as well. Third, in the aftermath of financial crises in low- and middle-income economies, capital inflows may increase as international capital seeks to take advantage of the crisis and acquire domestic financial and nonfinancial assets.”

  5. shivz
    April 23, 2014 at 10:51 am

    Given a world of private ownership, a strict micro and macro distinction should be made, because, first, private ownership matters (each one with his own capital), and secondly, because at the macro level it does not. Thus,

    Physical Capital:
    Micro level – any physical object that carries market value, owned by persons or firms (from kitchen tables and paintings to patents, software, product designs and machinery).
    Macro level – any man made item of the above (at market, or exchange, value), that can be used repeatedly for the purpose of income creation, plus the reinstatement value, minus depreciation, of publicly owned property.

    Financial Capital:
    Micro level – debt plus cash, owned by persons or firms.
    Macro level – the amount of money (out of the micro level total) actually spent on the creation of new macro level physical capital.

    1. Stock does not constitute financial capital, because nobody owes anything to its owners.
    2. Macro level financial capital is definable and measurable only by the act of spending on the creation of new macro level physical capital.
    3. Given the private ownership pillar of our socio-political systems, macro is not always an aggregation of micro.

  6. Dan Kervick
    April 25, 2014 at 12:55 am

    The book is not just about the accumulation of financial capital and the income that flows from it; it’s about every kind of capital – that is, about any kind of wealth in a form that can be bought and sold in some market. If you own stock in a company, that is something you can sell, and also something from which you can derive income. If you own land, same thing; if you own an apartment building, same thing; if you own a factory, same thing; if you own a patent, same thing. All of these are forms of wealth and represent ways of deriving an income from ownership rather than labor, and that is Piketty’s focus. Piketty’s definition of “capital”, and his justification for attending to that broad notion given his purposes in the book, is explained quite clearly on pages 47 and 48 of the book.

    I’m surprised Merijn agrees with Crook’s assessment. Crook is basically saying that it doesn’t matter whether the capital share of income is growing, and doesn’t even really matter all that much if unequal distributions of capital plus the increase in the capital share leads to greater and greater inequality, so long as all ships are rising on the tide and living standards are going up. But I would say that attitude is completely antithetical to Piketty’s main moral concern which is that inequality matters, and that its increase destroys the foundations of modern democratic society and self-understanding. He says inequality can attain levels “incompatible with the meritocratic values and principles of social justice fundamental to modern democratic societies.”

    Piketty isn’t telling some Marxist story about how how the over-accumulation of industrial capital leads to a crisis where the workers are immiserated, the capitalists stop making profits, and the economy falls apart and end everything collapses into a revolutionary disaster. He’s telling a story based on as long historical survey of empirical trends about how the rich keep getting richer and how it is possible for a pattern of grotesque inequality to persist indefinitely, and his interest in that question seems to be based on his concern that it can lead to the destruction of what we understand as democratic society, whether there is a cataclysmic economic disaster or not.

    • merijnknibbe
      April 25, 2014 at 8:22 am

      I should have made myself clearer. Economics is the science of complicated weighted averages. One of these weighted averages is the amount of physical capital, i.e. ‘land’ and ‘machinery’ and ‘buildings’ are lumped together using particular weights to weigh the different kinds of physical capital. This is the the average used in ‘growth accounting’. Crook is right that Pikkety’s book is not about growth accounting. On the other side we have financial capital, i.e. claims which give people right to part of the national pie, either in the shape of receiving interest on loans to households or companies or dividends or part of ‘mixed income’. This is one of the things Piketty’s book is about and Crook is wrong to criticize Piketty about this, as he does not pretend to have written a book about growth accounting. Crook mixes up both concepts in one sentence…

      Aside from these concepts we have the tautological neoclassical concept of the value of capital, i.e. the capitalized value of the future stream of income associated with a certain asset. Which has been trashed during the famous battle of the Cambridges, though people still use it to criticize Piketty: http://spire.sciencespo.fr/hdl:/2441/6d6bmqq2mq9avo75ba1s430vom/resources/wp-25-bonnet-et-al-liepp.pdf

      More on this soon.

  7. Calgacus
    April 25, 2014 at 1:52 am

    “Physical capital” is newer and more problematic. “Financial capital” is the original meaning of “capital”, and is preferred by businessmen,Geoffrey Hodgson, Alfred Mitchell-Innes, Joseph Schumpeter and Thorstein Veblen. See Piketty has redefined capital, after 200 years of confusion and What is capital? Economists and sociologists have changed its meaning: should it be changed back?

  8. Bruce E. Woych
    April 25, 2014 at 10:38 pm

    Capital as Power: A Study of Order and Creorder (RIPE Series in Global Political Economy) by Jonathan Nitzan and Shimshon Bichler (May 22, 2009)

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