A new IMF study, Testing Piketty’s Hypothesis on the Drivers of Income Inequality: Evidence from Panel VARs with Heterogeneous Dynamics, by Carlos Góes finds flaws in Thomas Piketty’s famous R > G hypothesis that returns to capital exceeding the growth rate increases inequality. Looking at 19 advanced economies over the last 30 years Góes finds:
“…no evidence to corroborate the idea that the r-g gap drives the capital share in national income. There are endogenous forces overlooked by Piketty particularly the cyclicality of the savings rate which balance out predicted large increases in the capital share. On inequality, the evidence against Piketty’s predictions is even stronger: for at least 75% of the countries, the response of inequality to increases in r – g has the opposite sign to that postulated by Piketty…”
In addition to Piketty’s flawed understanding of savings namely that the savings rate net of depreciation remains constant, Góes speculates that Piketty could be underestimating the diminishing returns to capital thus overestimating the elasticity of substitution between capital and labor.
Góes concludes, “If one is looking to potential solutions to increasing income inequality, one should not focus on r – g, but elsewhere.”