by Robert Rosenkranz

The economist’s book caused a sensation last year, but now he says the redistributionists drew the wrong conclusions.

‘Capital in the 21st Century,” a dense economic tome written by French economist Thomas Piketty, became a publishing sensation last spring when Harvard University Press released its English translation. The book quickly climbed to the top of best-seller lists, and more than 1.5 million copies are now in circulation in several languages.

The book’s central proposition, that inequality in capitalist societies will inevitably grow, can be summed up with a simple equation: r>g. That is, the return on capital (r) outpaces the growth rate of the economy (g) over time, leading inexorably to the dominance of inherited wealth. Progressives such as Princeton economist Paul Krugman seized on Mr. Piketty’s thesis to justify policies they have long wanted—namely, very high taxes on the wealthy.

Now in an extraordinary about-face, Mr. Piketty has backtracked, undermining the policy prescriptions many have based on his conclusions. In “About Capital in the 21st Century,” slated for May publication in the American Economic Review but already available online, Mr. Piketty writes that far too much has been read into his thesis.

Though his formula helps explain extreme and persistent wealth inequality before World War I, Mr. Piketty maintains, it doesn’t say much about the past 100 years. “I do not view r>g as the only or even the primary tool for considering changes in income and wealth in the 20th century,” he writes, “or for forecasting the path of inequality in the 21st century.”

Instead, Mr. Piketty argues in his new paper that political shocks, institutional changes and economic development played a major role in inequality in the past and will likely do so in the future.

When he narrows his focus to what he calls “labor income inequality”—the difference in compensation between front-line workers and CEOs—Mr. Piketty consigns his famous formula to irrelevance. “In addition, I certainly do not believe that r>g is a useful tool for the discussion of rising inequality of labor income: other mechanisms and policies are much more relevant here, e.g. supply and demand of skills and education.” He correctly distinguishes between income and wealth, and he takes a long historic perspective: “Wealth inequality is currently much less extreme than a century ago.”

All of this takes the wind out of enraptured progressives’ interpretation of Mr. Piketty’s book, which embraced the r>g formulation as relevant to debates playing out in Congress. Writing in the New York Review of Books last May, for example, Mr. Krugman lauded the book as a “magnificent, sweeping meditation on inequality.” He wrote that Mr. Piketty has proven that “we haven’t just gone back to nineteenth-century levels of income inequality, we’re also on a path back to ‘patrimonial capitalism,’ in which the commanding heights of the economy are controlled not by talented individuals but by family dynasties.”

The r>g formulation always struck me as unconvincing. First, Mr. Piketty’s definition of r as including “profits, dividends, interest, rents, and other income from capital” conflates returns on real business activity (profits) with returns on financial assets (dividends and interest).

Second, it ignores the basic rule of economics that when supply of capital increases faster than demand, the yield on capital falls. For instance, since the great recession, the money supply has grown far more rapidly than the real economy, driving down interest rates. Returns on government bonds, the least risky asset, are now close to zero before inflation and negative 1% to 2% after inflation. In today’s low-return environment, with the headwinds of income and estate taxes, it becomes a Herculean task to build and transmit intergenerational wealth.

Many mainstream economists had reservations about Mr. Piketty’s views even before he began walking them back. Consider the working paper issued by the National Bureau of Economic Research in December. Daron Acemoglu and James A. Robinson, professors at the Massachusetts Institute of Technology and Harvard, respectively, find Mr. Piketty’s theory too simplistic. “We argue that general economic laws are unhelpful as a guide to understand the past or predict the future,” the paper’s abstract reads, “because they ignore the central role of political and economic institutions, as well as the endogenous evolution of technology, in shaping the distribution of resources in society.”

The Initiative on Global Markets at the University of Chicago asked economists in October whether they agreed or disagreed with the following statement: “The most powerful force pushing towards greater wealth inequality in the U.S. since the 1970s is the gap between the after-tax return on capital and the economic growth rate.” Of 36 economists who responded, only one agreed.

Other critics have questioned the trove of statistical data Mr. Piketty assembled to chart trends in income and wealth in the U.S., U.K., France and Sweden over the past century. Are such diverse data comparable, and have the adjustments that Mr. Piketty introduced to make them comparable distorted the final picture?

After an extensive review, Chris Giles, the economics editor of the Financial Times, concluded in May last year that “Two of Capital in the 21st Century’s central findings—that wealth inequality has begun to rise over the past 30 years and that the U.S. obviously has a more unequal distribution of wealth than Europe—no longer seem to hold.”

Mr. Piketty is willing to stand up and say that the material in his book does not support all the uses to which it has been put, that “Capital in the 21st Century” is primarily a work of history. That is certainly admirable. Now it is time for those who cry that we are heading into a new gilded age to follow his lead.

by Allen Mattich

A surge in Italian bond yields is triggering a wholesale euro-zone panic.

Investors fear the financial conflagration that looks to be forcing Greece out of the euro will soon consume Europe’s biggest sovereign debtor too, putting the very existence of the single currency at risk.

Yields on 10-year Italian government bonds peaked just below 7.5% yesterday , a level that had been consideredthe point of no return for Ireland, Portugal and Greece during their own debt crises. There’s a widespread assumption that Italy wouldn’t be able to sustain yields at these levels, which would put it on the road to default.

But what few observers seem to be asking is what sort of yields are justified by Italy’s economic circumstances, rather than what’s necessary to hold the single currency together. History suggests perhaps not too far from where they are now, according to Paolo Manasse, an economics professor at Bologna University.

“The puzzle is that interest rates have risen so little and so late, despite the worsening of fundamentals,” he wrote last week, before the latest spike in yields.

For instance, Italian debt is forecast at around 121% of gross domestic product this year, almost exactly where it was in 1994, well before euphoria over the introduction of the single currency later in the decade started to force yields on the debt of all prospective member states to converge on Germany’s exceptionally low levels.

In 1994, yields on 10-year Italian debt hovered around 9%. It’s true Italian inflation was higher then, at 4.2%, compared with about 2.6% now. But assuming inflation expectations were rooted in current price levels, real expected yields are only moderately higher now than they were then.

Other fundamentals are different, too. In 1994, Italy was running bigger government deficits as a proportion of GDP and had higher unemployment. On the other hand, its ability to finance its deficit seemed more secure. The Italian economy was growing more solidly—2.2% in 1994 against 0.6% forecast for this year—and was generating a solid current-account surplus of 1.2% of GDP against an anticipated deficit worth 3.5% of GDP for 2011.

The lack of growth and low inflation compared with 1994 worries some economists. Italian officials may take comfort that the budget is in primary balance—after stripping out interest costs—but this is false comfort, says Charles Dumas of Lombard Street Research. Simple math shows why, he argues.

Take Italy’s net government debt, which is currently around 100% of GDP. Even though Italian government debt has a relatively long maturity—it averages out at about seven years—which means current high yields have a relatively small impact on interest payments, unless they come down smartly over the coming months, they will represent an interest cost of around 6% of GDP, Mr. Dumas estimates.

In a world of high growth or high inflation, those interest costs would be manageable. Either income covers the outlay or inflation erodes the debt burden.

But Italy has neither to look forward to. The International Monetary Fund forecasts Italy to grow by less than 1% a year over the coming three years and for Italian prices to rise by little more than 1% over the same period. Mr. Dumas is more pessimistic. He thinks there’s a real risk Italy doesn’t grow at all and suffers deflation. In this case, the Italian government has to find about 6% of GDP from spending cuts or tax rises unless it wants its debt burden to grow—something the markets are unlikely to accept.

And that sort of austerity is exactly what Greece is struggling against. It becomes a self-defeating downward spiral. Tax rises and spending cuts against a recessionary backdrop only cause the economy to contract further. Economic contraction pushes up government spending and reduces its revenue, making it impossible for the government to make headway on its finances while the economy just gets worse.

For Italy to get out of its ever-deepening hole, it needs much lower yields on its debt. The European Central Bank could engineer this by buying Italian government bonds in the market. It has done so as an emergency measure, albeit with only temporary success. The ECB has bought some €183 billion ($247 billion) in euro-zone government debt so far, a large proportion of which was Italian, and was reportedly intervening heavily in the market on Wednesday. But this is a pittance compared with how much it would have to buy if investors abandoned Italy. Next year alone, Italy has to roll over €300 billion in maturing debt and is expected to need another €25 billion to cover its budget deficit.

ECB members have made it clear they’re unwilling and legally unable to be unlimited buyers of government debt. But it is, in any case, questionable how much lower Mario Draghi, the ECB’s new president, would be willing to push Italian yields. Although Mr. Draghi says yields are now “overshooting,” he also admits they fell too low pre-Lehman.

Investors were demanding too little return from the Italian government during the euro’s long honeymoon. Its 10-year debt at one point yielded just nine basis points—less than a tenth of one percentage point—more than Germany’s equivalent issues. That spread is now around 570 basis points. Although this is high, it was higher in 1995. In 1994, the spread largely ranged between 300 and 450 basis points.

Unfortunately, even if fair value were toward the lower end of those spreads, Italy would find it brutally painful to pay what it owes. The only alternative, argues economist Nouriel Roubini, is for a debt restructuring. Default, in other words, and all the collateral damage that entails.

ROMA (MF-DJ)- Fiat sta ancora studiando l’alleanza con Chrysler, ma punta a chiudere l’accordo presto, entro il 17 febbraio. Entro quella data, infatti, l’azienda di Detroit dovrebbe presentare un piano per richiedere ulteriori aiuti al Governo federale, e in questo ambito l’accordo con Fiat sarebbe un elemento chiave. E’ quanto afferma l’a.d. di Fiat, Sergio Marchionne, intervistato dal Wall Street Journal.

Fiat, spiega Marchionne, fornirà utilitarie e motori ad alta efficienza, di cui il colosso statunitense ha bisogno e il cui sviluppo costerebbe almeno 3 mld di dollari. In cambio dovrebbe acquisire il 35% delle azioni della compagnia. Tuttavia per Fiat, prosegue l’a.d., l’alleanza con gli americani è “un biglietto della lotteria” che potrebbe non valere nulla se Chrysler non uscirà dalla crisi. L’obiettivo e’ “avere il 35% di un’azienda che vale qualcosa, io non voglio trovarmi per i prossimi cinque anni a possedere il 35% di niente. L’obiettivo è portare valore per gli azionisti di Fiat”.

L’alleanza con Fiat ha sollevato dubbi sul fatto che il sostegno del governo federale possa implicare il sostegno a un produttore straniero, ma Marchionne afferma che Fiat non toglierà un dollaro a Chrysler fino a quando non avrà rimborsato il prestito al Governo.

In base all’accordo, ha spiegato inoltre Marchionne, Fiat potrebbe vendere i veicoli propri, e quelli dei marchi che il Lingotto controlla, a partire da un anno dalla chiusura dell’accordo. Per permettere a Chrysler di uscire dalla crisi, Fiat investirà 3-4 mld in tecnologia nei prossimi anni: “daremo un supporto dove possiamo a livello operativo”.

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