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Comments on Joe Stiglitz’s

“Theoretical perspectives on the
distribution of income and
Branko Milanovic
New York 4 December 2014

The puzzles difficult to reconcile with the
standard approach
• Can wages fall as capital-deepening proceeds?
• Can return to capital r remain constant as K/L and K/Y increase?
• Can elasticity of substitution be greater than 1 when most empirical
studies show it to be <1?
• Can wealth (W) and capital (K) move differently?

A two-part paper
• Part I. Focused on the distinction between wealth and capital, how
the two can evolve differently and implications for personal income
• Part II. Combines a model of long-term wealth and income
distribution among individuals with theory of growth [based on
Stiglitz 1969, which I read as an undergraduate in Yugoslavia around
1975 and never thought I would have a chance to discuss it with the
• But here my comments will be on Part I.

Wealth is not capital
• It is legitimate to use W, and explicit and implicit returns from wealth,
in personal income distribution (as Piketty does; examples of housing
and land values)
• But it is not legitimate to use the results derived from the K world of
production function to apply in the W world of personal income
• How to solve this problem, that is to go from functional to personal
income distribution?
• Bring land (T), the largest component of W, back into the production
function = F(K,L,T)
• It could well be that paradoxes do not exist if K has not increased

Adam Smith weighs on the issue
Wealth is different from capital. CORRECT.
“Though a house, therefore, may yield a revenue to its proprietor, and
thereby serve in the function of a capital to him, it cannot yield any to the
public, nor serve in the function of a capital to it, and the revenue of the
whole body of the people can never be in the smallest degree increased by
it.” (“On the division of stock”. Book II, Ch 1)

Implicit income disregarded. NOT CORRECT.
“A dwelling-house, as such, contributes nothing to the revenue of its
inhabitant; and though it is, no doubt, extremely useful to him, it is as his
clothes and household furniture are useful to him, which, however, makes a
part of his expence, and not of his revenue.” (“On the division of stock”.
Book II, Ch 1)

How can W and K move in different directions?
• W = K + R/r = value of K + capitalized rent or W=K + pT = K + price of
land x quantity of land
• Suppose that price of land increases as the entire credit expansion is
used to buy land. No change in productive assets K. Land and K are
just two assets and in equilibrium 𝑑
(𝑙𝑛𝑝) 𝑟𝑒𝑛𝑡 𝑀𝑃𝑘
= 𝑑𝑡 𝑝

(𝑟) 𝐾(𝑟)
• So long as expected appreciation of land + rent/p exceed return on K,
people will invest in land
• Increase in p increases wealth inequality (land holders are rich) while
leaving productive potential unchanged.

• If not even depreciation of K is covered, K might go down even as W
• So, in the longer-run, there could be K “shallowing” and thus
decrease in wages, simultaneously with rising wealth/output ratio and
rising wealth and income inequalities. The original puzzles disappear.
• Some problems: Now, can the previous eq. that equalizes the return
on land and capital as stores of value be compatible with zero interest
rate (assumed in credit expansion)? Would not all 3 have to be in
equal (in equilibrium): return on financial assets, land and physical
• Why is speculative or positional demand for land different from similar
bubble-driven demands for any other asset?
• Suppose instead of land we use old paintings? The conclusions would
be the same.
• (Or land is different because it is a very big asset, half of all wealth,
and it is not held by the poor?)

Another aspect or explanation: Transmission of
inequality under globalization
• Let inequality increase in China & Russia only, and nowhere else
• For whatever reason, their rich demand land in Portugal (which e.g. is
used for wine-making, but now will be used for housing)
• Such demand reduces K directly by withdrawing a part of T out of
• But it also increases domestic W. This is a real (non-fictitious) increase
in W because the Portuguese can now by liquidating their wealth buy
more goods
• So, Portugal’s LT growth is unaffected since Q=f(K,L) is the same, but its
W/Y ratio has increased and its W and Y distribution are more unequal
• An interesting twist is whether this increased W and Y inequality might
in turn have negative effects on future growth

“The wealth-inequality effect”
• In conclusion, we are dealing with a peculiar wealth effect that is due
to the rising relative price of one (big) asset held by the non-poor.
• This increases wealth inequality directly, and income inequality
• The demand for the assets held by the non-poor increases while
leaving the production function unchanged, or even worse while
draining savings that would have been invested in productive assets
• Similar to A. Smith’s observation of how demand for non-productive
assets (like gold) made accumulation of productive K more difficult
• But here we have an inequality angle which was not noticed before

Important modelling assumptions for Part II
• Heterogeneous labor (different wage rates by wage groups)
• No separation between capitalists and workers, but rather unification of
high K and L income in the same persons (households). Based on the
empirical results from US tax data.
• High wage individuals save, become capitalists and invest in education of
their children; children then start as being both capitalists and high wage
• Higher returns to larger K 𝑦𝑖
= 𝑤𝑖 𝑘𝑖 + 𝑟(𝑘𝑖 )𝑘𝑖
With 𝑤′𝑘 >0 and 𝑟′𝑘 >0
• Higher MPS for higher income households
• Possibly modeling global income distribution by adding convergence
economics for the means