NOTES

Reaction Paper 1

1. How do aggregate wealth-to-income ratios evolve in the long run and why? (wealth income
and capital output ratios evolve in the long run and why)

Difficult coz national accounts were mostly about flows and not stocks. (resulted in limited
question to be asked)

Recently, restrospective national stock accounts including annual and consistent balance sheets.

National stock accounts report the market value of the financial and non-financial asset and
liabilities held by each sector of the economy and by the rest of the world. This could be used to
measure the stocks of private and national wealth at current market value.

Contribution: 1. New macro-historical data set on wealth and income

First international data base to include long-run, homogenous information

on national wealth. US, UK, JAPAN, GERMANY, FRANCE, ITALY, CANADA, AND
AUSTRALIA

The resulting database provides extensive information on the structure of wealth, saving, and
investment. Basic questions could be asked—such as private capital accumulation, the dynamics
of the public debt, and patterns in net foreign asset positions—altogether and over unusually long
periods of time.

Addressed using the 1970-2010 national balance sheets recently compiled in the top eight
developed countries,

US, UK, Germany and France (until 1700)

2. Exploit the database to establish a new result.

Every country, gradual rise of 200-300% in 1970 and 400-600% in 2010

Nowadays, 400 to 600% especially to Europe

The U-shaped evolution of the European accounts

Explained: 1. Long run swing in relative asset prices, itself a largely driven by
changes in capital policies in the course of the 20th century. WW1, many anticapital policies
which depressed assets, lifted in 1970, gradual rise, asset price recovery.
 2. Slowdown of productivity and population growth. Harrod –
Domar-Solow Formula.

Long Run of the wealth-income ratio is equal to the net depreciation saving rate
divided by the income growth rate.

This mechanism sheds light on the rise in the wealth-income ratios of Europe and Japan, two
economies where population and productivity growth has slowed markedly: capital is back
because low growth is back.

Still, it’s limited. In some countries, capital gains-particularly on housing, explain a large part of
the recent rise of wealth-income ratios.

It’s implications for the future and for policy making.

1. Low wealth-income ratios of the mid-20th century were due to special circumstances. World
wars caused disruption on the accumulation of the capital stock due to anticapital policies, which
is very unlikely to happen in free market. If income growth slows down in the decades ahead,
then wealth-income ratios may become high pretty much everywhere as long as they keep saving
sizable amounts, countries with low g are bound to have high B.

New Issues raised by the high wealth-income ratios

1. Capital Taxation and Regulation

High B implies than the inequality of wealth and potentially the inequality of inherited
wealth is likely to play a bigger role for the overall structure of inequality in the 21st century.
There should be progressive capital taxation.

It should have international cooperation to prevent wealth from hiding in offshore tax
havens. If international tax competition prevents these policies from happening, one cannot
prevent form the new wave of antiglobalization and anticapital policies.

Financial Regulation is important as s and g vary between countries.

Perfect capital markets and large differences in wealth-income ratios imply large net
foreign asset positions which creates political tensions between countries.

Monitoring wealth-income ratios may help in designing appropriate financial and

monetary policy. Like Japan and Spain, they don’t have any specific reference point, difficult to
policy makers when such evolutions have gone too far and whether they should act.

The findings shed new light on the long-run changes in the nature of wealth , the shape of the
production function the recent rise in the capital shares.
18th -19th : Land

20th and 21st : Many forms of capital, substitution rate is greater than level 1, rise in capital
shares.

RELATED LITERATURE

A. Literature on National Wealth

The first attempt to gather a large set of national balance sheets to analyze the long-run evolution
of wealth income ratios. Long time, impede by the lack of data. It’s 1993 when the System of
National Accounts included guideline for wealth. Early 20th century when economist give
interest in computing national wealth than national income and output.

Capital Shocks 1914-1945, long tradition of research on national wealth largely disappeared

1. New Emphasis on Short Run Output Fluctuations

2. Chaotic Asset Price Movement

B. Literature on Capital Accumulation and Growth

Neoclassical Growth Model (1950s)- applied for empirical studies of growth and later extended
to human capital

Perpetual Inventory Method- Growth literature capital is typically measured indirectly by

cumulating past investment flows and attempting to adjust for changes in relative prices.

Country balance sheets important advantages:

1. Includes non-produced assets- land

2. Balance sheets rely mostly on observed market prices obtained from real estate and
financial market transactions.

3. Includes most form of intangible capital contrary to older estimates

4. Country balance sheets now follow standardized international definitions and are
available for many countries.
C. Literature on External Balance Sheets

We extend this line of work to domestic wealth and to longer time periods: we document
the changing nature of domestic capital over time, and we investigate the extent to which the
observed aggregate dynamics can be accounted for by saving flows and valuation effects.

D. Literature on Income and Wealth Inequalities

Conceptual Framework and Methodology

We follow the UN System of National Accounts (SNA).
Private Wealth = Net Wealth
MV National wealth = PW+PBW

National wealth can also be decomposed into domestic capital

and net foreign assets:
Wnt¼Kt þ NFAt:

Domestic Capital can be decomposed as the sum of agricultural land, housing, and other
domestic capital

BS are constructed by national statistical

National Income is the sum of net domestic output and net foreign output.
Global level, the world wealth-income ratio is always equal to the world capital-output ratio

One Good Wealth Accumulation Model

THE RISE OF WEALTH-INCOME RATIOS 1970-2010

A. Private Wealth-Income Ratios

Europe, French, and UK trajectories are comparable: 300% in 1970 and 550% in 2010
Italy, less than 250% in 1970 and more than 650% today
Germany, larger than the France and UK

Japan, national trajectories also display interesting variations: 300% of national income to
almost 700% (asset price bubble) in 1990s and stabilized around 600%

Private wealth income ratios would be more spectacular if we use disposable personal income

B. From Private to National Wealth

NW- sum of private and government wealth; privatizations leading to a reduction in
government assets and an increase in public debt
Australia is the only country that ha ssignificantly net positive government wealth

C. From National wealth to domestic capital

National wealth is the sum of domestic capital and net foreign wealth.
Net foreign wealth has been relatively a small part of national wealth in rich countries.
In Japan and Germany, the rise in net foreign assets represents more than a quarter of the
total rise of the national wealth income ratio.

Capital Output Ratio differs from previous estimates obtained by the perpetual method : different
valuations of housing capital and of the corporation’s assets
BS: Real Estates are measured at CV using censuses and observed market price
PIM measures only structures by the use of past real estate investment

Corporate capital is measured thru market value of equities, in PIM thru corporations’
book value.
Corporate Capital Stock, market or book, which is better?
Germany: Stakeholder Effect, shareholders of German compny do not have full
control of company assets- they share voting rights with workers representatives and sometime
regional governments. In this case, BV m=is desirable to use.

DECOMPOSITIONS OF 1970-2010 WEALTH ACCUMULATION

A. Growth Rate vs. Saving Rates

Variations in GR is mainly because of the variations in population growth, average per capita
growth rates have been virtually the same in all rich countries. They fall between 1.7 -1.9%
New World: exceeded 1% per year in New World (high to low fertility)
Low Population growth (aging countries) have higher saving rate
B. Volume vs. Price Effects
New Savings explain the largest part of wealth accumulation explain around 70-80% of
the 1970 and 2010 and the residual capital gains 28%

C. Domestic vs. Foreign Capital Gains

D. Wealth Income Ratios in Rich Countries

THE CHANGING NATURE OF NATIONAL WEALTH

Prior to 1870: The data we have during the 18th and 19th century is insufficient to precisely
compare the levels of wealth-income ratios between the two countries or the two subperiods.

Agricultural land has been now replaced by the housing and other domestic capital. In the long
run, the decline of the share of the AL in national wealth mirrors that of the share of the
agriculture in national income, from over two thirds in th 18th century. Net foreign assets are
virtually zero in the 18th century.

Why wealth-income ratios are so high in the 18th and 9th century and why do they seem to
approach theses level in the 21st century. Slow growth, moderate saving rates lead to large
wealth-income ratios. Growth was low to the 18th to 19th century

Data limitations again make it difficult to evaluate the exact role played by alternative
explanations such as structural capital gains and losses and changes in the value of the natural
resources.
Pre-1870 estimates are too fragile to be used in wealth accumulation decompositions.

THE NATURE OF WEALTH: OLD EUROPE VS. NEW WROLD

The value of land in the Old Europe and in the New world.
Lower accumulated investment relative to economic and population growth in the New world.
The relatively low New World wealth-income ratios can also be explained by a land abundance
effect. Land was so abundant in America that its price per acre is low. The lower land values
prevailing in America were some extent compensated by the slavery system. Land is so
abundant that it was almost worthless, implying that it was really difficult to be really rich by
owning a land. However, the landed elite coult control a large share of national income by
owning a labor force, the total value of the slave stock could in principle be very large, say, as
large as 20 years of national income.

CAPITAL SHARES AND THE CHANGING NATURE OF TECHNOLOGY

Implications of our new data on capital for understanding the evolution of factor shares and the
shape of the production function.
Long-run on the evolution of the factor shares: Over time, human inputs may have become
relatively more important than capital inputs in the production process.
CONCLUSION
New wealth-income database reveals some striking facts. Capital is making a comeback .

Title
What I feel while reading?
Reaction Paper #2

A note on Piketty and Diminishing Returns to Capital

Matthew Rognlie

ABSTRACT

Capital in the Twenty First Century: predicts a rise in capital’s share of income and the gap
between capital returns and growth.
Argue that neither outcome is likely given realistically diminishing returns to capital
accumulation.
All else equal= more capital will erode the economy wide return on capital.
Inference of high elasticity from time series is UNSOUND assuming a constant real price of
capital DESPITE the dominant role of rising prices in pushing up the capital.
Housing capital

INTRODUCTION
Capital in the Twenty-First Century: new view of income, wealth, and inequality.
Singular trove of data assembled by Piketty and coauthors: distinctive theory about the trajectory
of the wealth and income trajection.

Central Themes
1. Capital Accumulation: slower growth will produce a rise in the ration of capital to income.
Expansion in capital’s share of income, g dwindles and return on capital holds relatively steady,
the gap will expand . Aggravate inequality in the wealth distribution. Capital’s role in the
economy will grow in the 21st century.

If the ROC falls quickly enough when more capital is accumulated, capital’s share
of income will fall rather than rise.

Most evidence suggests diminishing returns powerful enough that further capital accumulation
will cause a decline in net capital income rather than an expansion.

Section2. economic concept central to diminishing returns, the elasticity of substitution between
capital and labor.
Elasticity >1: higher capital or income ratio is associated with higher share of capital income
<1: opposite, problem is net or gross

Net concepts are more relevant for an analysis but they do not cover the distinction between net
and gross elasticities.
I agree that it should be gross income because net income are mechanically lower than gross
ones
Elasticity within the standard range of empirical estimates, an increase in capital is more likely to
be associated with substantial decrease in capital’s net share of income, not an increase. R-g will
fall

Net return ® on capital= gross –depreciation

Diminishing returns will hit the Gross then dep remains constant, therefore net return would be
affected.

Section3. Time Series evidenced

Capital stock housing accounts – accounts fo nearly 100% of the long-term increase in the
capital/income ratio and more than 100% of the long-term increase in the net capital share of
income.
Housing-removed: the long-term comovement emphasized by Piketty and Zucman as evidenced
for a high net elasticity no longer holds, there is instead a small increase in the capital/income
ratio and small decrease in the net capital share of income.
Proves that housing alone cannot be used as responsible for a high aggregate elasticity of
substitution.

The dominant role of housing reflects the influence of real price changes, particularly for land.

Section 4:
Technology and Capital: As we develop new and innovative ways to use capital, diminishing
returns will matter less and less. The vast majority of the existing capital stock is in structure,
houses, apartments, and offices rather than equipment and intellectual property. Tech-intensive
capital is not large enough at current prices to absorb much of the substantial increase envisioned
by Piketty.

ELASTICITY OF SUBSTITUTION

Will a rise in the capital stock translate into a higher share of income going to owners of capital?
Depends on the usage of gross or net income.
NI: subtracts capital depreciation while gross does not
Substitution, makes sense to use net income

Net vs. gross

Piketty consistently uses net interpretation which is more meaningful when studying income
distribution.
Critically, the product of these ratios are always less than 1. The net elasticity is always below
the gross elasticity.
When gross returns decline but depreciation does not, net returns decline even more rapidly.

Empirical literature on the elasticity of substitution

Arrow, Chenery, Minhas and Solow proposed the constant elasticity of substitution (CES)
production function. Clearly, the literature is imperfect and inconclusive and not all estimates
directly correspond to the aggregate elasticity that interests us. It is important to emphasize that
the formula given by Piketty- capital accumulation leads to substantially GREATER net capital
income- is far outside the range of values that most economists studying this issue believe
empirically plausible. Consensu view, Piketty’s forces are in fact more likely to result in a
DECREASE in net capital income.

Implications for r-g

Main themes in Piketty: The real return r on capital and the real growth rate g of the economy.
When r-g is higher, “old” accumulations of wealth become more important relative to “new”
ones. Higher r-g generally implies that the power law tail of the wealth distribution has a smaller
exponent- so that there is more INEQUALITY of wealth at the TOP and extreme levels are more
likely.
Basic argument is that: When g declines (slowed population and productivity growth), r is
unlikely to fall by the same amount.

Second Fundamental Law of Capitalism

The return to a structurally high capital/ income ratio in the 21st century, close to levels observed
in the 18th and 19th century \, return to a slow-growth regime. Decrease growth is responsible to
capital’s comeback.

Alternative Hypotheses on Savings

Solow growth model: Gross rather than net savings that are exogenous and the long-run ratio of
capital to gross income. New assumption means that the net savings rate will fall as the
CAPITAL STOCKS GROW.

TIME SERIES ON INCOME AND CAPITAL

Inferring elasticity from time series data

Constant Capital Prices: A problematic assumption

Piketty and Zucman look at the market value of the capital.
If the REAL PRICE of capital is constant:
Assumption: There is only one type of GOOD. If there are large changes in the real price
of capital, the quantity and MV may move in very different directions. It turns out that changes
can induce systematic comovement between the capital/income ratio and the capital share of
income, regardless of the elasticity, making inferences problematic. (elasticity)

Empirical importance of capital price changes

Changes in the real price of capital make inferences about the elasticity of the substitution
problematic, it is important to know the extent to which such changes occurred over the 1970-
2010 period.

Decomposition of MV wealth over income

PZ: decomposition of annual changes in national wealth, distinguishing between the
contribution from NET SAVINGS and the contribution from REAL CAPITAL GAINS.
Issues with the decomposition, and the BV alternative
Using national savings will deliver BIASED results. At the time of collection, most
national accounts did not include R&D
Since national wealth measured at market value-using market equity, rather than book
equity for corp. it includes the value of accumulated R&D meaning S/W will be biased
DOWNWARD.
Alternative: S augmented by a guess for the contribution of R&D to net savings. Real capital
gains ARE LOWER and account for SLOWER share of lower capital accumulation.

Alternative 2: Decomposition for BV wealth, as measured in national accounts rather than MV

wealth. Advantage of consistency between savings and wealth series.

General Importance of Capital Prices

Reaction Paper 3

DYNAMIC OPTIMIZATION

 Optimization implies that agents maximize their utility/profits subject to the restrictions
they face. When this optimization process spans more than one period, it is called
dynamic optimization.

I. INTRODUCTION

Economic activity takes place continuously

 Continuous trading corresponds closely to reality

 The continuous-time modeling allows application of powerful mathematical tool, the
theory of optimal dynamic control

Purpose of the Notes:

1. Present intuitive derivations of the first-order necessary: solutions of basic continuous –

time optimization problems.
2. Shows similar conditions apply to deterministic and stochastic environments alike.

Optimal Control Theory

 A simple unified treatment of continuous-time deterministic and stochastic optimization

requires some restrictions on the form that economic uncertainty takes.

II. DETERMINISTIC OPTIMIZATION IN CONTINUOUS TIME

 The optimal program determined by this new decision maker will coincide with the
continuation, form time T onward, of the optimal program determined at time 0, given k
(0). It is related to the notion of “dynamic consistency”.
 Bellman’s principle of dynamic programming: leads to the characterization of an
optimum. Maximization problem and then proceed to the limit of continuous time.
(Further research…….)

 PROPOSITION II.1
 HAMILTONIAN
 In this model, the intertemporal tradeoff involves a choice between higher current
c and higher future k.
  If c is consumption and k is wealth: The model is one in which the utility from
consuming now must continuously be traded off against the utility value of
savings.
 Measure of the flow value: consumption-savings combination implied by the
consumption choice, given a predetermined value.
 It solves the problem of “pricing” saving in terms of current utility by multiplying
the flow of saving, the effect of an increment to wealth on total lifetime utility.
 Hamiltonian: J’ (k) has a natural interpretation as the shadow price (marginal
current utility) of wealth. It should be associated with the state variable k.
 If we are to measure the current payout of the plan by U alone, we would not be
taking proper account of the value of the current increase in k. It feels like leaving
the “investment” in the calculation of GNP.
 K= higher future
 The Hamiltonian solves this problem by valuing the increment to k using the
shadow price J’(k).
 The reason this condition is necessary is easy to grasp. At each moment the
decision maker can decide to "consume" a bit more, but at some cost in terms of
the value of current "savings."
 The utility value of a marginal fall in savings, and if the planner is indeed at an
optimum, it must be that this marginal cost just equals the marginal current utility
benefit from higher consumption.

NEW FAMILIAR ECONOMIC INTERPRETATION

 If k is an asset stock (capital, foreign bonds, whatever)

 If J’(k) is a shadow price of the state variable k
 The shadow price corresponds to asset price
 Furthermore, we know that under perfect foresight, asset prices adjust so as to
equate the asset’s total instantaneous rate of return to some required or benchmark
rate of return, which in the present context can only be the time-preference rate

 Asset-pricing equation
 If total return to holding unit of stock k into “dividends and capital gains”.
 Dividend: the direct effect of an extra unit of k on utility, Uk, and its effect on the
rate of increase.
 Capital Gain: Increase in the price of k
 The sum of this two: Sum/ Asset Price = along an optimal path

 MILTON FRIEDMAN’S PERMANENT-INCOME MODEL

 People consume the annuity value of wealth, this results to level consumption
path, however the optimal consumption path will be tilted, with consumption
rising/falling over time.
 MFR relative to elasticity
 The elasticity of intertemporal substitution measures an individual’s willingness
to substitute consumption today for consumption in the future.
Reaction Paper 4

IS U.S. ECONOMIC GROWTH OVER? FALTERING INNOVATION CONFRONTS

THE SIX HEADWINDS
Robert J. Gordon
Working Paper 18315
http://www.nber.org/papers/w18315
NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue Cambridge, MA 02138
August 2012

Beyond the Rainbow: The American Standard of Living since the Civil War
Book in progress

ABSTRACT
 Raises question about basic questions on economic growth
 Solow’s seminal contributions of the 1950s
 Economic growth is a continuous process that will persist forever
 No growth before 1750
 This paper: The rapid progress made over the past 250 years could turn out to be a
unique episode in the human history.
 Only about the United States from 2007, pretending that financial crisis did not
happen
 Question: How much further could be the frontier growth rate decline?
 Links on the three IR
1: steam and railroads
2: Electricity, internal combustion engine, running water, indoor toilets,
communications, entertainment, chemicals, petroleum
More important than the others
Responsible for the 80 years of relatively rapid productivity growth between
1890-1972
3: computers, web, mobile phones
Created only a short-lived growth revival between 1996 and 2004

 US faces six headwinds that are in the process of dragging long-term growth to half or
less than of the 1.9 percent annual rate experienced between 1860 to 2007
 These include demography, education, inequality, globalization, energy/environment, and
the overhang of consumer and government debt.

INTRODUCTION
 Dismal: not noticed because of the euphoria of the internet invention and the related
development in the information technology and communications (ICT)
 Pulls back from the past five years of financial crisis to pose a question with implications
that will persist for decades even if the current international economic disorder is
eventually resolved.
 US economic growth through 2007 and the future post-2007 path of trend for the
subsequent 20 to 50 years.
 Negative effects (slow recovery and recession) were ignored, its impact on the trend and
the gap between the actual and trend GDP
 Unorthodox yet worth pondering
 Applicable only in US
 BASIC POINTS
1. Solow’s seminal work: economic growth has been regarded as a continuous
process
2. Process of slowing down further: the frontier established by the US for output per
capita, gradually began to grow more rapidly, reached its fastest growth rate in the
middle of 20th century, and has slowed down since.
3. Useful organizing principle is the sequence of three industrial revolutions.
1 and 2: requires 100 years for their full effects to percolate through the economy
4. The IR 3: began 1960 and reached its peak in 1990s, but its main impact on
productivity has withered away in the past 8 years
1970-1980: replaced clerical labor by computers
2000: centered on entertainment and communication devices that are smaller,
smarter, and more capable, but do not fundamentally change labor productivity or
the standard of living in the way that electric light changed it.
5. It is useful to think of the innovative process as a series of discrete inventions
followed by incremental improvements which tap the full potential of the initial
invention.
6. The benefits of ongoing innovation on the standard of living will not stop and will
continue, albeit at a slower pace than in the past.
It holds back from the potential fruits of innovations by six headwinds buffeting
the US growth. Future growth in real GDP per capita will be slower than in any
extended period since the late 19th century, and growth in real consumption per
capita for the bottom 99 percent of the income distribution will be even slower
than that.
Headwinds: end of the “demographic dividend”: rising inequality.
The twin educational problems of cost inflation in higher education and poor
secondary student performance; All of these problems were already evident in
2007, and it simplifies our thinking about long-run growth to pretend that the
post-2007 crisis did not happen.

Transport speed: speed of passenger and freight traffic remains slower in 1958 in
order to conserve fuel.