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Piketty has got it wrong

The implied savings estimates for India, derived from his calculations of income distribution, do not conform to any known model of savings behaviour

Nobel Laureate Economist Thomas Piketty during his lecture and presentation at the JNU in New Delhi on thursday. Express Photo by Tashi Tobgyal New Delhi 210116

In a provocative cover story, The Economist (January 13-January 19, 2018), a reputed newspaper I have read and admired over the last 40 years, reached the conclusion that there was a missing middle class in India, and that “income inequality in India had reached historically high levels. In 2014, the share of national income accruing to India’s top one per cent of earners was 22 per cent, while the share of the top 10 per cent was around 56 per cent.” The Economist offers a caveat about this radical conclusion: “Some have doubts about Piketty’s methodology. But other surveys suggest pretty similar distribution patterns”.

As it happens, inequality is a subject I have worked on for decades, and besides several academic papers, have written two books on the subject: Imagine There’s No Country (2002), and The New Wealth of Nations (2017). I not only have doubts about Thomas Piketty’s methodology, I have grave doubts. Piketty’s results for India just do not stand up to any scrutiny, and fails several smell tests (a smell test is akin to a duck test — if it doesn’t walk like a duck, and if it doesn’t quack like a duck, it is not a duck). Indian columnist Swaminathan Aiyar has also been deeply critical of Piketty’s analysis and conclusions ( see https://object.cato.org/sites/cato.org/files/pubs/pdf/edb-28-bio.pdf).

In 2014, Piketty produced a masterpiece, Capital in the Twenty-First Century, and this book is said to have sold over 3 million copies, substantially above my favourite John Le Carre book, Tinker, Tailor, Soldier, Spy. His work should not be taken lightly. He, along with his associates, has changed our understanding of inequality in the advanced economies of the world — they are more unequal than was conventionally thought (especially the US).

The major Piketty innovation (again, it is a body of work with several scholars, but as shorthand, I will refer to Piketty only) was the recognition that tax payments give much better information on income than household survey responses — a very reasonable inference.

Typically, household surveys only capture 25 to 50 per cent of national income. In the US, since 2006, the IRS publishes data on the tax compliance of households, and they report that over 80 per cent of the tax that is due to the IRS is paid. In other words, the income estimate from the tax data is close to 80 per cent of national accounts data.

In World Inequality Report, Piketty and his colleagues, as the title implies, go several steps further than just analysing income distribution data for advanced economies. They estimate it for almost all the major countries of the world. For India, they estimate inequality for 92 years, 1922-2014. The method used by Piketty et al is broadly the same as that used for an advanced country like the US — that is, use household survey data on consumption and income, and “marry” these data with tax payments.

There will be other occasions to discuss the major flaw in the assumption that tax data in India has the same information as tax data in the US. In summary form, it does not. Tax compliance in India, in 2014, was close to 25 per cent, not the 80-plus compliance in the US (and presumably Europe).

This article is about duck-smell tests. First, something curious has happened with the computation of income shares of the top one per cent of the population for India. In an earlier Piketty paper (with Abhijit Banerjee, Top Indian Incomes, World Bank Economic Review, January 2005; hereafter BP), Piketty reported the share of the top one per cent in India for 1999 as nine per cent, that is, the top one per cent had nine per cent of the income. The NSS consumption shares for 1999/2000 for the top one per cent was 6.3 per cent.

Thus, comparing NSS consumption and BP income shares, we obtain the result that in 1999/2000, BP income share of the top one per cent was about 2.7 percentage points (ppt) higher than the NSS consumption share. This result is very typical of inequality calculations for different countries. Typically, the Gini coefficient of inequality for income is about six ppt above that for consumption.

According to the NCAER-University of Maryland IHDS survey for 2011/12, (and the survey used by Piketty with Lucas Chancel, Indian Income Inequality 1922-2014: From British Raj to Billionare Raj, hereafter CP), the top one per cent had a consumption share of 7.8 per cent, and an income share of 11.6 per cent, with the difference in consumption and income shares being 3.8 ppt, that is, close to the difference of 2.7 ppt observed in 1999/2000 between NSS and BP.

The first smell test failed by Piketty is that for 1999/2000 — his new work (CP) has the share of income accruing to the top one per cent as 14.7 per cent, some six ppt above his own earlier estimate. A revision of an earlier estimate is not at all uncommon, and is indeed to be welcomed. It is not the revision that is a problem — it is the fact that in the CP paper, it is not outlined as to why there is such a large difference between the two Piketty estimates for the same year, 1999, and the same country, India.

But there are other, more serious problems with the Piketty analysis for India. It is that the implied savings behaviour of the Piketty estimates does not conform to any known model of savings behaviour. Not the life-cycle model (the share of consumption in income stays flat over a lifetime as individuals borrow from future income to pay for present (higher-than-income) consumption. Not the permanent income hypothesis, PIH (savings as a constant fraction of income, regardless of any change in permanent income). Nor the modified PIH, which states that in developing economies, savings rise with the level of income; this modified PIH is the most applicable to developing economies like India.

The table computes average estimates of income, consumption, and savings for five categories of individuals — the entire population, the top one per cent, the top 10 per cent, the middle 40 per cent (50th to 90th percentile) and the bottom 50 per cent. These categories are the same as those used by Piketty.

The method of computation is straightforward — consumption shares are taken from NSS consumption survey for 2011/12, the income shares from Chancel-Piketty. Given national income accruing to households (obtained from Piketty World Income Distribution database, WID), and the shares of each group in national household income (again, obtained from WID), one can obtain the absolute value of nominal income in command of each group. Consumption of each group (top one per cent, top 10 per cent etc) is obtained from the NSS consumption survey for 2011/12. The difference between income and consumption is the savings of each group.

The implied Piketty savings results are out of any known ballpark. The middle 50 per cent had a savings rate of 18 per cent in 1999/2000; in 1975/76 (NCAER Income Distribution survey) they had a savings rate of less than 10 per cent. In 2011/12, according to the Piketty data, the savings rate of the middle 50 per cent collapses to zero, indeed marginally negative. Let us ponder a bit about the Piketty misfortunes of the middle 50 per cent. This group was collectively saving Rs 1,229 billion in 1999/2000; just 12 years later, with nominal household incomes galloping ahead at a compound annual rate of 12.5 per cent, the absolute aggregate savings of these individuals decline.

It is this lack of correspondence with most realities that makes the recent Piketty calculations (with Chancel) very suspect. Note that the same illogicality does not apply to the earlier Piketty calculations with Abhijit Banerjee. And it is this illogicality that makes any calculations or inferences based on Chancel-Piketty, for example, The Economist article on India’s middle class, extremely suspect. Far from missing, India’s middle class in 2016 is more than double its 1999/00 level of 27 per cent. Details of middle-class calculations will be contained in a future article (but the interested reader can gain some advance knowledge from The New Wealth of Nations).

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