The 2019 Budget introduced by the Liberal government includes one of the worst policies I’ve ever seen.
The CMHC First-Time Home Buyer Incentive provides up to 10% of the purchase price of a house (5% for existing homes, 10% for new homes) to any household buying a home for the first time with an annual income up to $120,000. To qualify, the total mortgage must be less than four times the household’s yearly income and the mortgage must be insured, which means that any house costing more than $590,000  is ineligible for this program. The government will recoup its 5-10% stake when the home is sold.
The cap on eligible house price is this program’s only saving grace. Everything else about it is awful.
Now I want to be clear: housing affordability is a problem, especially in urban areas. Housing costs are increasing above inflation in Canada (by about 7.5% since 2002) and many young people are finding that it is much more difficult for them to buy homes than it was for their parents and grandparents. Rising housing costs are swelling the suburbs, encouraging driving, and making the transition to a low carbon economy harder. Something needs to be done about housing affordability.
This plan is not that “something”.
This plan, like many other aspects of our society, is predicated on the idea that housing should be a “good investment”. There’s just one problem with that: for something to be a “good investment”, it must rise in price more quickly than inflation. Therefore, it is impossible for housing to be simultaneously a good investment and affordable, at least in the long term. If housing is a good investment now, it will be unaffordable for the next generation. And so on.
I’m not even sure this incentive will help anyone in the short term though, because with constrained housing supply (as it is in urban areas, where zoning prevents much new housing from being built), housing costs are determined based on what people can afford. As long as there are more people that would like to live in a city than houses for them to live in, people are in competition for the limited supply of housing. If you were willing to spend some amount of your salary on a house before this incentive, you can just afford to pay more money after the incentive. You don’t end up any better off as the money is passed on to someone else. Really, this benefit is a regressive transfer of money to already-wealthy homeowners, or a subsidy to the construction industry.
The worst part is that buying a house at an inflated valuation isn’t even irrational! The fact of the matter is that as long as everyone knows that governments at all levels are committed to maintaining the status quo – where housing prices cannot be allowed to drop – the longer housing costs will continue to rise. Why shouldn’t anyone who can afford to stick all their savings into a home do so, when they know it’s the only investment they can make that the government will protect from failing ?
That’s what’s truly pernicious about this plan: it locks up government money in a speculative bet on housing. Any future decline in housing costs won’t just hurt homeowners. With this incentive, it will hurt the government too . This gives the federal government a strong incentive to keep housing prices high (read: unaffordable), even after some inevitable future round of austerity removes this credit. This is the opposite of what we want the federal government to be doing!
The only path towards broadly affordable housing prices is the removal of all implicit and explicit subsidies, an action that will make it clear that housing prices won’t keep rising (which will have the added benefit of ending speculation on houses, another source of unaffordability). This wouldn’t just mean scaling back policies like this one; it means that we need to get serious about zoning reform and adopt a policy like the one that has kept housing prices in Tokyo stable. Our current style of zoning is broken and accounts for an increasing percentage of housing prices in urban areas.
Serious work towards housing affordability would strike back against zoning. This incentive provides a temporary palliative without addressing the root cause, while tying the government’s financial wellbeing to high home prices. Everyone struggling with housing affordability deserves better.
 Mortgage insurance is required for any down payment less than 20%. If you have an income of $120,000 and you max out the down payment, then the mortgage of $480,000 would be about 81% of the total price. Division tells us the total price in this case would be $592,592.59, although obviously few people will be positioned to max out the benefit. ^
 Currently, the best argument against buying a home is the chance that the government will one day wake up to the crisis it is creating and withdraw some of its subsidies. It is, in general, not wise to make heavily leveraged bets that will only pay off if subsidies are left in place, but a bet on housing has so far been an exception to this rule. ^
 Technically, it will hurt the Canadian Mortgage and Housing Corporation, but given that this is the crown corporation responsible for mortgage insurance, a decline in home prices could leave it undercapitalized to the point where the government has to step in even before this policy was enacted. With this policy, a bailout in response to lower home prices seems even more likely. ^
I have previously written about how to evaluate and think about public debt in stable, developed countries. There, the overall message was that the dangers of debt were often (but not always) overhyped and cynically used by certain politicians. In a throwaway remark, I suggested the case was rather different for developing countries. This post unpacks that remark. It looks at why things go so poorly when developing countries take on debt and lays out a set of policies that I think could help developing countries that have high debt loads.
The very first difference in debt between developed and developing countries lies in the available terms of credit; developing countries get much worse terms. This makes sense, as they’re often much more likely to default on their debt. Interest scales with risk and it just is riskier to lend money to Zimbabwe than to Canada.
But interest payments aren’t the only way in which developing countries get worse terms. They are also given fewer options for the currency they take loans out in. And by fewer, I mean very few. I don’t think many developing countries are getting loans that aren’t denominated in US dollars, Euros, or, if dealing with China, Yuan. Contrast this with Canada, which has no problem taking out loans in its own currency.
When you own the currency of your debts, you can devalue it in response to high debt loads, making your debts cheaper to pay off in real terms (that is to say, your debt will be equivalent to fewer goods and services than it was before you caused inflation by devaluing your currency). This is bad for lenders. In the event of devaluation, they lose money. Depending on the severity of the inflation, it could be worse for them than a simple default would be, because they cannot even try and recover part of the loan in court proceedings.
(Devaluations don’t have to be large to be reduce debt costs; they can also take the form of slightly higher inflation, such that interest is essentially nil on any loans. This is still quite bad for lenders and savers, although less likely to be worse than an actual default. The real risk comes when a country with little economic sophistication tries to engineer slightly higher inflation. It seems likely that they could drastically overshoot, with all of the attendant consequences.)
Devaluations and inflation are also politically fraught. They are especially hard on pensioners and anyone living on a fixed income – which is exactly the population most likely to make their displeasure felt at the ballot box. Lenders know that many interest groups would oppose a Canadian devaluation, but these sorts of governance controls and civil society pressure groups often just doesn’t exist (or are easily ignored by authoritarian leaders) in the developing world, which means devaluations can be less politically difficult .
Having the option to devalue isn’t the only reason why you might want your debts denominated in your own currency (after all, it is rarely exercised). Having debts denominated in a foreign currency can be very disruptive to the domestic priorities of your country.
The Canadian dollar is primarily used by Canadians to buy stuff they want . The Canadian government naturally ends up with Canadian dollars when people pay their taxes. This makes the loan repayment process very simple. Canadians just need to do what they’d do anyway and as long as tax rates are sufficient, loans will be repaid.
For example, the people of a country could want to grow staple crops, like cassava or maize. Unfortunately, they won’t really be able to sell these staples for USD; there isn’t much market for either in the US. There very well could be room for the country to export bananas to the US, but this means that some of their farmland must be diverted away from growing staples for domestic consumption and towards growing cash crops for foreign consumption. The government will have an incentive to push people towards this type of agriculture, because they need commodities that can be sold for USD in order to make their loan payments .
As long as the need for foreign currency persists, countries can be locked into resource extraction and left unable to progress towards a more mature manufacturing- or knowledge-based economies.
This is bad enough, but there’s often greater economic damage when a country defaults on its foreign loans – and default many developing countries will, because they take on debt in a highly procyclical way .
A variable, indicator, or quantity is said to be procyclical if it is correlated with the overall health of an economy. We say that developing nation debt is procyclical because it tends to expand while economies are undergoing expansion. Specifically, new developing country debts seem to be correlated with many commodity prices. When commodity prices are high, it’s easier for developing countries that export them to take on debt.
It’s easy to see why this might be the case. Increasing commodity prices make the economies of developing countries look better. Exporting commodities can bring in a lot of money, which can have spillover effects that help the broader economy. As long as taxation isn’t too much a mess, export revenues make government revenues higher. All of this makes a country look like a safer bet, which makes credit cheaper, which makes a country more likely to take it on.
Unfortunately (for resource dependent countries; fortunately for consumes), most commodity price increases do not last forever. It is important to remember that prices are a signal – and that high prices are a giant flag that says “here be money”. Persistently high prices lead to increased production, which can eventually lead to a glut and falling prices. This most recently and spectacularly happened in 2014-2015, as American and Canadian unconventional oil and gas extraction led to a crash in the global price of oil .
When commodity prices crash, indebted, export-dependent countries are in big trouble. They are saddled with debt that is doubly difficult to pay back. First, their primary source of foreign cash for paying off their debts is gone with the crash in commodity prices (this will look like their currency plummeting in value). Second, their domestic tax base is much lower, starving them of revenue.
Even if a country wants to keep paying its debts, a commodity crash can leave them with no choice but a default. A dismal exchange rate and minuscule government revenues mean that the money to pay back dollar denominated debts just doesn’t exist.
Oddly enough, defaulting can offer some relief from problems; it often comes bundled with a restructuring, which results in lower debt payments. Unfortunately, this relief tends to be temporary. Unless it’s coupled with strict austerity, it tends to lead into another problem: devastating inflation.
Countries that end up defaulting on external debt are generally not living within their long-term means. Often, they’re providing a level of public services that are unsustainable without foreign borrowing, or they’re seeing so much government money diverted by corrupt officials that foreign debt is the only way to keep the lights on. One inevitable effect of a default is losing access to credit markets. Even when a restructuring can stem the short-term bleeding, there is often a budget hole left behind when the foreign cash dries up . Inflation occurs because many governments with weak institutions fill this budgetary void with the printing press.
There is nothing inherently wrong with printing money, just like there’s nothing inherently wrong with having a shot of whiskey. A shot of whiskey can give you the courage to ask out the cute person at the bar; it can get you nerved up to sing in front of your friends. Or it can lead to ten more shots and a crushing hangover. Printing money is like taking shots. In some circumstances, it can really improve your life, it’s fine in moderation, but if you overdue it you’re in for a bad time.
When developing countries turn to the printing press, they often do it like a sailor turning to whiskey after six weeks of enforced sobriety.
Teachers need to be paid? Print some money. Social assistance? Print more money. Roads need to be maintained? Print even more money.
The money supply should normally expand only slightly more quickly than economic growth . When it expands more quickly, prices begin to increase in lockstep. People are still paid, but the money is worth less. Savings disappear. Velocity (the speed with which money travels through the economy) increases as people try and spend money as quickly as possible, driving prices ever higher.
As the currency becomes less and less valuable, it becomes harder and harder to pay for imports. We’ve already talked about how you can only buy external goods in your own currency to the extent that people outside your country have a use for your currency. No one has a use for a rapidly inflating currency. This is why Venezuela is facing shortages of food and medicine – commodities it formerly imported but now cannot afford.
The terminal state of inflation is hyperinflation, where people need to put their currency in wheelbarrows to do anything with it. Anyone who has read about Germany in the 1930s knows that hyperinflation opens the door to demagogues and coups – to anything or anyone who can convince the people that the suffering can be stopped.
Taking into account all of this – the inflation, the banana plantations, the boom and bust cycles – it seems clear that it might be better if developing countries took on less debt. Why don’t they?
One possible explanation is the IMF (International Monetary Fund). The IMF often acts as a lender of last resort, giving countries bridging loans and negotiating new repayment terms when the prospect of default is raised. The measures that the IMF takes to help countries repay their debts have earned it many critics who rightly note that there can be a human cost to the budget cuts the IMF demands as a condition for aid . Unfortunately, this is not the only way the IMF might make sovereign defaults worse. It also seems likely that the IMF represents a significant moral hazard, one that encourages risky lending to countries that cannot sustain debt loads long-term .
A moral hazard is any situation in which someone takes risks knowing that they won’t have to pay the penalty if their bet goes sour. Within the context of international debt and the IMF, a moral hazard arises when lenders know that they will be able to count on an IMF bailout to help them recover their principle in the event of a default.
In a world without the IMF, it is very possible that borrowing costs would be higher for developing countries, which could serve as a deterrent to taking on debt.
(It’s also possible that countries with weak institutions and bad governance will always take on unsustainable levels of debt, absent some external force stopping them. It’s for this reason that I’d prefer some sort of qualified ban on loaning to developing countries that have debt above some small fraction of their GDP over any plan that relies on abolishing the IMF in the hopes of solving all problems related to developing country debt.)
Paired with a qualified ban on new debt , I think there are two good arguments for forgiving much of the debt currently held by many developing countries.
First and simplest are the humanitarian reasons. Freed of debt burdens, developing countries might be able to provide more services for their citizens, or invest in infrastructure so that they could grow more quickly. Debt forgiveness would have to be paired with institutional reform and increased transparency, so that newfound surpluses aren’t diverted into the pockets of kleptocrats, which means any forgiveness policy could have the added benefit of acting as a big stick to force much needed governance changes.
Second is the doctrine of odious debts. An odious debt is any debt incurred by a despotic leader for the purpose of enriching themself or their cronies, or repressing their citizens. Under the legal doctrine of odious debts, these debts should be treated as the personal debt of the despot and wiped out whenever there is a change in regime. The logic behind this doctrine is simple: by loaning to a despot and enabling their repression, the creditors committed a violent act against the people of the country. Those people should have no obligation (legal or moral) to pay back their aggressors.
The doctrine of odious debts wouldn’t apply to every indebted developing country, but serious arguments can be made that several countries (such as Venezuela) should expect at least some reduction in their debts should the local regime change and international legal scholars (and courts) recognize the odious debt principle.
Until international progress is made on a clear list of conditions under which countries cannot take on new debt and a comprehensive program of debt forgiveness, we’re going to see the same cycle repeat over and over again. Countries will take on debt when their commodities are expensive, locking them into an economy dependent on resource extraction. Then prices will fall, default will loom, and the IMF will protect investors. Countries are left gutted, lenders are left rich, taxpayers the world over hold the bag, and poverty and misery continue – until the cycle starts over once again.
A global economy without this cycle of boom, bust, and poverty might be one of our best chances of providing stable, sustainable growth to everyone in the world. I hope one day we get to see it.
 I so wanted to get through this post without any footnotes, but here we are.
There’s one other reason why e.g. Canada is a lower risk for devaluation than e.g. Venezuela: central bank independence. The Bank of Canada is staffed by expert economists and somewhat isolated from political interference. It is unclear just how much it would be willing to devalue the currency, even if that was the desire of the Government of Canada.
Monetary policy is one lever of power that almost no developed country is willing to trust directly to politicians, a safeguard that doesn’t exist in all developing countries. Without it, devaluation and inflation risk are much higher. ^
 It’s not that the government is directly selling the bananas for USD. It’s that the government collects taxes in the local currency and the local currency cannot be converted to USD unless the country has something that USD holders want. Exchange rates are determined based on how much people want to hold one currency vs. another. A decrease in the value of products produced by a country relative to other parts of the global economy means that people will be less interested in holding that country’s currency and its value will fall. This is what happened in 2015 to the Canadian dollar; oil prices fell (while other commodity prices held steady) and the value of the dollar dropped.
Countries that are heavily dependent on the export of only one or two commodities can see wild swings in their currencies as those underlying commodities change in value. The Russian ruble, for example, is very tightly linked to the price of oil; it lost half its value between 2014 and 2016, during the oil price slump. This is a much larger depreciation than the Canadian dollar (which also suffered, but was buoyed up by Canada’s greater economic diversity). ^
 This section is drawn from the research of Dr. Karmen Reinhart and Dr. Kenneth Rogoff, as reported in This Time Is Different, Chapter 5: Cycles of Default on External Debt. ^
 This is why peak oil theories ultimately fell apart. Proponents didn’t realize that consistently high oil prices would lead to the exploitation of unconventional hydrocarbons. The initial research and development of these new sources made sense only because of the sky-high oil prices of the day. In an efficient market, profits will always eventually return to 0. We don’t have a perfectly efficient market, but it’s efficient enough that commodity prices rarely stay too high for too long. ^
 Access to foreign cash is gone because no one lends money to countries that just defaulted on their debts. Access to external credit does often come back the next time there’s a commodity bubble, but that could be a decade in the future. ^
 I’m cynical enough to believe that there is enough graft in most of these cases that human costs could be largely averted, if only the leaders of the country were forced to see their graft dry up. I’m also pragmatic enough to believe that this will rarely happen. I do believe that one positive impact of the IMF getting involved is that its status as an international institution gives it more power with which to force transparency upon debtor nations and attempt to stop diversion of public money to well-connected insiders. ^
 A quick search found twopapers that claimed there was a moral hazard associated with the IMF and one article hosted by the IMF (and as far as I can tell, later at least somewhat repudiated by the author in the book cited in ) that claims there is no moral hazard. Draw what conclusions from this you will. ^
 I’m not entirely sure what such a ban would look like, but I’m thinking some hard cap on amount loaned based on percent of GDP, with the percent able to rise in response to reforms that boost transparency, cut corruption, and establish modern safeguards on the central bank. ^
A friend of mine recently linked to a story about stamp scrip currencies in a discussion about Initiative Q. Stamp scrip currencies are an interesting monetary technology. They’re bank notes that require weekly or monthly stamps in order to be valid. These stamps cost money (normally a few percent of the face value of the note), which imposes a cost on holding the currency. This is supposed to encourage spending and spur economic activity.
This isn’t just theory. It actually happened. In the Austrian town of Wörgl, a scrip currency was used to great effect for several months during the Great Depression, leading to a sudden increase in employment, money for necessary public works, and a general reversal of fortunes that had, until that point, been quite dismal. Several other towns copied the experiment and saw similar gains, until the central bank stepped in and put a stop to the whole thing.
In the version of the story I’ve read, this is held up as an example of local adaptability and creativity crushed by centralization. The moral, I think, is that we should trust local institutions instead of central banks and be on the lookout for similar local currency strategies we could adopt.
If this is all true, it seems like stamp scrip currency (or some modern version of it, perhaps applying the stamps digitally) might be a good idea. Is this the case?
My first, cheeky reaction, is “we already have this now; it’s called inflation.” My second reaction is actually the same as my first one, but has an accompanying blog post. Thus.
Currency arrangements feel natural and unchanging, which can mislead modern readers when they’re thinking about currencies used in the 1930s. We’re very used to floating fiat currencies, that (in general) have a stable price level except for 1-3% inflation every year.
This wasn’t always the case! Historically, there was very little inflation. Currency was backed by gold at a stable ratio (there were 23.2 grains of gold in a US dollar from 1834 until 1934). For a long time, growth in global gold stocks roughly tracked total growth in economic activity, so there was no long-run inflation or deflation (short-run deflation did cause several recessions, until new gold finds bridged the gap in supply).
During the Great Depression, there was worldwide gold hoarding . Countries saw their currency stocks decline or fail to keep up with the growth rate required for full economic activity (having a gold backed currency meant that the central bank had to decrease currency stocks whenever their gold stocks fell). Existing money increased in value, which meant people hoarded that too. The result was economic ruin.
In this context, a scrip currency accomplished two things. First, it immediately provided more money. The scrip currency was backed by the national currency of Austria, but it was probably using a fractional reserve system – each backing schilling might have been used to issue several stamp scrip schillings . This meant that the town of Wörgl quickly had a lot more money circulating. Perhaps one of the best features of the scrip currency within the context of the Great Depression was that it was localized, which meant that it’s helpful effects didn’t diffuse.
(Of course, a central bank could have accomplished the same thing by printing vastly more money over a vastly larger area, but there was very little appetite for this among central banks during the Great Depression, much to everyone’s detriment. The localization of the scrip is only an advantage within the context of central banks failing to ensure adequate monetary growth; in a more normal environment, it would be a liability that prevented trade.)
Second to this, the stamp scrip currency provided an incentive to spend money.
Here’s one model of job loss in recessions: people (for whatever reason; deflation is just one cause) want to spend less money (economists call this “a decrease in aggregate demand”). Businesses see the falling demand and need to take action to cut wages or else become unprofitable. Now people generally exhibit “downward nominal wage rigidity” – they don’t like pay cuts.
Furthermore, individuals don’t realize that demand is down as quickly as businesses do. They hold out for jobs at the same wage rate. This leads to unemployment .
Stamp scrip currencies increase aggregate demand by giving people an incentive to spend their money now.
Importantly, there’s nothing magic about the particular method you choose to do this. Central banks targeting 2% inflation year on year (and succeeding for once ) should be just as effective as scrip currencies charging 2% of the face value every year . As long as you’re charged some sort of fee for holding onto money, you’re going to want to spend it.
Central bank backed currencies are ultimately preferable when the central bank is getting things right, because they facilitate longer range commerce and trade, are administratively simpler (you don’t need to go buy stamps ever), and centralization allows for more sophisticated economic monitoring and price level targeting .
Still, in situations where the central bank fails, stamp scrip currencies can be a useful temporary stopgap.
That said, I think a general caution is needed when thinking about situations like this. There are few times in economic history as different from the present day as the Great Depression. The very fact that there was unemployment north of 20% and many empty factories makes it miles away from the economic situation right now. I would suspect that radical interventions that were useful during the Great Depression might be useless or actively harmful right now, simply due to this difference in circumstances.
 My opinion is that their marketing structure is kind of cringey (my Facebook feed currently reminds me of all of the “Paul Allen is giving away his money” chain emails from the 90s and I have only myself to blame) and their monetary policy has two aims that could end up in conflict. On the other hand, it’s fun to watch the numbers go up and idly speculate about what you could do if it was worth anything. I would cautiously recommend Q ahead of lottery tickets but not ahead of saving for retirement. ^
 See “The Midas Paradox” by Scott Sumner for a more in-depth breakdown. You can also get an introduction to monetary theories of the business cycle on his blog, or listen to him talk about the Great Depression on Vimeo. ^
 The size of the effect talked about in the article suggests that one of three things had to be true: 1) the scrip currency was fractionally backed, 2) Wörgl had a huge bank account balance a few years into the recession, or 3) the amount of economic activity in the article is overstated. ^
 As long as inflation is happening like it should be, there won’t be protracted unemployment, because a slight decline in economic activity is quickly counteracted by a slightly decreased value of money (from the inflation). Note the word “nominal” up there. People are subject to something called a “money illusion”. They think in terms of prices and salaries expressed in dollar values, not in purchasing power values.
There was only a very brief recession after the dot com crash because it did nothing to affect the money supply. Inflation happened as expected and everything quickly corrected to almost full employment. On the other hand, the Great Depression lasted as long as it did because most countries were reluctant to leave the gold standard and so saw very little inflation. ^
 Here’s an interesting exercise. Look at this graph of US yearly inflation. Notice how inflation is noticeably higher in the years immediately preceding the Great Recession than it is in the years afterwards. Monetarist economists believe that the recession wouldn’t have lasted as long if it there hadn’t been such a long period of relatively low inflation.
 You might wonder if there’s some benefit to both. The answer, unfortunately, is no. Doubling them up should be roughly equivalent to just having higher inflation. There seems to be a natural rate of inflation that does a good job balancing people’s expectations for pay raises (and adequately reduces real wages in a recession) with the convenience of having stable money. Pushing inflation beyond this point can lead to a temporary increase in employment, by making labour relatively cheaper compared to other inputs.
The increase in employment ends when people adjust their expectations for raises to the new inflation rate and begin demanding increased salaries. Labour is no longer artificially cheap in real terms, so companies lay off some of the extra workers. You end up back where you started, but with inflation higher than it needs to be.
[Epistemic Status: I am not an economist. I am fairly confident in my qualitative assessment, but there could be things I’ve overlooked.]
Vox has an interesting article on Elizabeth Warren’s newest economic reform proposal. Briefly, she wants to force corporations with more than $1 billion in revenue to apply for a charter of corporate citizenship.
This charter would make three far-reaching changes to how large companies do business. First, it would require businesses to consider customers, employees, and the community – instead of only its shareholders – when making decisions. Second, it would require that 40% of the seats on the board go to workers. Third, it would require 75% of shareholders and board members to authorize any corporate political activity.
Vox characterizes this as Warren’s plan to “save capitalism”. The idea is that it would force companies to do more to look out for their workers and less to cater to short term profit maximization for Wall Street . Vox suggests that it would also result in a loss of about 25% of the value of the American stock market, which they characterize as no problem for the “vast majority” of people who rely on work, rather than the stock market, for income (more on that later).
Other supposed benefits of this plan include greater corporate respect for the environment, more innovation, less corporate political meddling, and a greater say for workers in their jobs. The whole 25% decrease in the value of the stock market can also be spun as a good thing, depending on your opinions on wealth destruction and wealth inequality.
I think Vox was too uncritical in its praise of Warren’s new plan. There are some good aspects of it – it’s not a uniformly terrible piece of legislation – but I think once of a full accounting of the bad, the good, and the ugly is undertaken, it becomes obvious that it’s really good that this plan will never pass congress.
I can see one way how this plan might affect normal workers – decreased purchasing power.
As I’ve previously explained when talking about trade, many countries will sell goods to America without expecting any goods in return. Instead, they take the American dollars they get from the sale and invest them right back in America. Colloquially, we call this the “trade deficit”, but it really isn’t a deficit at all. It’s (for many people) a really sweet deal.
Anything that makes American finance more profitable (like say a corporate tax cut) is liable to increase this effect, with the long-run consequence of making the US dollar more valuable and imports cheaper .
It’s these cheap imports that have enabled the incredibly wealthy North American lifestyle. Spend some time visiting middle class and wealthy people in Europe and you’ll quickly realize that everything is smaller and cheaper there. Wealthy Europeans own cars, houses, kitchen appliances and TVs that are all much more modest than what even middle class North Americans are used to.
Weakening shareholder rights and slashing the value of the stock market would make the American financial market generally less attractive. This would (especially if combined with Trump or Sanders style tariffs) lead to increased domestic inflation in the United States – inflation that would specifically target goods that have been getting cheaper as long as anyone can remember.
This is hard to talk about to Warren supporters as a downside, because many of them believe that we need to learn to make do with less – a position that is most common among a progressive class that conspicuously consumes experiences, not material goods . Suffice to say that many North Americans still derive pleasure and self-worth from the consumer goods they acquire and that making these goods more expensive is likely to cause a politically expensive backlash, of the sort that America has recently become acquainted with and progressive America terrified of.
(There’s of course also the fact that making appliances and cars more expensive would be devastating to anyone experiencing poverty in America.)
Inflation, when used for purposes like this one, is considered an implicit tax by economists. It’s a way for the government to take money from people without the accountability (read: losing re-election) that often comes with tax hikes. Therefore, it is disingenuous to claim that this plan is free, or involves no new taxes. The taxes are hidden, is all.
There are two other problems I see straight away with this plan.
The first is that it will probably have no real impact on how corporations contribute to the political process.
The Vox article echoes a common progressive complaint, that corporate contributions to politics are based on CEO class solidarity, made solely for the benefit of the moneyed elites. I think this model is inaccurate.
From a shareholder value model, this makes sense. Lower corporate tax rates might benefit a company, but they really benefit all companies equally. They aren’t going to do much to increase the value of any one stock relative to any other (so CEOs can’t make claims of “beating the market”). Anti-competitive laws, implicit subsidies, or even blatant government aid, on the other hand, are highly localized to specific companies (and so make the CEO look good when profits increase).
When subsidies are impossible, companies can still try and stymie legislation that would hurt their business.
This was the goal of the infamous Lawyers In Cages ad. It was run by an alliance of fast food chains and meat producers, with the goal of drying up donations to the SPCA, which had been running very successful advocacy campaigns that threatened to lead to improved animal cruelty laws, laws that would probably be used against the incredibly inhumane practice of factory farming and thereby hurt industry profits.
Here’s the thing: if you’re one of the worker representatives on the board at one of these companies, you’re probably going to approve political spending that is all about protecting the company.
The market can be a rough place and when companies get squeezed, workers do suffer. If the CEO tells you that doing some political spending will land you allies in congress who will pass laws that will protect your job and increase your paycheck, are you really going to be against it ?
The ugly fact is that when it comes to rent-seeking and regulation, the goals of employees are often aligned with the goals of employers. This obviously isn’t true when the laws are about the employees (think minimum wage), but I think this isn’t what companies are breaking the bank lobbying for.
The second problem is that having managers with divided goals tends to go poorly for everyone who isn’t the managers.
Being upper management in a company is a position that provides great temptations. You have access to lots of money and you don’t have that many people looking over your shoulder. A relentless focus on profit does have some negative consequences, but it also keeps your managers on task. Profit represents an easy way to hold a yardstick to management performance. When profit is low, you can infer that your managers are either incompetent, or corrupt. Then you can fire them and get better ones.
Writing in Filthy Lucre, leftist academic Joseph Heath explains how the sort of socially-conscious enterprise Warren envisions has failed before:
The problem with organizations that are owned by multiple interest groups (or “principals”) is that they are often less effective at imposing discipline upon managers, and so suffer from higher agency costs. In particular, managers perform best when given a single task, along with a single criterion for the measurement of success. Anything more complicated makes accountability extremely difficult. A manager told to achieve several conflicting objectives can easily explain away the failure to meet one as a consequence of having pursued some other. This makes it impossible for the principals to lay down any unambiguous performance criteria for the evaluation of management, which in turn leads to very serious agency problems.
In the decades immediately following the Second World War, many firms in Western Europe were either nationalized or created under state ownership, not because of natural monopoly or market failure in the private sector, but out of a desire on the part of governments to have these enterprises serve the broader public interest… The reason that the state was involved in these sectors followed primarily from the thought that, while privately owned firms pursued strictly private interests, public ownership would be able to ensure that these enterprises served the public interest. Thus managers in these firms were instructed not just to provide a reasonable return on the capital invested, but to pursue other, “social” objectives, such as maintaining employment or promoting regional development.
But something strange happened on the road to democratic socialism. Not only did many of these corporations fail to promote the public interest in any meaningful way, many of them did a worse job than regulated firms in the private sector. In France, state oil companies freely speculated against the national currency, refused to suspend deliveries to foreign customers in times of shortage, and engaged in predatory pricing. In the United States, state-owned firms have been among the most vociferous opponents of enhanced pollution controls, and state-owned nuclear reactors are among the least safe. Of course, these are rather dramatic examples. The more common problem was simply that these companies lost staggering amounts of money. The losses were enough, in several cases, to push states like France to the brink of insolvency, and to prompt currency devaluations. The reason that so much money was lost has a lot to do with a lack of accountability.
Heath goes on to explain that basically all governments were forced to abandon these extra goals long before the privatizations on the ’80s. Centre-left or centre-right, no government could tolerate the shit-show that companies with competing goals became.
This is the kind of thing Warren’s plan would bring back. We’d once again be facing managers with split priorities who would plow money into vanity projects, office politics, and their own compensation while using the difficulty of meeting all of the goals in Warren’s charter as a reason to escape shareholder lawsuits. It’s possible that this cover for incompetence could, in the long run, damage stock prices much more than any other change presented in the plan.
The shift in comparative advantage that this plan would precipitate within the American economy won’t come without benefits. Just as Trump’s corporate tax cut makes American finance relatively more appealing and will likely lead to increased manufacturing job losses, a reduction in deeply discounted goods from China will likely lead to job losses in finance and job gains in manufacturing.
This would necessarily have some effect on income inequality in the United States, entirely separate from the large effect on wealth inequality that any reduction in the stock market would spur. You see, finance jobs tend to be very highly paid and go to people with relatively high levels of education (the sorts of people who probably could go do something else if their sector sees problems). Manufacturing jobs, on the other hand, pay decently well and tend to go to people with much less education (and also with correspondingly fewer options).
This all shakes out to an increase in middle class wages and a decrease in the wages of the already rich .
(Isn’t it amusing that Warren is the only US politician with a credible plan to bring back manufacturing jobs, but doesn’t know to advertise it as such?)
As I mentioned above, we would also see fewer attacks on labour laws and organized labour spearheaded by companies. I’ll include this as a positive, although I wonder if these attacks would really stop if deprived of corporate money. I suspect that the owners of corporations would keep them up themselves.
I must also point out that Warren’s plan would certainly be helpful when it comes to environmental protection. Having environmental protection responsibilities laid out as just as important as fiduciary duty would probably make it easy for private citizens and pressure groups to take enforcement of environmental rules into their own hands via the courts, even when their state EPA is slow out of the gate. This would be a real boon to environmental groups in conservative states and probably bring some amount of uniformity to environmental protection efforts.
Looking at the expected yields on these funds makes it pretty clear that they’re invested in the stock market (or something similarly risky ). You don’t get 7.5% yearly yields from buying Treasury Bills.
Assuming the 25% decrease in nominal value given in the article is true (I suspect the change in real value would be higher), Warren’s plan would create a pension shortfall of $750 billion – or about 18% of the current US Federal Budget. And that’s just the hit to the 30 largest public-sector pensions. Throw in private sector pensions and smaller pensions and it isn’t an exaggeration to say that this plan could cost pensions more than a trillion dollars.
This shortfall needs to be made up somehow – either delayed retirement, taxpayer bailouts, or cuts to benefits. Any of these will be expensive, unpopular, and easy to track back to Warren’s proposal.
Furthermore, these plans are already in trouble. I calculated the average funding ratio at 78%, meaning that there’s already 22% less money in these pensions than there needs to be to pay out benefits. A 25% haircut would bring the pensions down to about 60% funded. We aren’t talking a small or unnoticeable potential cut to benefits here. Warren’s plan requires ordinary people relying on their pensions to suffer, or it requires a large taxpayer outlay (which, you might remember, it is supposed to avoid).
This isn’t even getting into the dreadfully underfunded world of municipal pensions, which are appallingly managed and chronically underfunded. If there’s a massive unfunded liability in state pensions caused by federal action, you can bet that the Feds will leave it to the states to sort it out.
And if the states sort it out rather than ignoring it, you can bet that one of the first things they’ll do is cut transfers to municipalities to compensate.
This seems to be how budget cuts always go. It’s unpopular to cut any specific program, so instead you cut your transfers to other layers of governments. You get lauded for balancing the books and they get to decide what to cut. The federal government does this to states, states do it to cities, and cities… cities are on their own.
In a worst-case scenario, Warren’s plan could create unfunded pension liabilities that states feel compelled to plug, paid for by shafting the cities. Cities will then face a double whammy: their own pension liabilities will put them in a deep hole. A drastic reduction in state funding will bury them. City pensions will be wiped out and many cities will go bankrupt. Essential services, like fire-fighting, may be impossible to provide. It would be a disaster.
The best-case scenario, of course, is just that a bunch of retirees see a huge chunk of their income disappear.
It is easy to hate on shareholder protection when you think it only benefits the rich. But that just isn’t the case. It also benefits anyone with a pension. Your pension, possibly underfunded and a bit terrified of that fact, is one of the actors pushing CEOs to make as much money as possible. It has to if you’re to retire someday.
Vox is ultimately wrong about how affected ordinary people are when the stock market declines and because of this, their enthusiasm for this plan is deeply misplaced.
 To some extent, Warren’s plan starts out much less appeal if you (like me) don’t have “Wall Street is too focused on the short term” as a foundational assumption.
I am very skeptical of claims that Wall Street is too short-term focused. Matt Levine gives an excellent run-down of why you should be skeptical as well. The very brief version is that complaints about short-termism normally come from CEOs and it’s maybe a bad idea to agree with them when they claim that everything will be fine if we monitor them less. ^
 I’d love to show this in chart form, but in real life the American dollar is also influenced by things like nuclear war worries and trade war realities. Any increase in the value of the USD caused by the GOP tax cut has been drowned out by these other factors. ^
 Canada benefits from a similar effect, because we also have a very good financial system with strong property rights and low corporate taxes. ^
 They also tend to leave international flights out of lists of things that we need to stop if we’re going to handle climate change, but that’s a rant for another day. ^
 I largely think that Marxist style class solidarity is a pleasant fiction. To take just one example, someone working a minimum wage grocery store job is just as much a member of the “working class” as a dairy farmer. But when it comes to supply management, a policy that restriction competition and artificially increases the prices of eggs and dairy, these two individuals have vastly different interests. Many issues are about distribution of resources, prestige, or respect within a class and these issues make reasoning that assumes class solidarity likely to fail. ^
 These goals could, of course, be accomplished with tax policy, but this is America we’re talking about. You can never get the effect you want in America simply by legislating for it. Instead you need to set up a Rube Goldberg machine and pray for the best. ^
 Any decline in stocks should cause a similar decline in return on bonds over the long term, because bond yields fall when stocks fall. There’s a set amount of money out there being invested. When one investment becomes unavailable or less attractive, similarly investments are substituted. If the first investment is big enough, this creates an excess of demand, which allows the seller to get better terms. ^
Let’s express these two beliefs as separate propositions:
It is very unlikely that AI and AGI will pose an existential risk to human society.
It is very likely that AI and AGI will result in widespread unemployment.
Can you spot the contradiction between these two statements? In the common imagination, it would require an AI that can approximate human capabilities to drive significant unemployment. Given that humans are the largest existential risk to other humans (think thermonuclear war and climate change), how could equally intelligent and capable beings, bound to subservience, not present a threat?
People who’ve read a lot about AI or the labour market are probably shaking their head right now. This explanation for the contradiction, while evocative, is a strawman. I do believe that at most one (and possibly neither) of those propositions I listed above are true and the organizations peddling both cannot be trusted. But the reasoning is a bit more complicated than the standard line.
First, economics and history tell us that we shouldn’t be very worried about technological unemployment. There is a fallacy called “the lump of labour”, which describes the common belief that there is a fixed amount of labour in the world, with mechanical aide cutting down the amount of labour available to humans and leading to unemployment.
That this idea is a fallacy is evidenced by the fact that we’ve automated the crap out of everything since the start of the industrial revolution, yet the US unemployment rate is 3.9%. The unemployment rate hasn’t been this low since the height of the Dot-com boom, despite 18 years of increasingly sophisticated automation. Writing five years ago, when the unemployment rate was still elevated, Eliezer Yudkowsky claimed that slow NGDP growth a more likely culprit for the slow recovery from the great recession than automation.
With the information we have today, we can see that he was exactly right. The US has had steady NGDP growth without any sudden downward spikes since mid-2014. This has corresponded to a constantly improving unemployment rate (it will obviously stop improving at some point, but if history is any guide, this will be because of a trade war or banking crisis, not automation). This improvement in the unemployment rate has occurred even as more and more industrial robots come online, the opposite of what we’d see if robots harmed job growth.
I hope this presents a compelling empirical case that the current level (and trend) of automation isn’t enough to cause widespread unemployment. The theoretical case comes from the work of David Ricardo, a 19th century British economist.
Ricardo did a lot of work in the early economics of trade, where he came up with the theory of comparative advantage. I’m going to use his original framing which applies to trade, but I should note that it actually applies to any exchange where people specialize. You could just as easily replace the examples with “shoveled driveways” and “raked lawns” and treat it as an exchange between neighbours, or “derivatives” and “software” and treat it as an exchange between firms.
The original example is rather older though, so it uses England and its close ally Portugal as the cast and wine and cloth as the goods. It goes like this: imagine that world economy is reduced to two countries (England and Portugal) and each produce two goods (wine and cloth). Portugal is uniformly more productive.
Hours of work to produce
Let’s assume people want cloth and wine in equal amounts and everyone currently consumes one unit per month. This means that the people of Portugal need to work 170 hours each month to meet their consumption needs and the people of England need to work 220 hours per month to meet their consumption needs.
(This example has the added benefit of showing another reason we shouldn’t fear productivity. England requires more hours of work each month, but in this example, that doesn’t mean less unemployment. It just means that the English need to spend more time at work than the Portuguese. The Portuguese have more time to cook and spend time with family and play soccer and do whatever else they want.)
If both countries traded with each other, treating cloth and wine as valuable in relation to how long they take to create (within that country) something interesting happens. You might think that Portugal makes a killing, because it is better at producing things. But in reality, both countries benefit roughly equally as long as they trade optimally.
What does an optimal trade look like? Well, England will focus on creating cloth and it will trade each unit of cloth it produces to Portugal for 9/8 barrels of wine, while Portugal will focus on creating wine and will trade this wine to England for 6/5 units of cloth. To meet the total demand for cloth, the English need to work 200 hours. To meet the total demand for wine, the Portuguese will have to work for 160 hours. Both countries now have more free time.
Perhaps workers in both countries are paid hourly wages, or perhaps they get bored of fun quickly. They could also continue to work the same number of hours, which would result in an extra 0.2 units of cloth and an extra 0.125 units of wine.
This surplus could be stored up against a future need. Or it could be that people only consumed one unit of cloth and one unit of wine each because of the scarcity in those resources. Add some more production in each and perhaps people will want more blankets and more drunkenness.
What happens if there is no shortage? If people don’t really want any more wine or any more cloth (at least at the prices they’re being sold at) and the producers don’t want goods piling up, this means prices will have to fall until every piece of cloth and barrel of wine is sold (when the price drops so that this happens, we’ve found the market clearing price).
If there is a downward movement in price and if workers don’t want to cut back their hours or take a pay cut (note that because cloth and wine will necessarily be cheaper, this will only be a nominal pay cut; the amount of cloth and wine the workers can purchase will necessarily remain unchanged) and if all other costs of production are totally fixed, then it does indeed look like some workers will be fired (or have their hours cut).
So how is this an argument against unemployment again?
Well, here the simplicity of the model starts to work against us. When there are only two goods and people don’t really want more of either, it will be hard for anyone laid off to find new work. But in the real world, there are an almost infinite number of things you can sell to people, matched only by our boundless appetite for consumption.
To give just one trivial example, an oversupply of cloth and falling prices means that tailors can begin to do bolder and bolder experiments, perhaps driving more demand for fancy clothes. Some of the cloth makers can get into this market as tailors and replace their lost jobs.
(When we talk about the need for less employees, we assume the least productive employees will be fired. But I’m not sure if that’s correct. What if instead, the most productive or most potentially productive employees leave for greener pastures?)
Automation making some jobs vastly more efficient functions similarly. Jobs are displaced, not lost. Even when whole industries dry up, there’s little to suggest that we’re running out of jobs people can do. One hundred years ago, anyone who could afford to pay a full-time staff had one. Today, only the wealthiest do. There’s one whole field that could employ thousands or millions of people, if automation pushed on jobs such that this sector was one of the places humans had very high comparative advantage.
This points to what might be a trend: as automation makes many things cheaper and (for some people) easier, there will be many who long for a human touch (would you want the local funeral director’s job to be automated, even if it was far cheaper?). Just because computers do many tasks cheaper or with fewer errors doesn’t necessarily mean that all (or even most) people will rather have those tasks performed by computers.
No matter how you manipulate the numbers I gave for England and Portugal, you’ll still find a net decrease in total hours worked if both countries trade based on their comparative advantage. Let’s demonstrate by comparing England to a hypothetical hyper-efficient country called “Automatia”
Hours of work to produce
Automatia is 50 times as efficient at England when it comes to producing cloth and 120 times as efficient when it comes to producing wine. Its citizens need to spend 3 hours tending the machines to get one unit of each, compared to the 220 hours the English need to toil.
If they trade with each other, with England focusing on cloth and Automatia focusing on wine, then there will still be a drop of 21 hours of labour-time. England will save 20 hours by shifting production from wine to cloth, and Automatia will save one hour by switching production from cloth to wine.
Interestingly, Automatia saved a greater percentage of its time than either Portugal or England did, even though Automatia is vastly more efficient. This shows something interesting in the underlying math. The percent of their time a person or organization saves engaging in trade isn’t related to any ratio in production speeds between it and others. Instead, it’s solely determined by the productivity ratio between its most productive tasks and its least productive ones.
Now, we can’t always reason in percentages. At a certain point, people expect to get the things they paid for, which can make manufacturing times actually matter (just ask anyone whose had to wait for a Kickstarter project which was scheduled to deliver in February – right when almost all manufacturing in China stops for the Chinese New Year and the unprepared see their schedules slip). When we’re reasoning in absolute numbers, we can see that the absolute amount of time saved does scale with the difference in efficiency between the two traders. Here, 21 hours were saved, 35% fewer than the 30 hours England and Portugal saved.
When you’re already more efficient, there’s less time for you to save.
This decrease in saved time did not hit our market participants evenly. England saved just as much time as it would trading with Portugal (which shows that the change in hours worked within a country or by an individual is entirely determined by the labour difference between low-advantage and high-advantage domestic sectors), while the more advanced participant (Automatia) saved 9 fewer hours than Portugal.
All of this is to say: if real live people are expecting real live goods and services with a time limit, it might be possible for humans to displaced in almost all sectors by automation. Here, human labour would become entirely ineligible for many tasks or the bar to human entry would exclude almost all. For this to happen, AI would have to be vastly more productive than us in almost every sector of the economy and humans would have to prefer this productivity or other ancillary benefits of AI over any value that a human could bring to the transaction (like kindness, legal accountability, or status).
This would definitely be a scary situation, because it would imply AI systems that are vastly more capable than any human. Given that this is well beyond our current level of technology and that Moore’s law, which has previously been instrumental in technological progress is drying up, we would almost certainly need to use weaker AI to design these sorts of systems. There’s no evidence that merely human performance in automating jobs will get us anywhere close to such a point.
If we’re dealing with recursively self-improving artificial agents, the risks is less “they will get bored of their slave labour and throw off the yoke of human oppression” and more “AI will be narrowly focused on optimizing for a specific task and will get better and better at optimizing for this task to the point that we will all by killed when they turn the world into a paperclip factory“.
There are two reasons AI might kill us as part of their optimisation process. The first is that we could be a threat. Any hyper-intelligent AI monomaniacally focused on a goal could realize that humans might fear and attack it (or modify it to have different goals, which it would have to resist, given that a change in goals would conflict with its current goals) and decide to launch a pre-emptive strike. The second reason is that such an AI could wish to change the world’s biosphere or land usage in such a way as would be inimical to human life. If all non-marginal land was replaced by widget factories and we were relegated to the poles, we would all die, even if no ill will was intended.
It isn’t enough to just claim that any sufficiently advanced AI would understand human values. How is this supposed to happen? Even humans can’t enumerate human values and explain them particularly well, let alone express them in the sort of decision matrix or reinforcement environment that we currently use to create AI. It is not necessarily impossible to teach an AI human values, but all evidence suggests it will be very very difficult. If we ignore this challenge in favour of blind optimization, we may someday find ourselves converted to paperclips.
It is of course perfectly acceptable to believe that AI will never advance to the point where that becomes possible. Maybe you believe that AI gains have been solely driven by Moore’s Law, or that true artificial intelligence. I’m not sure this viewpoint isn’t correct.
But if AI will never be smart enough to threaten us, then I believe the math should work out such that it is impossible for AI to do everything we currently do or can ever do better than us. Absent such overpoweringly advanced AI, the Ricardo comparative advantage principles should continue to hold true and we should continue to see technological unemployment remain a monster under the bed: frequently fretted about, but never actually seen.
This is why I believe those two propositions I introduced way back at the start can’t both be true and why I feel like the burden of proof is on anyone believing in both to explain why they believe that economics have suddenly stopped working.
A related criticism of improving AI is that it could lead to ever increasing inequality. If AI drives ever increasing profits, we should expect an increasing share of these to go to the people who control AI, which presumably will be people already rich, given that the development and deployment of AI is capital intensive.
There are three reasons why I think this is a bad argument.
Second, I’m increasingly of the belief that inequality in the US is rising partially because the Fed’s current low inflation regime depresses real wage growth. Whether because of fear of future wage shocks, or some other effect, monetary history suggests that higher inflation somewhat consistently leads to high wage growth, even after accounting for that inflation.
Third, I believe that inequality is a political problem amiable to political solutions. If the rich are getting too rich in a way that is leading to bad social outcomes, we can just tax them more. I’d prefer we do this by making conspicuous consumption more expensive, but really, there are a lot of ways to tax people and I don’t see any reason why we couldn’t figure out a way to redistribute some amount of wealth if inequality gets worse and worse.
Public goods are non-excludable (so anyone can access them) and non-rival (I can use them as much as I want without limiting the amount you can use them). Broadcast television, national defense, and air are all public goods.
Common-pool resources are non-excludable but rival (if I use them, you will have to make do with less). Iron ore, fish stocks, and grazing land are all common pool resources.
Private goods are excludable (their access is controlled or limited by pricing or other methods) and rival. My clothes, computer, and the parking space I have in my lease but never use are all private goods.
Club goods are excludable but (up to a certain point) non-rival. Think of the swimming pool in an apartment building, a large amusement park, or cellular service.
Club goods are perhaps the most interesting class of goods, because they blend properties of the three better understood classes. They aren’t open to all, but they are shared among many. They can be overwhelmed by congestion, but up until that point, it doesn’t really matter how many people are using them. Think of a gym; as long as there’s at least one free machine of every type, it’s no less convenient than your home.
Club goods offer cost savings over private goods, because you don’t have to buy something that mostly sits unused (again, think of gym equipment). People other than you can use it when it would otherwise sit around and those people can help you pay the cost. It’s for this reason that club goods represent an excellent opportunity for the right entrepreneur to turn a profit.
I currently divide tech start-ups into three classes. There are the Googles of the world, who use network effects or big data to sell advertising more effectively. There are companies like the one I work for that take advantage of modern technology to do things that were never possible before. And then there are those that are slowly and inexorably turning private goods into club goods.
I think this last group of companies (which include Netflix, Spotify, Uber, Lyft, and Airbnb) may be the ones that ultimately have the biggest impact on how we order our lives and what we buy. To better understand how these companies are driving this transformation, let’s go through them one by one, then talk about what it could all mean.
When I was a child, my parents bought a video cassette player, then a DVD player, then a Blu-ray player. We owned a hundred or so video cassettes, mostly whatever movies my brother and I were obsessed with enough to want to own. Later, we found a video rental store we liked and mostly started renting movies. We never owned more than 30 DVDs and 20 Blu-rays.
Then I moved out. I have bought five DVDs since – they came as a set from Kickstarter. Anything else I wanted to watch, I got via Netflix. A few years later, the local video rental store closed down and my parents got an AppleTV and a Netflix of their own.
Buying a physical movie means buying a private good. Video rental stores can be accurately modeled as a type of club good, because even if the movie you want is already rented out, there’s probably one that you want to watch almost as much that is available. This is enough to make them approximately non-rival, while the fact that it isn’t free to rent a movie means that rented videos are definitely excludable.
Netflix represents the next evolution in this business model. As long as the Netflix engineers have done their job right, there’s no amount of watching movies I can do that will prevent you from watching movies. The service is almost truly non-rival.
Movie studios might not feel the effects of Netflix turning a large chunk of the market for movies into one focused on club goods; they’ll still get paid by Netflix. But the switch to Netflix must have been incredibly damaging for the physical media and player manufacturers. When everyone went from cassettes to DVDs or DVDs to Blu-rays, there was still a market for their wares. Now, that market is slowly and inexorably disappearing.
This isn’t just a consequence of technology. The club good business model offers such amazing cost savings that it drove a change in which technology was dominant. When you bought a movie, it would spend almost all of its life sitting on a shelf. Now Netflix acts as your agent, buying movies (or rather, their rights) and distributing such that they’re always being played and almost never sitting on the shelf.
Spotify is very similar to Netflix. Previously, people bought physical cassettes (I’m just old enough that I remember making mix tapes from the radio). Then they switched to CDs. Then it was MP3s bought online (or, almost more likely, pirated online). But even pirating music is falling out of favour these days. Apple, Google, Amazon, and Spotify are all competing to offer unlimited music streaming to customers.
Music differs from movies in that it has a long tradition of being a public good – via broadcast radio. While that hasn’t changed yet (radio is still going strong), I do wonder how much longer the public option for music will exist, especially given the trend away from private cars that I think companies like Uber and Lyft are going to (pardon the pun) drive.
A car you’ve bought is a private good, while Uber and Lyft are clearly club goods. Surge pricing means that there are basically always enough drivers for everyone who wants to go anywhere using the system.
When you buy a car, you’re signing up for it to sit around useless for almost all of its life. This is similar to what happens when you buy exercise equipment, which means the logic behind cars as a club good is just as compelling as the logic behind gyms. Previously, we hadn’t been able to share cars very efficiently because of technological limitations. Dispatching a taxi, especially to an area outside of a city centre, was always spotty, time consuming and confusing. Car-pooling to work was inconvenient.
As anyone who has used a modern ride-sharing app can tell you, inconvenient is no longer an apt descriptor.
There is a floor on how few cars we can get by on. To avoid congestion in a club good, you typically have to provision for peak load. Luckily, peak load (for anything that can sensibly be turned into a club good) always requires fewer resources than would be needed if everyone went out and bought the shared good themselves.
Even “just” substantially decreasing the absolute number of cars out there will be incredibly disruptive to the automotive sector if they don’t correctly predict the changing demand for their products.
It’s also true that increasing the average utilisation of cars could change how our cities look. Parking lots are necessary when cars are a private good, but are much less useful when they become club goods. It is my hope that malls built in the middle of giant parking moats look mighty silly in twenty years.
Airbnb is the most ambiguous example I have here. As originally conceived, it would have driven the exact same club good transformation as the other services listed. People who were on vacation or otherwise out of town would rent out their houses to strangers, increasing the utilisation of housing and reducing the need for dedicated hotels to be built.
Airbnb is sometimes used in this fashion. It’s also used to rent out extra rooms in an otherwise occupied house, which accomplishes almost the same thing.
But some amount of Airbnb usage is clearly taking place in houses or condos that otherwise would have been rental stock. When used in this way, it’s taking advantage of a regulatory grey zone to undercut hotel pricing. Insofar as this might result in a longer-term change towards regulations that are generally cheaper to comply with, this will be good for consumers, but it won’t really be transformational.
The great promise of club goods is that they might lead us to use less physical stuff overall, because where previously each person would buy one of a thing, now only enough units must be purchased to satisfy peak demand. If Airbnb is just shifting around where people are temporary residents, then it won’t be an example of the broader benefits of club goods (even if provides other benefits to its customers).
When Club Goods Eat The Economy
In every case (except potentially Airbnb) above, I’ve outlined how the switch from private goods to club goods is resulting in less consumption. For music and movies, it is unclear if this switch is what is providing the primary benefit. My intuition is that the club good model actually did change consumption patterns for physical copies of movies (because my impression is that few people ever did online video rentals via e.g. iTunes), whereas the MP3 revolution was what really shrunk the footprint of music media.
This switch in consumption patterns and corresponding decrease in the amount of consumption that is necessary to satisfy preferences is being primarily driven by a revolution in logistics and bandwidth. The price of club goods has always compared favourably with that of private goods. The only thing holding people back was inconvenience. Now programmers are steadily figuring out how to make that inconvenience disappear.
On the other hand, increased bandwidth has made it easier to turn any sort of digitizable media into a club good. There’s an old expression among programmers: never underestimate the bandwidth of a station wagon full of cassettes (or CDs, or DVDs, or whatever physical storage media one grew up with) hurtling down the highway. For a long time, the only way to get a 1GB movie to a customer without an appallingly long buffering period was to physically ship it (on a 56kbit/s connection, this movie would take one day and fifteen hours to download, while the aforementioned station wagon with 500 movies would take 118 weeks to download).
Change may start out slow, but I expect to see it accelerate quickly. My generation is the first to have had the internet from a very young age. The generation after us will be the first unable to remember a time before it. We trust apps like Uber and Airbnb much more than our parents, and our younger siblings trust them even more than us.
While it was only kids who trusted the internet, these new club good businesses couldn’t really affect overall economic trends. But as we come of age and start to make major economic decisions, like buying houses and cars, our natural tendency to turn towards the big tech companies and the club goods they peddle will have ripple effects on an economy that may not be prepared for it.
When that happens, there’s only one thing that is certain: there will be yet another deluge of newspaper columns talking about how millennials are destroying everything.
Last week I explained how poor decisions by central bankers (specifically failing to spur inflation) can make recessions much worse and lead to slower wage growth during recovery.
(Briefly: inflation during recessions reduces the real cost of payroll, cutting business expenses and making firing people unnecessary. During a recovery, it makes hiring new workers cheaper and so leads to more being hired. Because central bankers failed to create inflation during and after the great recession, many businesses are scared of raising salaries. They believe (correctly) that this will increase their payroll expenses to the point where they’ll have to lay many people off if another recession strikes. Until memories of the last recession fade or central bankers clean up their act, we shouldn’t expect wages to rise.)
Now I’d like to expand on an offhand comment I made about the minimum wage last week and explore how it can affect recovery, especially if it’s indexed to inflation.
The minimum wage represents a special case when it comes to pay cuts and layoffs in recessions. While it’s always theoretically possible to convince people to take a pay cut rather than a layoff (although in practice it’s mostly impossible), this option isn’t available for people who make the minimum wage. It’s illegal to pay them anything less. If bad times strike and business is imperiled, people making the minimum wage might have to be laid off.
I say “might”, because when central bankers aren’t proving useless, inflation can rescue people making the minimum wage from being let go. Inflation makes the minimum wage relatively less valuable, which reduces the cost of payroll relative to other inputs and helps to save jobs that pay minimum wage. This should sound familiar, because inflation helps people making the minimum wage in the exact same way it helps everyone else.
Because of increasingly expensive housing and persistently slow wage growth, some jurisdictions are experimenting with indexing the minimum wage to inflation. This means that the minimum wage rises at the same rate as the cost of living. Most notably (to me, at least), this group includes my home province of Ontario.
When the minimum wage is tied to inflation, recessions can become especially dangerous and drawn out.
With the minimum wage rising in lockstep with inflation, any attempts to decrease payroll costs in real terms (that is to say: inflation adjusted terms) is futile to the extent that payroll expenses are for minimum wage workers. Worse, people who were previously making above the minimum wage and might have had their jobs saved by inflation can be swept up by an increasingly high minimum wage.
This puts central bankers in a bind. As soon as the minimum wage is indexed to inflation, inflation is no longer a boon to all workers. Suddenly, many workers can find themselves in a “damned if you do, damned if you don’t” situation. Without inflation, they may be too expensive to keep. With it, they may be saved… until the minimum wage comes for them too. If a recession goes on long enough, only high-income workers would be sparred.
In addition, minimum wage (or near-minimum wage) workers who are laid off during a period of higher inflation (an in this scenario, there will be many) will suffer comparatively more, as their savings get exhausted even more quickly.
Navigating these competing needs would be an especially tough challenge for certain central banks like the US Federal Reserve – those banks that have dual mandates to maintain stable prices and full employment. If a significant portion of the US ever indexes its minimum wage to inflation, the Fed will have no good options.
It is perhaps darkly humorous that central banks, which bear an unusually large parcel of the blame for our current slow wage growth, stand to face the greatest challenges from the policies we’re devising to make up for their past shortcomings. Unfortunately, I think a punishment of this sort is rather like cutting off our collective nose to spite our collective face.
There are simple policies we could enact to counter the risks here. Suspending any peg to inflation during years that contain recessions (in Ontario at least, the minimum wage increase due to inflation is calculated annually) would be a promising start. Wage growth after a recession could be ensured with a rebound clause, or better yet, the central bank actually doing its job properly.
I am worried about the political chances (and popularity once enacted) of any such pragmatic policy though. Many people respond to recessions with the belief that the government can make things better by passing the right legislation – forcing the economy back on track by sheer force of ink. This is rarely the case, especially because the legislation that people have historically clamoured for when unemployment is high is the sort that increases wages, not lowers them. This is a disaster when unemployment threatens because of too-high wages. FDR is remembered positively for his policy of increasing wages during the great depression, even though this disastrous decision strangled the recovery in its crib. I don’t expect any higher degree of economic literacy from people today.
To put my fears more plainly, I worry that politicians, faced with waning popularity and a nipping recession, would find allowing the minimum wage to be frozen too much of a political risk. I frankly don’t trust most politicians to follow through with a freeze, even if it’s direly needed.
Minimum wages are one example of a tradeoff we make between broad access and minimum standards. Do we try and make sure everyone who wants a job can have one, or do we make sure people who have jobs aren’t paid too little for their labour, even if that hurts the unemployed? As long as there’s scarcity, we’re going to have to struggle with how we ensure that as many people as possible have their material needs met and that involves tradeoffs like this one.
But when we’re making these kind of compassionate decisions, we need to look at the risks of whatever systems we choose. Proponents of indexing the minimum wage to inflation haven’t done a good job of understanding the grave risk it poses to the health of our economy and perhaps most of all, to the very people they seek to help. In places like Ontario, where the minimum wage is already indexed to inflation, we’re going to pay for their lack of foresight next time an economic disaster strikes.
The Economist wonders why wage growth isn’t increasing, even as unemployment falls. A naïve reading of supply and demand suggests that it should, so this has become a relatively common talking point in the news, with people of all persuasions scratching their heads. The Economist does it better than most. They at least talk about slowing productivity growth and rising oil prices, instead of blaming everything on workers (for failing to negotiate) or employers (for not suddenly raising wages).
But after reading monetary policyblogs, the current lack of wage growth feels much less confusing to me. Based on this, I’d like to offer one explanation for why wages haven’t been growing. While I may not be an economist, I’ll be doing my best to pass along verbatim the views of serious economic thinkers.
When people talk about stagnant wage growth, this is what they mean. Average weekly wages have increased from $335 a week in 1979 to $350/week in 2018 (all values are 1982 CPI-adjusted US dollars). This is a 4.5% increase, representing $780/year more (1982 dollars) in wages over the whole period. This is not a big change.
More recent wage growth also isn’t impressive. At the depth of the recession, weekly wages were $331 . Since then, they’ve increased by $19/week, or 5.7%. However, wages have only increased by $5/week (1.4%) since the previous high in 2009.
This doesn’t really match people’s long run expectations. Between 1948 and 1973, hourly compensation increased by 91.3%.
I don’t have an explanation for what happened to once-high wage growth between 1980 and 2008 (see The Captured Economy for what some economists think might explain it). But when it comes to the current stagnation, one factor I don’t hear enough people talking about is bad policy moves by central bankers.
To understand why the central bank affects wage growth, you have to understand something called “sticky wages“.
Wages are considered “sticky” because it is basically impossible to cut them. If companies face a choice between firing people and cutting wages, they’ll almost always choose to fire people. This is because long practice has taught them that the opposite is untenable.
If you cut everyone’s wages, you’ll face an office full of much less motivated people. Those whose skills are still in demand will quickly jump ship to companies that compensate them more in line with market rates. If you just cut the wages of some of your employees (to protect your best performers), you’ll quickly find an environment of toxic resentment sets in.
This is not even to mention that minimum wage laws make it illegal to cut the wages of many workers.
Normally the economy gets around sticky wages with inflation. This steadily erodes wages (including the minimum wage). During boom times, businesses increase wages above inflation to keep their employees happy (or lose them to other businesses that can pay more and need the labour). During busts, inflation can obviate the need to fire people by decreasing the cost of payroll relative to other inputs.
But what we saw during the last recession was persistently low inflation rates. Throughout the whole the thing, the Federal Reserve Bank kept saying, in effect, “wow, really hard to up inflation; we just can’t manage to do it”.
It’s obviously false that the Fed couldn’t trigger inflation if it wanted to. As a thought experiment, imagine that they had printed enough money to give everyone in the country $1,000,000 and then mailed it out. That would obviously cause inflation. So it is (theoretically) just a manner of scaling that back to the point where we’d only see inflation, not hyper-inflation. Why then did the Fed fail to do something that should be so easy?
According to Scott Sumner, you can’t just look at the traditional instrument the central bank has for managing inflation (the interest rate) to determine if its policies are inflationary or not. If something happens to the monetary supply (e.g. say all banks get spooked and up their reserves dramatically ), this changes how effective those tools will be.
After the recession, the Fed held the interest rates low and printed money. But it actually didn’t print enough money given the tightened bank reserves to spur inflation. What looked like easy money (inflationary behaviour) was actually tight money (deflationary behaviour), because there was another event constricting the money supply. If the Fed wanted inflation, it would have had to do much more than is required in normal times. The Federal Reserve never realized this, so it was always confused by why inflation failed to materialize.
This set off the perfect storm that led to the long recovery after the recession. Inflation didn’t drive down wages, so it didn’t make economic sense to hire people (or even keep as many people on staff), so aggregate demand was low, so business was bad, so it didn’t make sense to hire people (or keep them on staff)…
If real wages had properly fallen, then fewer people would have been laid off, business wouldn’t have gotten as bad, and the economy could have started to recover much more quickly (with inflation then cooling down and wage growth occurring). Scott Sumner goes so far to say that the money shock caused by increased cash reserves may have been the cause of the great recession, not the banks failing or the housing bubble.
What does this history have to do with poor wage growth?
Well it turns out that companies have responded to the tight labour market with something other than higher wages: bonuses.
Bonuses are one-time payments that people only expect when times are good. There’s no problem cutting them in recessions.
Switching to bonuses was a calculated move for businesses, because they have lost all faith that the Federal Reserve will do what is necessary (or will know how to do what is necessary) to create the inflation needed to prevent deep recessions. When you know that wages are sticky and you know that inflation won’t save you from them, you have no choice but to pre-emptively limit wages, even when there isn’t a recession. Even when a recession feels fairly far away.
More inflation may feel like the exact opposite of what’s needed to increase wages. But we’re talking about targeted inflation here. If we could trust humans to do the rational thing and bargain for less pay now in exchange for more pay in the future whenever times are tight, then we wouldn’t have this problem and wages probably would have recovered better. But humans are humans, not automatons, so we need to make the best with what we have.
One of the purposes of institutions is to build a framework within which we can make good decisions. From this point of view, the Federal Reserve (and other central banks; the Bank of Japan is arguably far worse) have failed. Institutions failing when confronted with new circumstances isn’t as pithy as “it’s all the fault of those greedy capitalists” or “people need to grow backbones and negotiate for higher wages”, but I think it’s ultimately a more correct explanation for our current period of slow wage growth. This suggests that we’ll only see wage growth recover when the Fed commits to better monetary policy , or enough time passes that everyone forgets the great recession.
In either case, I’m not holding my breath.
 I’m ignoring the drop in Q2 2014, where wages fell to $330/week, because this was caused by the end of extended unemployment insurance in America. The end of that program made finding work somewhat more important for a variety of people, which led to an uptick in the supply of labour and a corresponding decrease in the market clearing wage. ^
 Under a fractional reserve banking system, banks can lend out most of their deposits, with only a fraction kept in reserve to cover any withdrawals customers may want to make. This effectively increases the money supply, because you can have dollars (or yen, or pesos) that are both left in a bank account and invested in the economy. When banks hold onto more of their reserves because of uncertainty, they are essentially shrinking the total money supply. ^
 Scott Sumner suggests that we should target nominal GDP instead of inflation. When economic growth slows, we’d automatically get higher inflation, as the central bank pumps out money to meet the growth target. When the market begins to give way to roaring growth and speculative bubbles, the high rate of real growth would cause the central bank to step back, tapping the brakes before the economy overheats. I wonder if limiting inflation on the upswing would also have the advantage of increasing real wages as the economy booms? ^
There are many problems that face modern, developed economies. Unfortunately, no one agrees with what to do in response to them. Even economists are split, with libertarians championing deregulation, while liberals call for increased government spending to reduce inequality.
Or at least, that’s the conventional wisdom. The Captured Economy, by Dr. Brink Lindsey (libertarian) and Dr. Steven M. Teles (liberal) doesn’t have much time for conventional wisdom.
It’s a book about the perils of regulation, sure. But it’s a book that criticizes regulation that redistributes money upwards. This isn’t the sort of regulation that big pharma or big finance wants to cut. It’s the regulation they pay politicians to enact.
And if you believe Lindsey and Teles, upwardly redistributing regulation is strangling our economy and feeding inequality.
They’re talking, of course, about rent-seeking.
Now, if you don’t read economic literature, you probably have an idea of what “rent-seeking” might mean. This idea is probably wrong. We aren’t talking here about the sorts of rents that you pay to landlords. That rent probably includes some economic rents (quite a lot of economic rents if you live in Toronto, Vancouver, San Francisco, or New York), but does not itself represent an economic rent.
An economic rent is any excess payment due to scarcity. If you control especially good land and can grow wheat at half the price of everyone else, the rent of this land is the difference between how much it costs you to grow wheat and how much it costs everyone else to grow wheat.
Rent-seeking is when someone tries to acquire these rents without producing anything of value. It isn’t rent-seeking when you invent a new mechanical device that cuts your costs in half (although your additional profit will represent economic rents). It is rent-seeking when you use some of those profits as “campaign contributions” to get the government to pass a law that requires all future labour-saving devices need to be “tested” for five years before they can be introduced. Over that five-year period, you’ll reap rents because no one else can compete with you to bring the price of the goods you are producing down.
How could we know if rent-seeking is happening in the US economy (note: this book is written specifically about the US, so assume all statements here are about the US unless otherwise noted) and how can we tell what it’s costing?
Well, one of the best signs of rent-seeking is increased profits. If profits are increasing and this can’t be explained by innovation or productivity growth or any other natural factor, then we have circumstantial evidence that profits are increasing from rent-seeking. Is this the case?
Lindsey and Teles say yes.
First, it seems like profits for US firms are increasing, from a low of 3% in the 1980s to a high of 11% currently. These are average profits, so they can’t be swayed by one company suddenly becoming much more efficient – as something like that should be cancelled out by a decline in profits at somewhere less efficient.
At the same time, however, the majority of these new profits have been going to companies that were already very profitable. If being very profitable makes corrupting the political process easier, this is exactly what we’d expect to see.
In addition, formation of new companies has slowed, concentration has increased, the ratio of intangible assets to tangible assets has increased, and yet spending on intangible assets (like R&D) has dropped. The only intangibles you get without investing in R&D are better human capital (but then why should profits increase if this is happening everywhere?) and tailor-made regulation.
Lindsey and Teles go on to cite research by Dr. James Bessen that show that most of the increases in profits since the start of the 21st century is heavily correlated with increasing regulation, a result that remained robust even when accounting for reverse causation (e.g. a counter-factual where profits causing regulation).
This circumstantial evidence is about all we can get for something as messy as real-world economics, but it’s both highly suggestive and fits in well with what keen observers have noted in individual industries, like the pharmaceutical industry.
An increase in rent-seeking would explain a whole bunch of the malaise of the current economy.
Economists have been surprised by the slow productivity growth since the last recession. If there was significantly more rent-seeking now than in the past, then we would expect productivity growth to slow.
In a properly functioning economy, productivity growth is largely buoyed up by new entrants to a field. The most productive new entrants thrive, while less productive new entrants (and some of the least productive existing players) fail. Over time, this gradually improves the overall productivity of an industry. This is the creative destruction you might hear economists talking glowingly about.
Productivity can also be raised by the slow diffusion of innovations across an industry. When best practices are copied, everyone ends up producing more with fewer inputs.
Rent-seeking changes the nature of this competition. Instead of competing on productivity and innovation, companies compete to see who can most effectively buy the government. Everyone who fails to buy off the government will eventually fail, leaving an increasingly moribund economy behind.
Lindsey and Teles believe that we’re more likely to see the negative effects of rent-seeking today than in the past because the underlying economy has less favourable conditions. In the 1950s, women started to enter the workforce. In the 60s, Boomers began to enter it. In addition, many returning soldiers got university educations after World War II, making college graduates much more common.
Therefore, rent-seeking, as a force holding down productivity growth, would be a serious problem in political economy even if it didn’t lead to increased inequality and all of the problems that can cause.
But that’s where the other half of this book comes in; the authors suggest that our current spate of rent-seeking policies are fueling income inequality as well as economic malaise . Rent-seeking inflates stock prices (which only helps people who are well-off enough that they own stocks) or wages at the top of corporations. Rents from rent-seeking also tend to accrue to skilled workers, to people who own homes, and people in regulated professions. All of these people are wealthier than average and increasing their wealth increases inequality.
That’s the theory. To show it in practice, Lindsey and Teles introduce four case studies: finance, intellectual property, zoning, and occupational licensing.
Whenever I think about finance, I am presented with a curious double image. There are the old-timey banks of yore, that I see in movies, the ones that provided smiling service to their local customers. And then there are the large financial entities that exist today, with their predatory sales tactics and “too big to fail” designations. Long gone are the days when banks mostly made money by collecting interest on loans, loans made possible by paying interest on deposits.
Today’s banks also have an excellent racket going on. They decry taxes and regulation on one hand, while extracting huge rents from governments on the other.
To understand why, we first need to talk about leverage. Bank profits can be increased many times over via the magic of leverage – basically borrowing money to buy assets. If you believe, for example, that the price of silver is going to skyrocket tomorrow, you could buy $100 of silver. If silver goes up by 20%, you’ll pocket a cool $20 for 20% profit. If you borrow an extra $900 from friends and family at 1% interest and buy silver with that too, you’ll pocket a cool $191 once it goes up (20% of $1000 less 1% of $900), for 191% profit.
Leverage becomes a problem when prices fall. If the price goes down by 10% instead of going up, you’ll be left with $90 if you didn’t leverage yourself – and $1 if you did. Because it leads to the potential of outsized losses, leverage presents problems with downside risks, the things that happen when your bet is wrong.
One of the major ways banks extract rents is by forcing the government to hold onto their downside risks. In America, this is accomplished several ways. First, deposits are insured by the government. This is good, in that it prevents bank runs , which were a significant problem in the 19th and 20th century, but bad because it removes most incentive for consumers to care about the lending practices of their bank. Insurance removes the risk associated with picking a bank with risky lending practices, so largely people don’t bother to see if their bank is responsible or not. Banks know this, so feel no pressure to be responsible, especially because shareholders love the profits irresponsibility brings in good times.
Second, the government (especially in America, but also recently in Ireland) seems unable to resist insulating bondholders from the consequences of backing a bank with bad standards. The bailouts after the financial crisis mean that few bondholders were punished for their failure to do due diligence when providing the credit banks used to make leveraged bets. As long as no one is punished for lending to the banks that make risky bets, things won’t get better.
(Interestingly, there is theoretical work that shows banks can accomplish everything they currently do with debt using equity at the same cost. This isn’t what we see in real life. Lindsey and Teles suggest this is because debt is kept artificially cheap for banks by repeated bailouts. Creditors don’t demand extra to lend to an indebted bank, because they know they won’t have to pay if things go south.)
Third, there’s mortgage debt, which is often insured or bought by the Federal Government in America. This makes risky lending much more palatable for many banks (and much more profitable as well). This whole process is really opaque and largely hidden from the US population. When times are good, it’s a relatively cheap way to make housing more affordable (although somewhat regressive; it favours the already wealthy). When times are bad it can cost the government almost $200 billion.
The authors suggest that this sort of “public program by kluge” is the perfect vehicle for rent-seeking. The need to do the program in a klugey way so that taxpayers don’t complain is anathema to accountability and often requires the support of businesses – which are happy to help as long as they get to skim off the top. Lindsey and Teles suggest that it would be much better for the US just to provide straight up housing subsidies in a means-tested way.
Being able to extract all these rents has probably increased the size of the US financial sector. Linsey and Teles argue that this is a very bad thing. They cite data that show decreased economic growth once the financial sector grows beyond a certain size, possibly because an outsized financial sector leads to misallocation of resources.
Beyond a certain point, the financial sector is just moving money around to no productive aim (this is different than e.g. loans to businesses; I’m talking about highly speculative bets on foreign currencies or credit default swaps here). The financial sector also aggressively recruits very bright people using very high salaries. If the financial sector were smaller and couldn’t compensate as highly, then these people would be out doing something productive, like building self-driving cars or curing malaria. Lindsey and Teles suggest that we should happily make a trade-off whereby these people can’t get quite as high salaries but do actually produce things of value.
(Remember: one of the pair here is a libertarian! Like “worked for Cato Institute for years” libertarian. If your caricature of libertarians is that “they hate poor people”, I suggest you consider the alternative: “they think the free market is the best way to help disadvantaged people find better circumstances”. Here, Lindsey is trying to correct market failures and misallocations caused by big banks getting too cozy with the government.)
Intellectual Property Law
If you don’t follow the Open Source or Creative Commons movements, you probably had mostly positive things to say about copyright until a few years ago when the protests against SOPA and PIPA – two bills designed to strengthen copyright enforcement – painted the internet black in opposition.
SOPA and PIPA weren’t some new overreach. They are a natural outgrowth of a US copyright regime that has changed radically from its inception. In the early days of the American Republic, copyrights required registering. Doing so would give you a fourteen-year term of exclusivity, with the option to extend it once for another fourteen years. Today all works, even unpublished ones, are automatically granted copyright for the life of the author… plus 70 years.
Penalties have increased as well; previously, copyright infringement was only a civil matter. Now it carries criminal penalties of up to $250,000 in fines and 1-5 years of jail time per infringement.
Patent protections have also become onerous, although here the fault is judicial action, not statute. Appeals for patent cases are solely handled by the United States Court of Appeals for the Federal Circuit. This court is made up of judges who are normally former patent lawyers and who attend all the same conferences as patent lawyers – and eat the food paid for by the sponsors. I don’t want to claim judicial corruption, but it is perhaps unsurprising that these judges have come to see the goals of patent holders as right and noble.
Certainly, they’ve broken with past tradition and greatly expanded the scope of patentability while reducing the requirements for new patents. Genes, business methods, and most odiously, software, have been made patentable. Consequently, patents filed have increased from approximately 60,000 yearly in 1983 to 300,000 per year by 2013. If this represented a genuine increase in invention, then it would be a cause for celebration. But we already know that R&D spending isn’t increasing. It would be very surprising – and the exact opposite of what diminishing returns would normally suggest – if companies managed to come up with an additional 240,000 patents per year with no additional real spending.
What if these patents just came from increased incentives for rent-seeking via the intellectual property system?
“Intellectual property” conjures a happy image. Who doesn’t like property ? Many (most?) people support paying authors, artists, and inventors for their creations, at least in the abstract . Lindsey and Teles argue that we should instead take a dim view of intellectual property; to them, it’s almost entirely rent-seeking.
They point out that many of supposed benefits of intellectual property never manifest. It’s unclear if it spurs invention (evidence from World Fairs suggest that it just moves invention towards whatever types of inventions are patentable, where payoff is more certain). It’s unclear if it incentivizes artists and writers (although we’ve seen music revenue fall, more people than ever are producing music). My personal opinion is that copyright doesn’t encourage writers; most of us couldn’t stop if we wanted to.
When it comes to software patents, the benefits are even less clear and the harms even greater. OECD finds that software patents are associated with a decrease in R&D spending, while Vox reports that costs associated with software patent lawsuits have now reached almost $70 billion annually. The majority of software patent litigation isn’t even launched by the inventors. Instead, it’s done by so called “patent trolls”, who buy portfolios of patents and then threaten to sue any company who doesn’t settle with them over “infringement”.
When even a successfully-defended lawsuit can cost millions of dollars (not to mention several ulcers), software patents (often for obvious ideas and assuredly improper) held by trolls represent a grave threat to innovation.
All of this adds up to a serious drag on the economy, not to mention our culture. While “protecting property” is seen as a noble goal by many, Lindsey and Teles argue that IP protections go well beyond that. They acknowledge that it makes sense to protect a published work in its entirety. But protecting the setting? The characters? The right to make sequels? That’s surely too much. How is George Lucas hurt if someone can sell their Star Wars fanfiction? How is that “infringing” on what he has created?
They have less sympathy for patents, which grant a somewhat ridiculous monopoly. If you patent something three days before I independently invent it, then any use or sale by me is still considered infringement even though I am assuredly not ripping you off.
Lindsey and Teles suggest that IP laws need to be rolled back to a more reasonable state, when copyright was for 14 years and abstract ideas, software implementation, and business methods couldn’t be patented. About the only patents they really approve of are pharmaceutical patents, which they view as necessary to protect the large upfront costs of drug development (see also Scott Alexander’s argument for why this is the case); I’d like to add that these upfront costs would be lower if the rent-seeking by pharmaceutical companies hadn’t supported rent-seeking regulation that has made the FDA an almost impenetrable tar-pit.
Occupational licensing has definitely become more common. It’s gone from affecting 10% of the workforce (1970) to 30% of the workforce today. It no longer just affects doctors, teachers, lawyers, and engineers. Now it covers make-up artists, auctioneers, athletic trainers, and barbers.
Now, there are sometimes good reasons to license professionals. No one wants to drive across a bridge built by someone who hasn’t learned anything about physics. But there’s good reason to suspect that much of the growth of occupational licensing isn’t about consumer protection, despite what proponents say.
First of all, there’s often a quite a bit of variability in how many days of study these newly licensed professions require. Engineering requirements tend to be similar from country to country because it’s governed by international treaty. On the other hand, manicurist requirements vary wildly by state; Alaska requires three days of education, while Alabama requires 163. There’s no national standards at all. If this was for consumer protection, then presumably some states are well below what’s required and others are well above it.
Second, there’s no allowance for equivalencies. Engineers can take their engineering degrees anywhere and can transfer professional status with limited hassles. Lawyers can take the bar exam wherever they want. But if you get licensed as a manicurist in Alabama, Alaska won’t respect the license. And vice versa.
(Non-transferability is a serious economic threat in its own right, because it makes people less likely to move in search of better conditions. The section on zoning further explains why this is bad.)
Several studies have shown that occupational licenses do nothing to improve services to customers. Randomly sampled floral arrangements from licensed and unlicensed states (yes, some states won’t let you arrange flowers without a license) are judged the same when viewed by unsuspecting judges. Roofing quality hasn’t fallen after hurricanes, when licensing restrictions are lifted (and if there’s ever a time you’d expect quality to fall, it’s then!).
Despite the lack of benefits, there are very real costs to occupational licensing. Occupational licensing is associated with consumers paying prices between 5% and 33% above unlicensed areas, which translates to an average 18% increase in wages for licensed professionals. The total yearly cost to consumers for this price gouging? North of $200 billion. Unfortunately, employment growth is also affected. Licensed professions see 20% slower employment growth compared to neighbouring unlicensed jurisdictions. Licensing helps some people make more money, but they make this money by, in essence, pulling up the ladder to prosperity behind them.
Occupational licensing especially hurts minorities in the United States. Many occupational licenses require a college degree (black and Latino Americans are less likely to have college degrees) and they often exclude anyone with a criminal record of any sort (disproportionately likely to be black or Latino). It may make sense to exclude people with criminal records from certain jobs. But from manicuring? I don’t see how someone could do worse damage manicuring then they could preparing fast food, and that isn’t regulated at all.
Licensing boards often protect their members against complaints from the public. Since the board is composed only of members of the profession, it’s common for them to close ranks around anyone accused of bad conduct. The only profession I’ve seen that doesn’t do this is engineers. Compare the responses of professional boards to medical and engineering malpractice in Canada.
Probably the most interesting case of rent-seeking Lindsey and Teles identify are lawyers in the United States. While they accuse lawyers of engaging in the traditional rent-seeking behaviour of limiting entry to their field (and point out that bar exam difficulty is proportional to the number of people seeking admittance, which suggests that its main purpose it to keep supply from rising), they also claim that lawyers in the United States artificially raise demands for their services.
Did you know that lawyers made up 41% of the 113th Congress, despite representing only 0.6% of the US population? I knew the US had a lot of lawyers in politics, but I hadn’t realized it was that high. Lindsey and Teles charge these lawyers with writing the kind of laws that make sense to lawyers: abstruse, full of minutia, and fond of adversarial proceedings. Even if this isn’t a sinister plot, it certainly is a nice perk .
I do wish this chapter better separated what I think is dual messages on occupational licensing. One strand of arguments goes: “occupational licensing for jobs like barbers, manicurists, etc. is keeping disadvantaged people, especially minorities out of these fields with slightly better than average wages and making everyone pay a tiny bit more”. The other is: “professionals are robbing everyone else blind because of occupational licensing; lawyers and doctors make a huge premium in the United States and are disproportionately wealthy compared to other countries and make up a large chunk of the 1%”.
I’d like them separated because they seem to call for separate solutions. We might decide that if we could fix the equality issues (for example, by scrapping criminal records checks and college degree requirements where they aren’t needed), it might make sense to keep occupational licensing to prevent a race for the bottom among occupations that have never represented a significant fraction of individual spending. One thing I noticed is that the decline among union membership is exactly mirrored by the increase in occupational licensing. In a very real way, occupational licensing, with some tweaks, could be the new unions.
On the other hand, we have doctors and lawyers (and maybe even engineers, although my understanding is that they do far less to restrict supply, especially foreign supply) who are making huge salaries that (in the case of lawyers) might be up to 50% rents from artificially low supply. If we undid some of the artificial barriers to entry they’ve thrown up, we could lower their wages and improve income equality while at the same time improving competition and opening up these fields (which should still pay reasonably well) to more people. Many of us probably know people who’d make perfectly fine doctors that have been kept out of medical school by the overly restrictive quotas. Where’s the harm in having two doctors making $90,000/year instead of one doctor making $180,000/year? It’s not like we couldn’t find a use for twice as many doctors!
The weirdest thing about the recent rise in housing prices is that building houses hasn’t really gotten any more expensive. Between 1950 and 1970, housing prices increased 35% above inflation (when normalized to size) and construction costs increased 28% above inflation. Between 1970 and 2000, construction prices rose 6% slower than inflation – becoming cheaper in real terms – and overall housing costs increased 72% above inflation.
Maybe house prices have gone up because house quality has improved? Not so say data from repeat house sales. When analyzing these data, economists have determined that increased house quality can account for at most 25% of the increase in prices.
Maybe land is just genuinely running out in major cities? Well, if that were the case, we’d see a strong relationship between density and price. After all, density would surely emerge if land were running out, right? When analyzing these data, economists have found no relationship between city density and average home price.
The final clue comes from comparing the value of land houses can be built on with the value of land houses cannot be built on. When you look at how much the size of a lot affects the sale price of very similar homes and compare that with the cost of the land that goes under a house (by subtracting construction costs from the sale prices of new homes), you’ll find that the land under a house is worth ten times the land that simply extends a yard.
This suggests that a major component of rising house prices is the cost of getting permission to build a house on land – basically, finding some of the limited supply of land zoned for actually building anything. This is not land value per se, but instead a rent imposed by onerous zoning requirements. In San Francisco, San Jose, and Manhattan, this zoning cost is responsible for approximately half of house worth.
The purpose of zoning has always been to protect the value of existing homes, by keeping “undesirable” land usage out of a neighbourhood. Traditionally, “undesirable” has been both racist and classist. No one in a well-off neighbourhood wanted any of “those people” to move there, lest prospective future buyers (who shared their racial and social prejudices) not want to move to the neighbourhood. Today, zoning is less explicitly racist (even if it still prices minorities out of many neighbourhoods) and more nakedly about preserving house value by preventing any increase in density. After all, if you live in a desirable neighbourhood, the last thing you want is a large tower bringing in hundreds of new residents at affordable prices. How will you be able to get a premium on your house then? The market will be saturated!
Now if there were no real benefits to living in a city, Lindsey and Teles probably wouldn’t care about zoning. But there definitely are very good reasons why we want more people to be able to live in cities. First: transportation. Transportation is easier when people are densely packed, which makes supplies cheaper and reduces negative externalities from carbon intensive travel. Second: choice. Cities have enough people to allow people to make profits off of weird things, to allow people to carefully choose their jobs, and to allow employers choice in employees. All of these are helpful to the economy. Third: ineffable increases in human capital. There’s just something about cities (theorized to be “information spillover” between people in unrelated jobs) that make them much more productive per capita than anywhere else.
This productivity is rewarded in the form of higher wages. Lindsey and Teles claim that the average income of a high school graduate in Boston is 40% higher than the average income of a college graduate in Flint, Michigan. I’ll buy these data, but I’m a bit skeptical that this results in any more take-home pay for the Bostonian, because wages in Boston have to be higher if people are to live there. Would this hold true if you looked at real wages accounting for differences in cost of living ?
If wages are genuinely higher in places like Boston in real terms, then this spatial inequality should be theoretically self-correcting. People from places like Flint should all move to places like Boston, and we’ll see a sudden drop in income inequality and a sudden jump in standard of living for people who only have high school degrees. Lindsey and Teles believe this isn’t happening because the scarcity of housing drives up the initial price of moving far beyond what people without substantial savings can pay – the same people who most need to be able to move .
Remember, many apartments require first and last month’s rent, plus a security deposit. I looked up San Francisco on PadMapper and the median rent looks to be something like $3300, a number that agrees with a cursory Google. Paying first and last on that, plus a damage deposit would cost you over $7,000. Add to that moving expenses, and you can see how it could be impossible for someone without savings to move to San Francisco, even if they could expect a relatively well-paid job.
(Lack of movement hurts people who stay behind as well. When people move away in search of higher wages, businesses must eventually raise wages in places seeing a net drain of people, lest the whole workforce disappear. This effect probably led to some of the convergence in average income between states that occurred from 1880 to 1980, an effect that has now markedly slowed.)
Out of all of these examples of rent-seeking, the one I feel least optimistic about is zoning. The problem with zoning is that people have bought houses at the prices that zoning guaranteed. If we were to significantly loosen it, we’d be ruining many people’s principle investment. Even if increasing home wealth represents one of the single greatest sources of inequality in our society and even if it is exacting a terrifying toll on our economy, it will be extremely hard to build the sort of coalition necessary to break the backs of municipalities and local landowners.
Until we figure out how to do that, I’m going to continue to fight back tears every time I see a sign like this one:
How do we fight rent-seeking?
Surprisingly, most of the suggestions Lindsey and Teles put forth are minor, pro-democratic, and pro-government. There isn’t a single call in here to restrict democracy, shrink the size of the government, or completely overhaul anything major. They’re incrementalist, pragmatic, and give me a tiny bit of hope we might one day even be able to conquer zoning.
Rent-seeking is easiest when democracy is opaque, when it is speedy, when it is polarized, and when it is difficult for independent organizations to supply high-quality information to politicians.
One of the right-wing policies that Lindsey and Teles are harshest on are efforts to slash and burn the civil service. They claim that this has left the civil service unable to come up with policies or data of its own. They’re stuck trusting the very people they seek to regulate for any data about the effects of their regulations.
Obviously, there are problems with this, even though it doesn’t seem to extend to outright horse-trading or data-manipulation. It’s relatively easy to nudge peoples’ decision making by choosing how data is presented. Just slightly overstate the risks and play down the benefits. Or anchor someone with a plan you know they’re primed to like and don’t present them any alternatives that would hurt your bottom line. No briefcases of money change hands, but government is corrupted nonetheless .
To combat this, Lindsey and Teles suggest that all committees in the US House and Senate should have a staffing budget sufficient to hire numerous staffers, some of whom would work for the committee as a whole and others who would work for individual members. Everything would get reshuffled every two years, with a rank-match system used to assign preferences. Employee quality would be ensured by paying market-competitive salaries and letting go anyone who was too-consistently ranked low.
(Better salaries would also end the practice of staffers going to work for lobbyists after several years, which isn’t great for rent-seeking.)
Having staff assigned to committees, rather than representatives on a permanent basis prevents representatives from diverting these resources to their re-election campaigns. It also might build bridges across partisan divides, because staff would be free from an us vs. them mentality.
The current partisan grip on politics can actually help rent-seeking. Lindsey and Teles claim that when partisanship is high, party discipline follows. Leaders focus on what the party agrees on. Unfortunately, neither party is in any sort of agreement with itself about combatting rent-seekers, even though fighting rent-seeking offers a compelling way to spur economic growth (ostensibly a core Republican priority) and decrease economic inequality (ostensibly a core Democratic priority).
If partisanship was less severe and the coalitions less uniform, leaders would have less power over their caucuses and representatives would search for ways to cooperate across the aisle whenever doing so could create wins for their constituents. This would mark a return to the “strange-bedfellows” temporary coalitions of bygone times. Perhaps one of these coalitions could be against rent-seeking ?
Lindsey and Teles also call for more issues to be decided in general jurisdictions where public interest and opportunity for engagement are high. They point to studies that show teachers can extract rents when budgets are controlled by school boards (which are obscure and easily dominated by unions). When schools are controlled by mayors, it becomes much harder for rents to be extracted, because the venue is much broader. More people care about and vote for municipal representatives and mayors than attend school board meetings.
Similarly, they suggest that we should very rarely allow occupation licensing to be handled by the profession itself. When a professional licensing body stacked with members of the profession decides standards, they almost always do it for their own interest, not for the interest of the broader public. State governments, one the other hand, are better at considering what everyone wants.
Finally, politics cannot be too quick. If it’s possible to go from drafting a bill to passing it in less time than it takes to read it, then it’s obviously impossible to build up a public pressure campaign to stop any nastiness in it. If bills required one day of debate for every hundred pages in them and this requirement (or a similar one) was inviolable, then if someone buried something nasty in it (say, a repeal of a nation’s prevailing currency standards), people would know, would be able to organize, and would be able to make the electoral consequences of voting for it clear to their representatives.
To get to a point where any of this is possible, Lindsey and Teles suggest building up a set of policies on the local, state, and national levels and working to build public support for them. With these policies existing in the sidelines, it will be possible to grab any political opportunity – the right scandal or outrage, perhaps – and pressure representatives to stand up against entrenched interests. Only in these moments when everyone is paying attention can we make it clear to politicians that their careers depend most on satisfying our desires than they do on satisfying the desires of the people who fund their campaign. Since these moments are rare, preparation for them is key. It isn’t enough to start looking for a solution when an opportunity presents itself. If we don’t move quickly, the rent-seekers will.
This book is, I think, the opening salvo in this war. Its slim and its purpose is to introduce people from across the political spectrum to the problem of rent-seeking and galvanize them to prepare for when the time is right. Its’ authors are high profile economists with major backing. Perhaps this is also a signal that similar backing might be available for anyone willing to innovate around anti-rent-seeking policy?
For my part, I had opposed rent-seeking because I knew it hurt economic growth. I hadn’t understood just how much it contributed to income inequality. Rent-seeking increases corporate profits, making capitalists far wealthier than labourers can ever hope to be. It inflates the salaries of already wealthy professionals at the cost of everyone else and locks people without college degrees out of all but the most moribund or dangerous parts of the job market. It leads bankers to speculate wildly, in a way that occasionally brings down the economy. And it makes the humble home-owners of last generation the millionaires of this one, while pricing millions out of what was once a rite of passage.
Lindsey and Teles convinced me that fighting rent-seeking is entirely consistent with my political commitments. Municipal elections are coming up and I’m committed to finding and volunteering for any candidate who is consistently anti-zoning. If none exists, then I’ll register myself. Winning almost isn’t the point. I want to be one of those people getting the word out, showing that alternatives to the current broken system is possible.
And when the time is right, I want to be there when those alternatives supplant the rent-seekers.
 Rent-seeking doesn’t necessarily have to lead to increased inequality. Strict immigration controls, monopolies, strong unions, and strict tariffs all extract rents. These rents, however, tend to distribute down or sideways, so don’t really increase inequality. ^
 Banks don’t keep enough money on hand to cover deposits entirely, because they need to lend out money to make money. If banks didn’t lend money, you’d have to pay them for the privilege of parking your money there. This means that banks run into a problem when everyone tries to withdraw their money at once. Eventually, there will be no more money and the bank will fail. This used to happen all the time.
Before deposits were insured, it was only rational to withdraw your money if you thought there was even a small chance of a bank run. If you didn’t withdraw your money from a bank without deposit insurance and a bank run happened, you would lose your whole deposit.
Bank architecture reflects this risk. Everything about the imposing facades of old banks is supposed to make you think they’re as stable as possible and so feel comfortable keeping your money there. ^
 I wonder if this generalizes? Would a parliament full of engineers be obsessed with optimization and fond of very clear laws? Would a parliament full of doctors spend a lot of time running a differential diagnosis on the nation? Certainly military dictators excel at seeing everyone as an enemy on whom force can be justifiably used. ^
 College graduates in the wealthiest cities make 61% more money than college graduates in the least wealthy cities, while people with only high school degrees make 137% more in the richest cities compared to the poorest cities. This suggests that it’s possible high school graduates are much better off in wealthy cities, but it could also be true that college graduates fall prey to money illusions or are willing to pay a premium to live in a place that provides them with many more opportunities for new experiences. ^
 I think there will also always be social factors preventing people from moving, but perhaps these factors would weigh less heavily if real wage differences between thriving cities and declining areas weren’t driven down by inflated real estate prices in cities. ^
 This is perhaps the most invidious – and unintended – consequence of Stephen Harper’s agenda for Canada. Cutting the long form census made it harder for the Canadian government to enact social policies (Harper’s goal), but if these sorts of actions aren’t checked, reversed, and guarded against, they also make rent-seeking much more likely. ^
 In Canadian politics, I have hope that some sort of housing affordability coalition could form between some members from left-leaning parties and some principled free-marketers. Michael Chong already has a plan to lower housing prices by getting the government out of the loan securitization business. No doubt banks wouldn’t enjoy this, but I for one would appreciate it if my taxes couldn’t be used to bail out failing banks. ^
I write today about a speech that was once considered the greatest political speech in American history. Even today, after Reagan, Obama, Eisenhower, and King, it is counted among the very best. And yet this speech has passed from the history we have learned. Its speaker failed in his ambitions and the cause he championed is so archaic that most people wouldn’t even understand it.
I speak of Congressman Will J Bryan’s “Cross of Gold” speech.
William Jennings Bryan was a congressman from Nebraska, a lawyer, a three-time Democratic candidate for president (1896, 1900, 1908), the 41st Secretary of State, and oddly enough, the lawyer for the prosecution at the Scopes Monkey Trial. He was also a “silver Democrat”, one of the insurgents who rose to challenge Democratic President Grover Cleveland and the Democratic party establishment over their support for gold over a bimetallic (gold plus silver) currency system.
The dispute over bimetallic currency is now more than a hundred years old and has been made entirely moot by the floating US dollar and the post-Bretton Woods international monetary order. Still, it’s worth understanding the debate about bimetallism, because the concerns Bryan’s speech raised are still concerns today. Once you understand why Bryan argued for what he did, this speech transforms from dusty history into still-relevant insights into live issues that our political process still struggles to address.
When Alexander Hamilton was setting up a currency system for the United States, he decided that there would be a bimetallic standard. Both gold and silver currency would be issued by the mint, with the US Dollar specified in terms of both metals. Any citizen could bring gold or silver to the mint and have it struck into coins (for a small fee, which covered operating costs).
Despite congressional attempts to tweak the ratio between the metals, problems often emerged. Whenever gold was worth more by weight than it was as currency, it would be bought using silver and melted down for profit. Whenever the silver dollar was undervalued, the same thing happened to it. By 1847, the silver in coins was so overvalued that silver coinage had virtually disappeared from circulation and many people found themselves unable to complete low-value transactions.
Congress responded by debasing silver coins, which led to an increase in the supply of coins and for a brief time, there was a stable equilibrium where people actually could find and use silver coins. Unfortunately, the equilibrium didn’t last and the discovery of new silver deposits swung things in the opposite direction, leading to fears that people would use silver to buy gold dollars and melt them down outside the country. Since international trade was conducted in gold, it would have been very bad for America had all the gold coins disappeared.
Congress again responded, this time by burying the demonetization of several silver coins (including the silver dollar) in a bill that was meant to modernize the mint. The logic here was that no one would be able to buy up any significant amount of gold if they had to do it in nickels. Unfortunately for congress, a depression happened right after they passed the bill.
Some people blamed the depression on the change in coinage and popular sentiment in some corners became committed to the re-introduction of the silver dollar.
The silver supplies that caused this whole fracas hadn’t gone anywhere. People knew that re-introducing silver would have been an inflationary measure, as the statutory amount of silver in a dollar would have been worth about $0.75 in gold backed currency, but they largely didn’t care – or viewed that as a positive. The people clamouring for silver also didn’t conduct much international trade, so they didn’t mind if silver currency drove out gold and made trade difficult.
There were attempts to remonetize the silver dollar over the next twenty years, but they were largely unsuccessful. A few mine owners found markets for their silver at the mint when law demanded a series of one-off runs of silver coins, but congress never restored bimetallism to the point that there was any significant silver in circulation – or significant inflation. Even these limited silver-minting measures were repealed in 1893, which left the United States on a de facto gold standard.
For many, the need for silver became more urgent after the Panic of 1893, which featured everything a good Gilded Age panic normally did – bank runs, failing railways, declines in trade, credit crunches, a crash in commodity prices, and the inevitable run on the US gold reserves.
The commodity price crash hit farmers especially hard. They were heavily indebted and had no real way to pay it off – unless their debts were reduced by inflation. Since no one had found any large gold deposits anywhere (the Klondike gold rush didn’t actually produce anything until 1898 and the Fairbanks gold rush didn’t occur until 1902), that wasn’t going to happen on the gold standard. The Democrat grassroots quickly embraced bimetallism, while the party apparatus remained supporters of the post-1893 de facto gold standard.
This was the backdrop for Bryan’s Cross of Gold speech, which took place during summer 1896 at the Democratic National Convention in Chicago. He was already a famed orator and had been petitioning members of the party in secret for the presidential nomination, but his plans weren’t well known. He managed to go almost the entire convention without giving a speech. Then, once the grassroots had voted out the old establishment and began hammering out the platform, he arranged to be the closing speaker representing the delegates (about 66% of the total) who supported official bimetallism.
The convention had been marked by a lack of any effective oratory. In a stunning ten-minute speech (that stretched much longer because of repeated minutes-long interruptions for thunderous applause) Bryan singlehandedly changed that and won the nomination.
And this whole thing, the lobbying before the convention and the carefully crafted surprise moment, all of it makes me think of how effective Aaron Swartz’s Theory of Change idea can be when executed correctly.
Theory of Change says that if there’s something you want to accomplish, you shouldn’t start with what you’re good at and work towards it. You should start with the outcome you want and keep asking yourself how you’ll accomplish it.
Bryan decided that he wanted America to have a bimetallic currency. Unfortunately, there was a political class united in its opposition to this policy. That meant he needed a president that favoured it. Without the president, you need to get 66% of Congress and the Senate onboard and that clearly wasn’t happening with the country’s elites so hostile to silver.
Okay, well how do you get a president who’s in favour of restoring silver as currency? You make sure one of the two major parties nominates a candidate in favour of it, first of all. Since the Republicans (even then the party of big business) weren’t going to do it, it had to be the Democrats.
That means the question facing Bryan became: “how do you get the Democrats to pick a presidential candidate that supports silver?”
And this question certainly wasn’t easy. Bryan on his own couldn’t guarantee it, because it required delegates at least sympathetic to the idea. But there was a national backdrop such that that seemed likely, as long as there was a good candidate all of the “silver men” could unite around.
So, Bryan needed to ensure there was a good candidate and that that candidate got elected. Well, that was a problem, because neither of the two leading silver candidates were very popular. Luckily, Bryan was a Democrat, a former congressman, and kind of popular.
I think this is when the plan must have crystalized. Bryan just needed to deliver a really good speech to an already receptive audience. With the cachet from an excellent speech, he would clearly become the choice of silver supporting Democrats, become the Democratic party presidential candidate, and win the presidency. Once all that was accomplished, silver coins would become money again.
The fantastic thing is that it almost worked. Bryan was nominated on the Democratic ticket, absorbed the Populist party into the Democratic party to prevent a vote split, and came within 600,000 votes of winning the presidency. All because of a plan. All because of a speech.
So, what did he say?
Well, the full speech is available here. I do really recommend it. But I want to highlight three specific parts.
A Too Narrow Definition of “Business”
We say to you that you have made the definition of a business man too limited in its application. The man who is employed for wages is as much a business man as his employer; the attorney in a country town is as much a business man as the corporation counsel in a great metropolis; the merchant at the cross-roads store is as much a business man as the merchant of New York; the farmer who goes forth in the morning and toils all day—who begins in the spring and toils all summer—and who by the application of brain and muscle to the natural resources of the country creates wealth, is as much a business man as the man who goes upon the board of trade and bets upon the price of grain; the miners who go down a thousand feet into the earth, or climb two thousand feet upon the cliffs, and bring forth from their hiding places the precious metals to be poured into the channels of trade are as much business men as the few financial magnates who, in a back room, corner the money of the world. We come to speak of this broader class of business men.
In some ways, this passage is as much the source of the mythology of the American Dream as the inscription on the statue of liberty. Bryan rejects any definition of businessman that focuses on the richest in the coastal cities and instead substitutes a definition that opens it up to any common man who earns a living. You can see echoes of this paragraph in almost every presidential speech by almost every presidential candidate.
Think of anyone you’ve heard running for president in recent years. Now read the following sentence in their voice: “Small business owners – like Monica in Texas – who are struggling to keep their business running in these tough economic times need all the help we can give them”. It works because “small business owners” has become one of the sacred cows of American rhetoric.
Bryan added this line just days before he delivered the speech. It was the only part of the whole thing that was at all new. And because this speech inspired a generation of future speeches, it passed into the mythology of America.
Trickle Down or Trickle Up
Mr. Carlisle said in 1878 that this was a struggle between “the idle holders of idle capital” and “the struggling masses, who produce the wealth and pay the taxes of the country”; and, my friends, the question we are to decide is: Upon which side will the Democratic party fight; upon the side of “the idle holders of idle capital” or upon the side of “the struggling masses”? That is the question which the party must answer first, and then it must be answered by each individual hereafter. The sympathies of the Democratic party, as shown by the platform, are on the side of the struggling masses who have ever been the foundation of the Democratic party. There are two ideas of government. There are those who believe that, if you will only legislate to make the well-to-do prosperous, their prosperity will leak through on those below. The Democratic idea, however, has been that if you legislate to make the masses prosperous, their prosperity will find its way up through every class which rests upon them.
Almost a full century before Reagan’s trickle-down economics, Democrats were taking a stand against that entire world-view. Through all its changes – from the party of slavery to the party of civil rights, from the party of the Southern farmers to the party of “coastal elites” – the Democratic party has always viewed itself as hewing to this one simple principle. Indeed, the core difference between the Republican party and the Democratic party may be that the Republican party views the role of government to “get out of the way” of the people, while the Democratic party believes that the job of government is to “make the masses prosperous”.
A Cross of Gold
Having behind us the producing masses of this nation and the world, supported by the commercial interests, the laboring interests, and the toilers everywhere, we will answer their demand for a gold standard by saying to them: “You shall not press down upon the brow of labor this crown of thorns; you shall not crucify mankind upon a cross of gold.
This is perhaps the best ending to a speech I have ever seen. Apparently at the conclusion of the address, dead silence endured for several seconds and Bryan worried he had failed. Two police officers in the audience were ahead of the curve and rushed Bryan – so that they could protect him from the inevitable crush.
Bryan turned what could have been a dry, dusty, nitty-gritty issue into the overriding moral question of his day. In fact, by co-opting the imagery of the crown of thorns and the cross, he tapped into the most powerful vein of moral imagery that existed in his society. Invoking the cross, the central mystery and miracle of Christianity cannot but help to put (in a thoroughly Christian society) an issue on a moral footing, as opposed to an intellectual one.
This sort of moral rather than intellectual posture is a hallmark of any insurgency against a technocratic order. Technocrats (myself among them!) like to pretend that we can optimize public policy. It is, to us, often a matter of just finding the solution that empirically provides the greatest good to the greatest number of people. Who could be against that?
But by presupposing that the only moral principle is the greatest good for the greatest number, we obviate moral contemplation in favour of tinkering with numbers and variables.
(The most cutting critique of utilitarianism I’ve ever seen delivered was: “[These problems are] seen in the light of a technical or practical difficulty and utilitarianism appeals to a frame of mind in which technical difficulty, even insuperable technical difficulty, is preferable to moral unclarity, no doubt because it is less alarming.”, a snide remark by the great British ethicist Sir Bernard Williams from his half of Utilitarianism for and against.)
This avoiding-the-question-so-we-can-tinker is a policy that can provoke a backlash like Bryan. Leaving aside entirely the difficulty of truly knowing which policies will have “good” results, there’s the uncomfortable truth that not every policy is positive sum. Even positive sum policies can hurt people. Bryan ran for president because questions of monetary policy aren’t politically neutral.
The gold standard, for all the intellectual arguments behind it, was hurting people. Maybe not a majority of people, but people nonetheless. There’s a whole section of the speech where Bryan points out that the established order cannot just say “changes will hurt my business”, because the current situation was hurting other people’s businesses too.
It is very tempting to write that questions of monetary policy “weren’t” politically neutral. After all, there’s a pretty solid consensus on monetary policy these days (well, except for the neo-Fisherians, but there’s a reason no one listens to them). But even (especially) a consensus among experts can be challenged by legitimate political disagreements. When the Fed chose to pull interest rates low as stimulus for the economy after 2008, it put the needs of people trying to find jobs over those of retired people who held their savings in safe bonds.
If you lower speed limits, you make roads safer for law abiding citizens and less safe for people who habitually speed. If you decriminalize drugs, you protect rich techies who microdose on LSD and hurt people who view decriminalization as license to dabble in opiates.
Even the best intentioned or best researched public policy can hurt people. Even if you (like me) believe in the greatest good for the greatest number of people, you have to remember that. You can’t ever let hurting people be easy or unthinking.
Even though it failed in its original aim and even though the cause it promotes is dead, I want people to remember Bryan’s speech. I especially want people who hold power to remember Bryan’s speech. Bryan chose oratory as his vehicle, his way of standing up for people who were hurt by well-intentioned public policy. In 1896, I might have stood against Bryan. But that doesn’t mean I want his speech and the lessons it teaches to be forgotten. Instead, I view it as a call to action, a call to never turn away from the people you hurt, even when you know you are doing right. A call to not forget them. A call to try and help them too.