Economics, Politics

Good Intentions Meet A Messy Reality In Elizabeth Warren’s Corporate Citizenship Push

[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.

(There’s also some minor corporate governance stuff around limiting the ability of CEOs to sell their stock which I think is an idea that everyone should be strongly behind, although I’d bet many CEOs might beg to differ.)

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 [1]. 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.

The Bad

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 [2].

It’s these cheap imports that have enabled the incredibly wealthy North American lifestyle [3]. 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 just since 1997! Very basic colour TVs cost more than $1000 (unadjusted for inflation) when first introduced. Today I would expect to pay less than $600 for a 40″ 4k TV.

 

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 [4]. 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.

It is certainly true that very wealthy individuals contribute to political campaigns in the hopes that this will lead to less taxes for them. But this isn’t really how corporations contribute. I’ve written in detail about this before, but corporations normally focus their political contributions to create opportunities for rent-seeking – that is to say, trying to get the government to give them an unfair advantage they can take all the way to the bank.

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 [5]?

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.

I also have two minor quibbles that I believe are adequately covered elsewhere, but that I want to include for completeness. First, I think this plan is inefficient at controlling executive pay compared to bracketed scaled payroll taxes. Second, if share buybacks were just a short-term profit scheme, they would always backfire. If they’re being done, it’s probably for rational reasons.

The Good

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 [6].

(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.

The Ugly

Everyone always forgets the pensions.

The 30 largest public pensions in the United States have, according to Wikipedia, a combined value of almost $3 trillion, an amount equivalent to almost 4% of all outstanding stocks in the world or 10% of the outstanding stocks in America.

Looking at the expected yields on these funds makes it pretty clear that they’re invested in the stock market (or something similarly risky [7]). 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.

Footnotes

[1] 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. ^

[2] 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. ^

[3] Canada benefits from a similar effect, because we also have a very good financial system with strong property rights and low corporate taxes. ^

[4] 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. ^

[5] 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. ^

[6] 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. ^

[7] 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. ^

Economics, Model

You Shouldn’t Believe In Technological Unemployment Without Believing In Killer AI

[Epistemic Status: Open to being convinced otherwise, but fairly confident. 11 minute read.]

As interest in how artificial intelligence will change society increases, I’ve found it revealing to note what narratives people have about the future.

Some, like the folks at MIRI and OpenAI, are deeply worried that unsafe artificial general intelligences – an artificial intelligence that can accomplish anything a person can – represent an existential threat to humankind. Others scoff at this, insisting that these are just the fever dreams of tech bros. The same news organizations that bash any talk of unsafe AI tend to believe that the real danger lies in robots taking our jobs.

Let’s express these two beliefs as separate propositions:

  1. It is very unlikely that AI and AGI will pose an existential risk to human society.
  2. 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
Cloth Wine
England 100 120
Portugal 90 80

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
Cloth Wine
England 100 120
Automatia 2 1

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.

Coda: Inequality

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.

First, profits are a signal. When entrepreneurs see high profits in an industry, they are drawn to it. If AI leads to high profits, we should see robust competition until those profits are no higher than in any other industry. The only thing that can stop this is government regulation that prevents new entrants from grabbing profit from the incumbents. This would certainly be a problem, but it wouldn’t be a problem with AI per se.

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.

(By the way, rising income inequality is largely confined to America; most other developed countries lack a clear and sustained upwards trend. This suggests that we should look to something unique to America, like a pathologically broken political system to explain why income inequality is rising there.

There is also separately a perception of increasing inequality of outcomes among young people world-wide as rent-seeking makes goods they don’t already own increase in price more quickly than goods they do own. Conflating these two problems can make it seem that countries like Canada are seeing a rise in income inequality when they in fact are not.)

Economics, Politics

Book Review: The Captured Economy

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.

Image courtesy of the St. Louis Fed. I continue to appreciate that all US Government media has no copyright.

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.

All of these trends have now stagnated or reversed. It’s hard for developed countries to get any more educated. Most of the women who want to or have to work are already in the labour force. And the Boomers are starting to retire. Therefore, we can no longer rely on strong underlying growth. We either need a lot of investment or a lot of productivity growth if we’re going to see strong overall growth. And it’s politically hard to get people to delay their consumption to invest.

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 [1]. 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.

Finance

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 [2], 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 [3]? Many (most?) people support paying authors, artists, and inventors for their creations, at least in the abstract [4]. 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 [5]); 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

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 [6].

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!

Zoning

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 [7]?

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 [8].

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.)

Zoning isn’t great anywhere, but it’s worst in the Bay Area and in New York. 75% of the economic costs of misallocated labour and lost productivity growth come from New York, San Francisco, and San Jose. Furthermore, housing might be entirely responsible for Thomas Piketty’s conclusion that we’re doomed to a spiraling cycle of inequality.

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:

Why should I get a say in whether a local commercial landlord provides the businesses in their building slightly smaller parking spots? Shouldn’t we be aiming for a walkable, decarbonized downtown where parking is irrelevant? That’s what all the plans call for. Of course, the whole thing makes sense if it isn’t about what size parking spots should be and is about making it impossible for anyone to build anything in my downtown neighbourhood.

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 [9].

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 [10]?

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.

Footnotes

[1] 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. ^

[2] 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. ^

[3] Socialists. ^

[4] The rise of streaming and torrenting suggests that this is more often held as an abstract principle than it is followed “in the breach”. ^

[5] See also his argument for why we shouldn’t retroactively grant new exclusivity on generics. ^

[6] 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. ^

[7] 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. ^

[8] 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. ^

[9] 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. ^

[10] 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. ^

Data Science, Economics, Falsifiable

The Scale of Inequality

When dealing with questions of inequality, I often get boggled by the sheer size of the numbers. People aren’t very good at intuitively parsing the difference between a million and a billion. Our brains round both to “very large”. I’m actually in a position where I get reminded of this fairly often, as the difference can become stark when programming. Running a program on a million points of data takes scant seconds. Running the same set of operations on a billion data points can take more than an hour. A million seconds is eleven and a half days. A billion seconds 31 years.

Here I would like to try to give a sense of the relative scale of various concepts in inequality. Just how much wealth do the wealthiest people in the world possess compared to the rest? How much of the world’s middle class is concentrated in just a few wealthy nations? How long might it take developing nations to catch up with developed nations? How long before there exists enough wealth in the world that everyone could be rich if we just distributed it more fairly?

According to the Forbes billionaire list, there are (as of the time of writing) 2,208 billionaires in the world, who collectively control $9.1 trillion in wealth (1 trillion seconds ago was the year 29691 BCE, contemporaneous with the oldest cave paintings in Europe). This is 3.25% of the total global wealth of $280 trillion.

The US Federal Budget for 2019 is $4.4 trillion. State governments and local governments each spend another $1.9 trillion. Some $700 billion dollars is given to those governments by the Federal government. With that subtracted, total US government spending is projected to be $7.5 trillion next year.

Therefore, the whole world population of billionaires holds assets equivalent to 1.2 years of US government outlays. Note that US government outlays aren’t equivalent to that money being destroyed. It goes to pay salaries or buy equipment. The comparison here is simply to illustrate how private wealth stacks up against the budgets that governments control.

If we go down by a factor of 1000, there are about 15 million millionaires in the world (according to Wikipedia). Millionaires collectively hold $37.1 trillion (13.25% of all global wealth). All of the wealth that millionaires hold would be enough to fund US government spending for five years.

When we see sensational headlines, like “Richest 1% now owns half the world’s wealth“, we tend to think that we’re talking about millionaires and billionaires. In fact, millionaires and billionaires only own about 16.5% of the world’s wealth (which is still a lot for 0.2% of the world’s population to hold). The rest is owned by less wealthy individuals. The global 1% makes $32,400 a year or more. This is virtually identical to the median American yearly salary. This means that almost fully half of Americans are in the global 1%. Canadians now have a similar median wage, which means a similar number are in the global 1%.

To give a sense of how this distorts the global middle class, I used Povcal.net, the World Bank’s online tool for poverty measurement. I looked for the percentage of a country’s population making between 75% and 125% of the median US income (at purchasing power parity, which takes into account cheaper goods and services in developing countries), equivalent to $64-$107US per day (which is what you get when you divide 75% and 125% of the median US wage by 365 – as far as I can tell, this is the procedure that gives us numbers like $1.25 per day income as the threshold for absolute poverty).

I grabbed what I thought would be an interesting set of countries: The G8, BRICS, The Next 11, Australia, Botswana, Chile, Spain, and Ukraine. These 28 countries had – in the years surveyed – a combined population of 5.3 billion people and had among them the 17 largest economies in the world (in nominal terms). You can see my spreadsheet collecting this data here.

The United States had by far the largest estimated middle class (73 million people), followed by Germany (17 million), Japan (12 million), France (12 million), and the United Kingdom (10 million). Canada came next with 8 million, beating most larger countries, including Brazil, Italy, Korea, Spain, Russia, China, and India. Iran and Mexico have largely similar middle-class sizes, despite Mexico being substantially larger. Botswana ended up having a larger middle class than the Ukraine.

This speaks to a couple of problems when looking at inequality. First, living standards (and therefore class distinctions) are incredibly variable from country to country. A standard of living that is considered middle class in North America might not be the same in Europe or Japan. In fact, I’ve frequently heard it said that the North American middle class (particularly Americans and Canadians) consume more than their equivalents in Europe. Therefore, this should be looked at as a comparison of North American equivalent middle class – who, as I’ve already said, are about 50% encompassed in the global 1%.

Second, we tend to think of countries in Europe as generally wealthier than countries in Africa. This isn’t necessarily true. Botswana’s GDP per capita is actually three times larger than Ukraine’s when unadjusted and more than twice as large at purchasing power parity (which takes into account price differences between countries). It also has a higher GDP per capita than Serbia, Albania, and Moldova (even at purchasing power parity). Botswana, Seychelles, and Gabon have per capita GDPs at purchasing power parity that aren’t dissimilar from those possessed by some less developed European countries.

Botswana, Gabon, and Seychelles have all been distinguished by relatively high rates of growth since decolonization, which has by now made them “middle income” countries. Botswana’s growth has been so powerful and sustained that in my spreadsheet, it has a marginally larger North American equivalent middle class than Nigeria, a country approximately 80 times larger than it.

Of all the listed countries, Canada had the largest middle class as a percent of its population. This no doubt comes partially from using North American middle-class standards (and perhaps also because of the omission of the small, homogenous Nordic countries), although it is also notable that Canada has the highest median income of major countries (although this might be tied with the United States) and the highest 40th percentile income. America dominates income for people in the 60th percentile and above, while Norway comes out ahead for people in the 30th percentile or below.

The total population of the (North American equivalent) middle class in these 28 countries was 170 million, which represents about 3% of their combined population.

There is a staggering difference in consumption between wealthy countries and poor countries, in part driven by the staggering difference in the size of middle (and higher classes) – people with income to spend on things beyond immediate survival. According to Trading Economics, the total disposable income of China is $7.84 trillion (dollars are US). India has $2.53 trillion. Canada, with a population almost 40 times smaller than either, has a total disposable income of $0.96 trillion, while America, with a population about four times smaller than either China or India has a disposable income of $14.79 trillion, larger than China and India put together. If China was as wealthy as Canada, its yearly disposable income would be almost $300 trillion, approximately equivalent to the total amount of wealth in the world.

According to Wikipedia, The Central African Republic has the world’s lowest GDP per capita at purchasing power parity, making it a good candidate for the title of “world’s poorest country”. Using Povcal, I was able to estimate the median wage at $1.33 per day (or $485 US per year). If the Central African Republic grew at the same rate as Botswana did post-independence (approximately 8% year on year) starting in 2008 (the last year for which I had data) and these gains were seen in the median wage, it would take until 2139 for it to attain the same median wage as the US currently enjoys. This of course ignores development aid, which could speed up the process.

All of the wealth currently in the world is equivalent to $36,000 per person (although this is misleading, because much of the world’s wealth is illiquid – it’s in houses and factories and cars). All of the wealth currently on the TSX is equivalent to about $60,000 per Canadian. All of the wealth currently on the NYSE is equivalent to about $65,000 per American. In just corporate shares alone, Canada and the US are almost twice as wealthy as the global average. This doesn’t even get into the cars, houses, and other resources that people own in those countries.

If total global wealth were to grow at the same rate as the market, we might expect to have approximately $1,000,000 per person (not inflation adjusted) sometime between 2066 and 2072, depending on population growth. If we factor in inflation and want there to be approximately $1,000,000 per person in present dollars, it will instead take until sometime between 2102 and 2111.

This assumes too much, of course. But it gives you a sense of how much we have right now and how long it will take to have – as some people incorrectly believe we already do – enough that everyone could (in a fair world) have so much they might never need to work.

This is not of course, to say, that things are fair today. It remains true that the median Canadian or American makes more money every year than 99% of the world, and that the wealth possessed by those median Canadians or Americans and those above them is equivalent to that held by the bottom 50% of the world. Many of us, very many of those reading this perhaps, are the 1%.

That’s the reality of inequality.