Acemoglu on Inequality and the Financial Crisis
Feb 21 2011

Daron Acemoglu of MIT talks with EconTalk host Russ Roberts about the role income inequality may have played in creating the financial crisis. Raghuram Rajan in his book, Fault Lines, argues that growing income inequality in the last part of the 20th century created a political demand for redistribution and various policy changes. This in turn created the push for higher home ownership rates and led to the distortions of the housing market that in turn led to excessive risk-taking in the financial market. Acemoglu suggests a simpler story where the financial sector through its political influence distorted the rules of the game, benefiting executives in the industry, which in turn led to outsized rewards and ultimate instability in the financial industry. The conversation discusses ways of distinguishing between these two arguments and what might be done to change the incentives of politicians.

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Explore audio highlights, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Sean Dillon
Feb 21 2011 at 10:48am

I don’t know if this has already been mentioned, but professor Acemoglu’s name is pronounced A-je-mo-lu, (Acemoğlu), with the c pronounced like a j and the g being silent.

Eric Falkenstein
Feb 21 2011 at 11:15am

The fact that you guys can’t imagine the value of asset speculation doesn’t mean much to me, but you seem to think it implies these guys somehow shouldn’t make so much money. What hubris. Those that made the most money on Wall street shut down the mortgage market in 2007, whereas FHA still gives out 3.5% down loans.

Russ still extrapolates the experience of CEOs and other superstars to misleadingly stereotype the financial sector. Most bankers lost a large fraction of their wealth in the 2008 crisis via their company-matched 401(k) investments in their own stock. I agree the Rubin, Stanley O’Neal, et al, were massively overpaid and suffered not much, but I think that’s a separate issue than the social value of asset markets, rather, a problem with large organizations in general (one I have no solution to, but agree it’s a problem).

Russ Roberts
Feb 21 2011 at 11:21am


The fact that they lost money on their own stock in a particular year does not measure the impact of the stock holdings in incentivizing good vs. bad behavior. The numbers for the top execs I have seen (Cayne and Fuld for example) show that they made immense amounts on their stocks (and cashed them out along the way so that their downside losses were very limited. See my argument in section five of this paper.

Per Kurowski
Feb 21 2011 at 11:28am

Russ Roberts says “People on Wall Street are allocating capital, and allocating capital through these kinds of trades and arbitrage is hugely valuable; true you can’t see it directly, but nothing is more important for capitalism is allocating capital. The problem with that argument is when you allocate trillions of dollars towards housing you’ve made a horrible blunder.”

Hold it there! Wall Street allocates capital starting from the Ground Zero set by the regulators. And that Ground Zero was dramatically altered when the bank regulators, arrogantly thinking them to be the risk-managers of the world, set up a system of capital requirements for banks with risk-weights based on perceived risks… Among other that permitted banks to leverage their capital more than 60 to 1 whenever a triple-A rating was involved that is what drove the banks into the AAA rated securities collateralized with badly awarded mortgages to the subprime sector… and to Irish banks or Greece.

What increased the profits of the banks? Easy! The increases in leverage that were authorized. If you as a bank were making a 1 percent margin on an operation with a triple-A rated client then, if you could only leverage yourself 12.5 to 1 like when lending to small businesses, you would be making 12.5% per year on your capital… decent but nothing to write home about… nothing to pay big bonuses on and nothing to grow too-big-to-fail on. But if you are instead allowed to leverage 62.5 to 1 then that return on capital morphs into 62.5% per year… pure manna from heaven… correction, from Basel.

Giuseppe Paleologo
Feb 21 2011 at 12:37pm

I have a few sparse comments.

First off, I believe that Ragu Rajan’s response to Acemoglu’s Denver talk (and Economist piece) should be posted:

Acemoglu’s intervention:

Rajan’s response on his blog:

Second observation: Acemoglu is aptly poking holes in the scarce empirical evidence behind Rajan’s thesis. He is much more parsimonious in his own self-criticism. His thesis is that the financial industry captured regulation policy and regulation (or lack thereof) caused inequality. What is his supporting evidence? for the second leg, Philippon-Reshef alone, which is a *very* interesting paper, but is the *first* word on the subject, not the last one. And it should not be forgotten, once and for all, that inequality has increased dramatically in the non-financial sector as well, and that “skill” is a changing concept. Philippon and Reshef don’t care to define “skill” once in their paper. However, people working in finance today have dramatically different skills today than in 1909 (the starting date of their study). And those skills may have dramatically different returns than a century ago. And then, of course, we just *know* that financiers are paid too much. The simple lack of differentiation in this very heterogeneous class goes to show the lack of subject matter of the industry. Falkenstein’s comment appropriately bashes the superficial statement of Acemoglu in which he can’t quantify the value of making short-term prices accurate.

As for regulatory capture, in passing Acemoglu says “we don’t have causality, but we have a very *interesting* correlation”. And then he quotes… Larry Bartels (summarized in “Unequal Democracy”). I have serious reservations about Bartel’s thesis, but mostly importantly, I don’t think that Bartel offers any data or transmissionary mechanism between the financial industry and regulation. Acemoglu quotes also Hacker & Pierson, which I haven’t read. I am very sympathetic to the concept of regulatory capture: think of Hank Paulson, Tim Geithner, Peter Orszag and Jon Corzine. But I think has very little to do with the crisis, and not much with inequality. My objections: i) even if politicians mostly address the concerns of their wealthiest constituents, very wealthy financial services constituents are concentrated in relatively few districts and states. Even though I believe Schumer to be an indentured servant of Wall Street, that leaves a lot of senators that would have to be captured through lobbying. ii) if truly “money begets power”, how is it that some subsets of the moneyed class (entrepreneurs, very wealthy professionals, entertainers) have not organized and extracted subset-specific benefits?

Summing up: Acemoglu and Rajan are fine economists, and very good at addressing very specific questions. When answering big questions, they can still craft reasonable narratives, but they are ultimately unconvincing.

Feb 21 2011 at 1:06pm

Is it possible to put up a link to that Neil Butta paper mentioned at about minute 50? I now have the name (couldn’t catch it on audio) from the above summary, so perhaps it’s an easy google find, but I thought I’d ask.

BTW, I really enjoyed this podcast and felt many important points were made throughout. Particularly, I liked what he said at about minute 27 about long term prices being so much more crucial than the daily fluctuations (thinking of QE & QE2 and derivatives trading & long term prices is depressing) and I thought the discussion around minute 36 about the similarities and differences in Rajan’s story and Acemoglu’s story of the crisis was terrific. I tend to think Acemoglu has the better idea of what politicians actually do and why they actually do it, but perhaps this is just my confirmation bias at work.

Feb 21 2011 at 2:34pm

If anyone was interested, I discovered the link to the Neil BHutta paper (above in the notes you’ve accidentally written “Butta” w/o an “h”) and that link is here.

[Thanks for the spelling correction, which I’ve fixed now. The paper actually discussed in the podcast is available at–Econlib Ed.]

john berg
Feb 21 2011 at 2:43pm

Before I read this podcast, is a way to discuss with others much earlier podcasts? Prompted by the last podcast I looked into several previous Dr. Cowen podcasts and found many valuable insights.

John Berg

[John: The comment section is still open on Cowen’s podcast from last week. You could discuss other of his podcasts there. Or, if you email me at the names of previous podcasts on which you want to comment, I can re-open the comment sections on them.–Lauren, Econlib Ed.]

Feb 21 2011 at 3:52pm

What timing, I recently listened to the Bruce Bueno de Mesquita podcasts. An excellent source to understand what constrains political power.

Feb 21 2011 at 8:44pm

“The fact that you guys can’t imagine the value of asset speculation doesn’t mean much to me.”

Is this suppose to be a defense of their value creation? I agree that it is impossible to properly assess what “value” this or that job contributes to a society, but I do think that one can look at a specific area and speculate about it possibly just being a rent, or an easy money machine for those who happen to be privileged enough to find the right connections.

For example there are traders who climb over each other to get their computers closest to currency trading floors simply so that they can shave fractions of a second of their computer driven currency transactions exploiting the “bug” where by currencies don’t adjust their exchange rate instantaneously.

This is done solely by computers and has a basically guaranteed return, and what value exactly does it provide for society? (I doubt smoothing exchange rates out down to the millisecond is all that beneficial).

Feb 22 2011 at 9:24am

Terrific conversation this week. I was reminded of Michael J. Thompson’s excellent study The Politics of Inequality: A Political History of the Idea of Economic Inequality in America, published by Columbia a few years ago.

As the title suggests, it’s an historical account of America’s long history of non-Marxist objections to inequality, the most fascinating of which are embedded within the Jeffersonian republican tradition and resonate with Acemoglu’s argument.

Their idea was that extreme inequality is objectionable not for moral reasons, but because it leads inevitably to a consolidation of economic and political power that in turn leads to conditions of “unfreedom” for the citizenry generally.

Feb 22 2011 at 12:24pm

The paper actually discussed in the podcast is available at .–Econlib Ed.

Thank you for adding the link. However, I’m certain both papers (the CRA one and the GSE one) were briefly referred to and discussed at about minute 50. So if anyone wants to read both papers mentioned by Acemoglu and Roberts, you now have both links. Comity?

Pietro Poggi-Corradini
Feb 22 2011 at 11:35pm

This is tangential. About Michael Jordan it was said that technology changed the equation because many more people were able to enjoy his performances. However, and this applies to athletes in general, it’s also in the nature of professional sports that there are huge barriers to entry. When the technology changed, the leagues did not all of a sudden double the number of teams, and final matches are still being played by only two teams, etc….So I would be careful to point to technological change without mentioning other institutional factors that make the technological change act in a perverse fashion. I guess what I’m trying to say is that I prefer an analysis of the institutions in place and how they interact with the outside changes.

One more point about transparency. Unfortunately I have very little hope that it can be demanded from politicians, unless, that is, we start electing robots?

David B. Collum
Feb 23 2011 at 7:53am

For about ten minutes I was fully convinced you guys were going to miss the tirade phase of the discussion, but you got there in adequate fashion.

Most on this website probably have a visceral response to discussions of inequality such discussion almost alway lead to some top-down wealth redistribution mechanism. There is, however, a case to be made that wealth inequality correlates (possibly through a lurking variable) with serious trouble down the road (let them eat cake moments). It strikes me that maybe out-of-whack wealth distributions may be symptomatic of an economy that is working inefficiently. Thus, it is one of the tells–a death rattle–of an economy in its final stages.

Russ: I think you are grotesquely underestimating the awareness of the inequality; to believe that the peasants are not aware is a mistake made by many power structures throughout history. And the peasants of yore did not have the internet. Nobody is screaming about Bill Gates, Michael Dell, or Steve Jobs. Maybe there is an occasional murmer, but no pitch forks. These guys represent, at some level, the pinnacle of the American dream. The majority don’t even care about Oprah Winfrey or A-Rod. What they do care about is the bankers. Many detest guys like Blankfein, Fuld, Thain, etc. Why? Because these robber barons appear to have commandeered the machinery of government (Federal Reserve and treasury) and looted the system. JPM lost money in their proprietary trading desk eight days in 2010. Somebody would need a CAT scan if they believed that to be anything but an inside job. A 60% win record would be spectacular. But no, these guys won 97% of the time. There’s highly unproductive, probably criminal, activity here. It is a question of morality, not wealth.

Inordinate profitability of the financial sector stems directly from a flawed credit system. I could start a blog about how much I detest the machinations of the Federal Reserve and never run out of material. They have subverted price discovery in the most important markets in the world–the capital markets. They suffer the fatal conceit, and we suffer for their actions. If I say anymore, my comments will get vetted by Lauren.

I am squarely on record with my growing anger, and I am just one of those peasants…

Pur Kerowski: The regulations got too promiscuous, but who do you think forced that? Yup. The banks. The big ones got leverage exemptions (specifically those that either went down for the count or were bailed out with vast sums of money.) The regulation is so profoundly captured by the banks as to be a bad joke.

John Berg: I am mowing through ALL previous podcasts and wish there was somebody to discuss them with. One approach would be to post it on a general blog and trigger a debate there. A second is to contact the interviewee directly.

Lauren Landsburg
Feb 23 2011 at 9:32am

David B. Collum writes

I am squarely on record with my growing anger, and I am just one of those peasants…

David, based on your urls and public information, you are a tenured Professor and Associate Chair in the Chemistry Department at Cornell. It is really hard for you to make a credible claim that you are just one of the peasants.

You did not lose your job in the last few years. It is unlikely that you are in the bottom 10th, bottom 50th, or even bottom 75th percentile of the income distribution. Frankly, from your job description, it is likely you are in the top 80th-90th percentile of the income distribution.

Peasant, you are not. That doesn’t mean you can’t empathize with those who are less educated, less established, less endowed, less secure than you. However, overdramatizing your concerns by exaggerating your situation does not improve your credibility.

[N.B. David, note that I am writing this comment as a private citizen. I imagine if you were to digress into foul language–as you implied you might be tempted to launch into were you to continue along one of your lines of thought–your comments would in fact trigger EconTalk’s spam filters. Your comments are welcome and have never been moderated for content.–Lauren Landsburg, Econlib Editor in another hat]

Feb 23 2011 at 12:58pm

Lauren Landsburg wrote,

“You did not lose your job in the last few years. It is unlikely that you are in the bottom 10th, bottom 50th, or even bottom 75th percentile of the income distribution. Frankly, from your job description, it is likely you are in the top 80th-90th percentile of the income distribution.”

Do you think this is a refutation of the “peasants are angry at bankers” theory David Collum advances above? Because your comment seems to be mostly about what David Collum likely does for employment. And that seems like the old “ad hominem/argument from authority/you-never-played-the-game” argument that I was taught in logic class isn’t persuasive. And yet it somehow knocks down Collum’s theory/comment?

I don’t know how it can, since even the internal logic of the rebuttal seems wrong. Wrong even if you ignore the ad hominem and look only at the structure of the argument. Because I think Lauren’s argument can be fairly restated as:

Commenter Collum did not lose his tenured University job b/c of bankers and their mistakes. Thus, his theory that ‘peasants’ who did lose their jobs (or their hours or some pay or benefits) are angry at the bankers who cost them those jobs (hours/pay/benefits) via their mistakes, is wrong?

To my mind, that doesn’t appear to make much sense as a refutation of the commenter’s theory. But, I’m often wrong and this may be one of those numerous occasions, so tell me what I am missing?

Of course, if this is simply an issue of credibility for you, then you can listen to me because I assure you, “I’m bona fide!!!”. I’m a seasonally unemployed farm laborer who works (during the season) with other farm laborers and those so-called ‘peasants’ truly are ticked off with bankers, particularly the Wall Street ones. But what do I know, I’m no tenured Cornell professor.

David B. Collum
Feb 23 2011 at 3:08pm

I have not been vetted for foul language (not by my standards at least). I have been vetted for not providing what you thought was adequate insight and for comments that you thought were too negative against members of the academy (like the Yale economist who suggested we sell off our gold reserve and who would have been treated more roughly by me if I had my way.)

If you don’t think I am a peasant, just watch which category I get put in when push comes to shove. The banks will recognize my peasantry very, very quickly. The Federal Reserve has recognized my peasantry by forcing my savings into harms way. The serfs in the Middle Ages could accrue wealth. They were still serfs. Also, my reference to being a peasant, at some level, is a reference to being an outsider.

Feb 23 2011 at 4:47pm

Hi, David.

I do accept your explanation that your describing yourself as a peasant was somewhat a metaphor. My comment was ad hominem and based on taking you too literally. I apologize sincerely.


Mike Laursen
Feb 23 2011 at 5:39pm

“Citizens United” got me thinking about campaign disclosure laws, which led to my new pet idea:

Make the side that wins an election fully disclose their donors, so we have an idea who to watch for rent-seeking. But let the losing side keep their donors completely anonymous, to protect them from any possible retribution.

David B. Collum
Feb 23 2011 at 7:34pm

Thanks. I will also confess that I bring a little Zero Hedge to a board that is distinctly different. I probably should have given Russ more credit for getting so animated. Group hug.

BTW-Keatssycamore made my case brilliantly. Here’s a part time farm laborer listening to Econtalk interview. That is such a huge wow. Couldn’t have happened in any other era cause access to this quality of info didn’t exist. He/she also sounds pretty PO’d. Lastly, I wish our undergrads could articulate ideas with this level of clarity and passion.

Feb 24 2011 at 6:42am

Let me try to redeem myself by posting in a calmer and more general way what I meant to say. Though, I may never live down my meltdown moment!

One of my takeaways from Acemoglu’s podcast–and something that surprised me a lot–was the immensity of the spurt in income growth of such a small group at the very tiny top of the income range–1% of the population. It is not the top 10%, but just the top 1%, which is now associated with 25% of U.S. income. The lower 9 points of the top ten percent are rather status quo. Their behavior is exactly like the rest of the economy.

For that income percentage earned by the top 1% to have grown from 10% to 25% since the 1970s is astounding and well worth further study. Ten percent of income for that top 1-percentile in the 1970s was big. Twenty-five percent now is eye-popping. (Enough to make me ask if there is a data problem, but let’s set that aside.)

But before you leap into saying, okay, let’s go get ’em, it’s important to remember that we who post here are thus probably all in the exact same boat. I doubt any of us are in the top 1% of income earners.

That is: the flip side of what is memorable and notable in Acemoglu’s work is that the progress of all the rest of the income earners–the “bottom” 90% or even bottom 99% of the population–has simply proceeded as usual. Not a big increase or decrease in circumstances for this group as a whole, at least not looking at the data produced by or cited by Acemoglu in his paper or the podcast.

So, yes, kumbaya. Why should anyone in the lower 99% of the income-earning population fight it out with others in the same boat?

Putting Acemoglu’s research together, though, we have an interesting political question. The bottom 90% or 99% of the population are certainly not disenfranchised. To re-purpose the slogan of an embarrassing Libyan dictator: This is not Tunisia; this is not Egypt.

In fact, our citizens can vote.

Why, then, do U.S. citizens appear to continue to vote in a way that promotes further augmenting of the top 1% of the population? That is the puzzle that Acemoglu addresses.

The answer he suggests is that when the political process focuses on fixes for the hardships of the lowest income groups at the expense of the middle-to-higher income groups, it misses and deflects from the main points. Reallocating money from those who earn in, say, the top 50-90% of the income distribution to those who earn in the bottom 1-49% of the income distribution is a strange but perhaps momentarily satisfying stopgap. However, focusing on that redistribution within the “bottom” 90% misses the main point of what has changed.

The main points of what has changed are: why has that topmost 1% grown so rapidly in income percentage, and has it grown so much because of lobbying or legislation that has subsidized it under the guise of implementing legislation helping the lower income groups?

If it grew because of lobbying or special interests, addressing those are the solution.

When ordinary people–you, me, and frankly anyone educated enough to be posting on EconTalk–claim to be part of the lower income groups, compassionate toward them, or neglected or disenfranchised, it does not address Acemoglu’s political question of whether subsidies have been in place to favor the top 1% of the income distribution.

I’m certainly not saying we should wipe out the uppermost classes or the opportunity to strive for, achieve, and reap the benefits of that! I’m only saying–as I think Acemoglu is saying–that if there are special interests or special legislations or special lobbying effects that have increasingly encouraged the income in the top 1% to grow like crazy in the last 20-30 years, removing those legislations and lobbying efforts is the solution. The solution is not adding insult to injury by redistributing more from one of the other percentiles to the other.

The point is that 99% of us are (metaphorically) peasants, so there is not much traction in the claim.

David B. Collum
Feb 24 2011 at 8:13am

I think we totally agree except that I am lacking in doubt (maybe facts but not doubt): there is a crime syndicate that has grabbed ahold of the system. I am not so sure I am speaking metaphorically. I know you do NOT want this to be a political forum, but bare with me with an example. Obama gets elected on a very populist campaign. As a right-wing-derived libertarian (yes, there are left-wing-derived libertarians IMO), I confess to some sense of awe. Here was obviously a very bright guy, puts together whole sentences, and he really seems to be able to communicate. He gets put in office by the masses and people are tearing up. Next thing you know, his inner circle is filled with the old guard. He installs Summers, Rubin, and Paulson to call the shots. His former Chief of Staff is now mayor-elect of Chicago. He has now installed the son of the infamous mayor Daley in his place.

This whole thing is aided and abetted by the media. Whether you like him or not, you’ve got to admit there is something wrong when Ron Paul shows some serious numbers in the primaries and the prominent right-wing network refuses to even mention him by name in their broadcasts. It’s all about capture: capture of the media, regulators, central banks, and Congress.

Angry counter-culture journalists like Matt Taibbi have this one right: there is total capture of the system. My conclusion is that the people ARE trying to use the ballot box and discovering that they keep electing crooks. My sense of urgency about the angry (and very informed) citizens is that the next move is not pretty. Oh, we could never have real unrest here, right? I’m pretty sure those who make such dismissive assertions did not predict a month ago that a couple of PO’d Tunisians could turn the Middle East into an ignited tinder box.

Pietro Poggi-Corradini
Feb 24 2011 at 3:03pm

Lauren, can I “like” your “redeeming” post?

I also don’t see an imminent revolution. You need a lot of idle people for that: either unemployed or employed in marginal jobs.

It could very well be that the current regulatory structure is skewing things in ways that were not contemplated. In that case, I would think the political process should try to reform it. Unfortunately, they have no incentive to do so. At best we will get a patchwork of punitive fixes here and there.

Feb 25 2011 at 12:48am

Re: The money influence on elections part of the discussion around the 50 minute mark.

I don’t think more money necessarily buys more votes, though many people perceive that causation.

I thought the amount of money collected by a candidate was an indicator of their popularity with voters.

That’s why some wealthy people who fund much of their own campaigns like Steve Forbes and Meg Whitman weren’t shoe-ins to win.

I enjoyed the podcast.

Mike Laursen
Feb 25 2011 at 2:31am

Maybe it’s not money that explains the strong correlation between representatives’ stances and their higher-income constituents. It may be because pretty much all successful political candidates come from the higher income brackets — they don’t just correlate with the high-income group — they ARE from the high-income group.

Frank Howland
Feb 25 2011 at 9:57am

I found the podcast very interesting and I am pleased that commentators have added links to missing stuff and prodded Russ to do the same. In addition, I am glad to learn that there is a real person behind EconLib’s internet presence.

I haven’t yet finished Rajan’s book (Fault Lines), but I’d be interested in hearing Russ and guests discuss the other claims that Rajan makes on such topics as export-led growth and international imbalances and on jobless recoveries and the response of the U.S. political system.

Robert Richards
Feb 25 2011 at 8:39pm

Thank you for this excellent discussion. Respecting lawyers’ income, American Bar Association has just published some recent data: .

[Link fixed–Econlib Ed.]

Feb 26 2011 at 12:04pm

I doubt the rage movement du jour, the Tea Party, would put Bill Gates and random Wall St CEOs in the same category of people. TBTF makes people angry, it makes them angry at government(what the media reports) and it makes them angry at the banks that get bailed out(what usually gets glossed over).

The current opposition to government intervention is DIFFERENT than that of the 90s. It is far less focused on redistribution downward and far more focused on redistribution upward. This IS a dangerous trend. Not in the short term, but if you have underemployment in the 20% range for the next 5-6-10 years and maybe another bubble at the end of that… All bets are off.

It doesn’t particularly help that we’re now getting jittery about an oil crisis and that a bunch of major nations’ economies are struggling with absurd amounts of public debt.

If the worst of the crisis period is behind us than we can ignore the structural issues and probably be fine. However that seems like an awful lot of wishful thinking right now.

Neil Pelkey
Mar 2 2011 at 9:00am

[Comment removed pending confirmation of email address. Email the to request restoring this comment. A valid email address is required to post comments on EconTalk.–Econlib Ed.]

Mar 4 2011 at 10:55am

I appreciate the empirical evidence that the differential that exists between the top 1% and the bottom has grown. However, I think something gets lost when we simply concentrate on the number of relative dollars. For example, think about how much differently the top 1% live from someone around the 50% percentile (so, in terms of what they are consuming). My question becomes, are there things the top 1% are doing that the 50% percentile never get to experience? I’m not sure that this difference has grown over time. In fact, it may have contracted. My point is that the lifestyle or standard of living may be compressing even though the number of relative dollars is expanding.
I have a colleague that shreks in horror as the super wealthy are able to frivolously spend money on lavish golf outings. Doing things I could never afford, I suppose. Yet, I’m not sure if I had that much more money that I would ever choose to do things like this– even if I had money to burn. So, it got me thinking, what is it I am missing that the top 1% are doing? The difference between the way John D. Rockefeller lived in the 1900s and those with more average incomes at that time lived contrasts more sharply with the way Oprah lives today and the rest of us. The Top 1% can vacation frequently in the Cayman Islands in resorts I’ll never touch. Yet, Branson, MO has never been better. Has Branson moved closer to providing amenities akin to luxury resorts even though the price tag has moved apart? Isn’t this a difficult thing to measure?

human mathematics
Mar 8 2011 at 2:19pm

Can you post the paper that divided voters into 3 wealth categories and assessed correlations between the category’s political opinion and the senator’s political opinion?

I think around Minute 40 Acemoglu mentions it.

human mathematics
Mar 9 2011 at 2:25pm

Apologies for that comment, I see that some astute readers posted the link as well as more great info.

(moderator, feel free to delete both of my comments)

human mathematics
Mar 9 2011 at 2:51pm

Minute 8:51

People who don’t read the newspaper still are aware of wealth differences (which often come across as cultural differences) e.g. between the coasts and the heartland, between the cities and the suburbs and other areas.

People get relatively acute information from people they see and talk to. So given the existence of travelers and closely connected social networks it’s not unreasonable to imagine that information and rumours about wealth travel outside of newspapers and media.

After all, this is similar to how people hear about jobs.


Thanks for taking such a strong position, Russ. And for admitting (a few mins earlier) that you were wrong in your shot-from-the-hip capital allocation (MRC=0) argument from years ago. I wonder if you will be saying the same thing a few years down the road about your mistaken wall street vs. SF v/c argument? Regardless, thanks for the boldness.

Relevant question. If it’s so profitable to be a CEO or trader, then why doesn’t everyone do it?

The first step to becoming a trader is to have a good trading record. That means you have to have $50k (small money) of your own and figure out a way to make money at the retail level.

There probably was another way during the period you’re talking about to get into the high finance world, which was to go to a really top notch school and get the attention of a finance company.


Supply and demand applies to grad students as well. Theory: economists desire the ability to speculate from an armchair and two things that they hate to do (but must do) are (1) learn math and (2) scour data and learn actual facts. Anybody who makes this job easier for them will be in a small group of suppliers providing a high demand item and will do welll.

Day traders
Russ, you’ve been extremely self-aware recently and in the 2011 Fazzari show even said, “I’m sorry to say I used to be one of the people who argued for X.”

The results of applying the same attitude to your statement about short-term traders could be really interesting. Would you have had a story years ago that justified the value of short-term trading? What would it have been and what would you say to “the old Russ” today?

Finally, what do you think are the socially beneficial kinds of investment, and why? If you’re right about short-term traders, then don’t we need to raise the short-term capital gains tax? And if you’re not right, that might inform other debates about responding to the financial crisis.

ric caselli
Mar 10 2011 at 8:36am

Excellent podcast!!!! Please keep bringing on questions rather than answers and we’ll get somewhere (past Hayek LOL).

Check out the essay by Walter Russell Mead on the March/April issue of Foreign Affairs, it’s relevant.


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0:36Intro. [Recording date: February 9, 2011.] Presentation on the Financial Crisis and the role of inequality. Inequality is often invoked as a potential explanation for various crises. I think sometimes the evidence for that is a little bit weak. But you were criticizing some of that work; particularly criticizing a release to an alternative put forth by Raghuram Rajan and his book, Fault Lines. What is Rajan's argument and your alternative? Let me first start by saying I think Ragu Rajan is one on the most creative and accomplished economists of his generation and somebody I always learn a lot from. And he always comes up with interesting ideas, and this is no exception. I actually think he has come up with a very rich analysis of the Financial Crisis and its implications and its causes, in his book Fault Lines. One of his ideas, or one of the lines of arguments in that book that has attracted a lot of attention and it is a creative and interesting that others have supported or said in other forms, and to me it sounded like an intriguing hypothesis that it made me think of related ideas and also why I am not fully convinced by this idea. This is what I've tried to argue in a presentation at the American Economic Association in Denver last month. Let me start with Rajan's hypothesis. Essentially, Rajan takes off from well-established literature in labor economics which relates aspects or parts of the increase in the labor market, which has risen quite considerably over the last 30 years to technological development--in particular things such as information technology, robotics, new organizational forms that have increased the demand for more abstract skilled, more skilled workers. The general consensus is that this combined with perhaps slower increase in skills in the last 20 years or so than the United States had experienced before led to a sharp increase in the college premium and a sharp overall increase in the overall inequality of the labor market. For example, measured by the gap between those who are at the 90th percentile of the earnings distributions--the richest top 10%, so to speak--versus the bottom 10th percentile. That gap has increased a lot. Or you can look at other measures such as standard deviation of wages or earnings or family income, they have similarly increased. There is a debate in labor economics what is the role of technology, trade; but most economists are comfortable in thinking technology has played a leading role here; trade has probably played quite a major role, too, but intermediated by technology so it is mostly not trade in goods of the 1980s, but kind of the offshoring and outsourcing of jobs that has been intermediated by information technology of the late 1990s and 2000s. Then there is a debate about what is the role of institutional factors, such as the demise of unions and the minimum wage and so on. That's still not entirely settled. But taking this consensus as given, there is this marginally exogenous increase in inequality, goes the argument, which has created tensions in the political system because part of the U.S. population is seeing its income rise rapidly while the other part is stagnating or not seeing the same kind of gains. Increased pressure on the political system to do something about this problem, to appease the bottom of the distribution that is not gaining from this increase. Now, different versions of the argument I've seen articulated are sometimes about appeasing the bottom, but you could also equally tell the story about appeasing the middle. If you look at what's going on to the top of the distribution, the 90th percentile, and also the middle, that's also increasing, so you could tell a story that the middle guys are feeling unhappy that they are not seeing the same extent of gains as the top guys. The political system in Raghu's story responds in the cheapest possible way, essentially encourages government-sponsored enterprises, the likes of Fannie and Freddie, to provide cheap credit to the bottom of the income distribution or perhaps the middle classes who would not have otherwise be enabled to afford houses at perhaps subsidized or over-subsidized rates. This political response then lays the groundwork for the financial crisis where there is a housing boom because too many people who were at the bottom and who didn't really have the purchasing power to buy houses are buying houses; housing bubble, source of what's going on. That in a nutshell is one part of Rajan's thesis. Last week we had on Tyler Cowen, talking about the Great Stagnation, and I expressed some skepticism about the median income numbers. But whether those are right or not, it's certainly true that measured inequality has grown, if you compare 90th or 95th or 99th percentile to the 50th. I always wonder how much people are aware of that if they read the New York Times. As a generator of demand--maybe it's a supply argument that has to be made--but as a demand factor I don't really think that the average person sits around thinking there are all these other people doing much better. Weak tangibility. Good question; don't really know. I think people really do draw relative comparisons, and we have a very globalized media market, so it's hard to imagine that people living in inner city Detroit or Nevada don't really know that there are parts of the country where incomes are increasing and people are living much more comfortably. People in Nevada probably know that the richer neighborhoods in California are prospering and so on. That's just a guess. Following the financial crisis, a lot of people have been acutely aware that the burden of the crisis has not been equally borne. Both on the left and the right there is a lot of talk of the bankers not having their pay cut, still have very high salaries. No doubt about that, and I think people are very aware of it. Fascinating to me how little politicians of a populist stripe have exploited that or tried to. Have a sinister theory of that.
10:15So that's Rajan's idea. You are going to give me an alternative plus how the data better explain your alternative. The alternative that I would put on the table and other people have suggested sort of similar things so I would not claim sole authorship of this. In the Rajan story, politics is just a response, an intervening channel. For understanding the financial crisis, it might be that politics was much more of a driving force. Might actually have been that it was politics acting as sort of an autonomous force really shapes the state of finance and the financial industry in the United States. Especially over the last 25 years or so. Developments in the financial industry then pose both the financial crisis and also through related processes part of the inequality that we observe in the United States. I think there is a difference between what I'm going to call labor market inequality, which is what I think Rajan is talking about, and top inequality. By top inequality, I mean: How much do people in the very, very top of the income distribution earn relative to the rest of the population? The top 1%, or the top 0.1% of the U.S. population, the very highly paid CEOs; and the financial industry; there are also some in the entertainment industry and so on. That top 1 or .1 percent, it's a pretty diverse group of business executives, lawyers, surgeons, basketball players, entrepreneurs. Not many people in any of those, since we are talking about the very top. But some overrepresented in that tranche than it had been before. We'll talk about some work other economists have done that provides some evidence consistent with that. But the reason I'm drawing this distinction between labor inequality and top inequality is that there is fairly detailed work on what causes labor inequality, the difference between college graduates and high school dropouts, between people with MBAs and people with just a college degree. Or the 90th percentile relative to the 10th percentile. There is much less work about what's going on or causes of the explosion of inequality at the top of the distribution. A little bit. The superstar literature. But not empirical. Good reason for that, which is that the usual data sources that people use for long-term inequality trend, the Current Population Survey (CPS) or Census data, they are all top-coded [sp.?], which means they tell you accurately what's going on at the 90th percentile but not much more about that. There is a certain level above which your income is not revealed. Meaning: it's 100,000 or more, or a million or nor. But we don't see Bill Gates's income. For that reason, the labor literature hasn't spoken that much about those people. Recent research by Thomas Pickety and Emmanuel Saez use IRS data to look at some of the trends, but it doesn't have the same sort of richness as the CPS or Census data. Harder to know who these people are, what their level of education is, what industry they are working on.
15:57Talk about top-inequality, then; what's driving it. One important point is that we have to distinguish between inequality and top inequality. Might well be that it's exactly the same factors that cause the rise in inequality that are also at the root of the spectacular increase in top inequality, but there are reasons for thinking that's not exactly the case. Let me be a little more explicit about it. We've had a fairly large increase in overall inequality in the United States. If you look at what's going on with the college premium, the ratio of the 90th to the 50th or the 10th percentile in earnings or hourly wage distributions; but we are talking still things that are not out of historical precedence. Certainly we are more unequal now than any time before WWII, but the levels of inequality we are seeing in the labor market are certainly not comparable to what's going on in labor markets in Latin America or what the United States experienced in the early 20th century. For instance, if you look at the gaps between the 90th and 10th percentile, that has sharply increased in the 1980s, and sort of stabilized in the 1990s; increased again in the late 1990s and so on. In line with historical trend. What's going on with the top inequality is rather remarkable and we probably haven't seen anything to this extent. Because of the composition of who is in the top. For instance, Pickety and Saez have data from the IRS; likely to be fairly accurate, although one could worry about certain things there. Like the word "fairly." In the 1970s, the top 1% of the earners in the United States captured about 10% of all national income in the United States. In the late 2000s, that number rises to close to 25%. That's a remarkable number, that 1% of the population is capturing almost a quarter of national income. Again, if you go back to the gilded age, you'll see numbers that are not dissimilar to this. Much less reliable data. The other fact Pickety and Saez document about these people is the top 1% used to be rentiers--they used to have their money from capital, to own buildings, bond coupons, probably inherited from their families. Over time, these earners have become much more like you and me--W2 earners. Remarkable thing here, unprecedented. Sure, for Michael Jordan we can see the skills that were so unique about him that made him a superstar. And the technology that made it possible for people to watch him play. So, his shoe contract is worth more. That's undoubtedly part of it. But I think it's also difficult to think this is just an increase in the demand for skills. There much be other organizational changes in society and how we organize different industries and how we incentivize people that have also changed. I'm not saying they have changed for the better or for the worse, but that we treat the CEOs have changed over the last 30 years and how we provide incentives to people who are in top management or in important positions in the financial industry have changed. Options and bonuses is one part of it, but I think it's a general sea-change. Hinted at some other research that was relevant for this: work by Thomas Philippon at New York University and Ariel Reshef. What they show is that precisely this period, starting in the 1970s, there is a remarkable explosion in the wages in the financial sector relative to the rest of the economy. All of those are suggesting--by all means, finance is not the only sector--but finance is playing a disproportionate role in the top 1%, and the top 1% are not the same kind of people who were the top 1% in the 1960s or 1970s. Much more remunerated for the work they are doing in finance or other high paid industries.
23:48So this is an empirical question. We do know that the profitability of the financial sector was extremely high in the 1980s, 1990s, and 2000s. We can probably get some pretty good evidence about some actual numbers. A lot of these firms are publicly traded. Most chilling part of the financial sector's success--there are other reasons I think it was unproductive--but the other chilling part is the sheer number of people other than the CEO who made enormous sums of money. You could probably get a count. Want to stress that I'm not against people making lots of money; I'm against people making lots of money for unproductive reasons using my money. Do we feel--right word because we don't have the empirical evidence to back this up--that based on the empirical facts we have and the theories we have that a software entrepreneur who has invented a new product that is being used all over the world and is making a billion dollars is contributing the same amount as somebody who made some great trades on some derivatives and is getting a billion dollars in bonus. Might want to think about what society is getting from these two people that are getting the same reward from society. The standard argument, which I'm unpersuaded by--it's tempting and I used to make it myself--is: People on Wall Street are allocating capital, and allocating capital through these kinds of trades and arbitrage is hugely valuable; true you can't see it directly, but nothing is more important for capitalism is allocating capital. The problem with that argument is when you allocate trillions of dollars towards housing you've made a horrible blunder. We got some benefit from it; most of it small relative to the costs; and I believe that was not a natural process. Destructive one engendered by bad policy. I think it's exactly what you are saying and the big picture. I think it's difficult to know, different types of arguments. Area that would require new research strategies. It's very difficult to measure the social value of any activity because most of it gets realized in very complex ways. I actually believe that allocating capital is an important thing, and if anybody who was playing a role in allocating capital took the right form, that would have a very high social reward. No doubt. The question in my mind is whether, when you are making money on short-term price fluctuations, that actually is essential for getting the long-run prices that are important for the allocation of the trillions of dollars, whether it helps us get those prices right. I think it would be important if the prices were right. The question is whether they were induced to be wrong. Exactly the point. We like people who do arbitrage to some degree because they help prevent prices being out of whack. But the prices we worry about being out of whack are the long-run prices, not the short-run prices. If IBM stock trades for 3 hours 10% more than it should, that probably doesn't create a disaster for the U.S. economy. You can make millions of dollars from that three hours of mispricing. That I think is the question: How much of the money that investment banks are making is due to short-run fluctuations in price that don't really have all that much to do with the long-run allocation of capital? Then there is the question you posed: this process and the variety of political channels it interacts with might also help get the prices wrong rather than right. For example, the prices of housing.
29:08Let me suggest a different empirical way to think about this. In the venture capital world, which is centered around a bunch of places in the United States, but I'm going to put it--it's in Texas, Massachusetts, California, but most of it is in California, so let's think of it as California--and we have Wall Street, mostly in New York, some in London, other places around the world, but let's contrast New York investment banking with California venture capitalist investing. If you are a venture capitalist, you have a fund. You make some bets. By definition it's hard to do. We understand this. Maybe 3 out of 10 go broke; 4 or 5 out of 10 are mediocre; and there's 2 or 3 that make you wealthy. If those 2 or 3 are successful enough, it makes up for the losses and the mediocrity. If you consistently pick badly, either by bad luck or stupidity, you end up with no money, and you don't get to allocate capital any more either from your own money or the people who trusted you with it. Similarly, if you come up with a good idea, it might not work out--things go wrong--but well-accepted in California that if people had good ideas, showed fortitude, or other sets of skills, that eventually if you continually start companies that fail with other people's money, you go out of business. You have to find a productive way to feed your family. But on Wall Street, what has happened in the last 25 years is that if you do really stupid things and you lose a lot of money for your firm, you keep going. You make a lot of money, hundreds of millions of dollars sometimes--as an individual. Even though you've destroyed your company. And you can stay in the game. So, something is drastically wrong. And you are doing it not with your own money, but with other people's money. The question is why would people continue, give them money; just like a venture capitalist would ask the fund's losers. After a while he doesn't get any money to spend. But on Wall Street, you can keep getting money for a while, from you and me, the Fed helps you out. It's clearly disastrously inefficient. I don't know enough about the career paths of traders and high-level finance executives. From what I've read and understand, if you are successful you get bigger bonuses; if you are not successful, you lose your job. It's not as if you make millions of dollars if you are consistently unsuccessful. But I think the problem is that in such a risk-taking environment, even if the story was much less bad than the way you just put it, which was that I get a cut of the enormous profits I make if I make profits, and if I don't make profits then I go home with my salary or take another job, make the salary an engineer in another job would make in a respectable company. That already creates terrible incentives because you don't bear the downside of the losses and you can make humongous amounts of money by being successful in the risks that you take. May not be as bad as you just said, but the incentives are just awful. And you are talking about the traders, an interesting subcategory of the folks I'm talking about. I'm thinking about the executives. Some of the executives have golden parachutes; they can go run another company if they are not successful. Because their success is hard to judge because it's such a complex job, I think the issues are even more problematic in that respect. Very interesting empirical issue. Babchuk and Span [?], nice work on this showing how much the folks gained even when their firms did badly. For those out there listening who are graduate students, this is an interesting case study opportunity: magnitudes of these things. Let me underscore that. There is a large number of economists here talking about these issues, but we have to kind of extrapolate on the basis of limited data. Economists generally look down on just data-collection. But I think if you look at Pickety and Saed's work, which was mostly date collection and data analysis, it's been amazingly useful, socially valuable. Provocative. Finding good data sources to answer really important questions is one of the things people can do very productively, very important questions there. I think just the back-of-the-envelope calculation, you have a very good idea about salaries in the major professional sports; a pretty good idea about movie salaries, how much they make at the highest level. We have very good information about CEOs and executives at publicly traded companies. We don't have very good information about law people in high profile partnerships. Something like the tobacco settlement that enriched a very small number of people an immense amount is harder to get at. But some of that might be public, too. I don't know. So, there's a digging and compiling there for a creative person.
35:33Slightly more depressing afterwards top inequality? Let's cut to the chase. The Rajan story is fairly depressing. But in the Rajan story, political resources are responsive, and that's it. The more depressing one is that there was a political process that led to certain types of distortions in the financial industry. Those distortions then both laid the seeds of the financial crisis--because they encouraged the wrong type of risk-taking--and they also in the process made a lot of money for those people taking risks while those people hadn't turned south yet. Simple story; many people have sort of written about it. In your presentation you talked about the Political Science literature that correlates, giving contributions to politicians with policy outcomes that benefited, say, the housing industry. So if you kind of compare Rajan's hypothesis to the alternative hypothesis I just laid out, politics is very important in both of them. But politics plays out very differently in the two stories. In the Rajan story, the political responses come because politicians are somehow responding to the discontent of the bottom of the distribution. Or, in response to my comments, Raghu said it's the middle of the distribution. Whereas in the story that I suggested, politics is playing out by responding to lobbying campaign contributions and otherwise the ability of the already well-off and already well-organized to influence and guide the political process. It's not technological change. It's institutional change. It's the good-old technology that people have known for centuries: money begets you power. I cite it from Mark Hanna, William McKinley's campaign manager: There are two things that matter in politics--the first is money and I can't remember the second. It's the same thing. Just we are now 100 years since then. Political scientists have done a bunch of work on this. I must caveat that here we have some data, but the data are not ideal, so much more data are needed. Also, the empirical work here is not well-identified, not causality; but correlation. So, Larry Bartels and bunch of other political scientists took data on how senators or other politicians vote and looked at how their votes correlate with the opinions of their constituents from a number of surveys. Can do this issue-by-issue or overall--are they voting more to the right or more to the left? You sort of get the same picture independent of how you do it. At the end, a correlational level, regardless of how you look at economic issues such as budget waiver, minimum wage, budget rules, social issues such as civil rights, abortion, and so on: the way that senators vote is very highly correlated with what their high income constituencies think. Moderately correlated with what their middle-income constituencies think. High income is top 1/3; middle income is middle 1/3; and low income is bottom 1/3. It's absolutely not correlated with what the bottom, low-income one. Difficult to see how American politicians are responding to what their low-income constituents want. If you say it's not low income, it's middle income: Even there they are correlated but much less than with high income. Not so surprising. I think the reason for that is exactly the second piece that Political Scientists have, which is that there has been an explosion in Political Action Committees, campaign financing and lobbying expenditures, both for the Congress and the Federal grants over the last 30-35 years. The press is full of anecdotal evidence that both parties have really had to change their positions because of their concerns about fund raising. So, when you take that into account, I think there is a good channel for why politicians are going to be more correlated with their high-income constituents. They want the money.
42:10Now the question is: What limits that desire to make the people who give you money happy? The answer is, although it's true that poor people can't donate much money, they vote. Now, they vote at lower rates than high-educated people and I assume higher-income people for example, but they still vote. There's a lot of people below the median--by definition, about half of them. It's not irrelevant. But before we come to that, let's look at how these views of politics matter. At face value, it's going to be much less likely that the political system was responding to discontent and the angst of the bottom, especially in the 1980s and 1990s, than what the top of the distribution wanted. So I think a story that works through lobbying and campaign contributions--and not only that but access to politicians. It's not just that you are buying the politicians. I think you are influencing the politicians. And the best way to influence the politicians is to talk to them. Having access, which is also again something that requires money, is very important at this point. What limits that? Several things. First, I think the decency of politicians limits it. Shame matters. I'm not going to say that all politicians have lack of decency--some do, some don't. But I think in economics we don't just want to rely on the decency of people. We don't want to deny the decency or condone indecent behavior. But we want to make sure that incentives are right so we don't have to rely on heroes. Second thing that limits that is political competition. If one party is veering to a particular position, then the other party can take a different position that's more attractive to the voters and try to get more votes. I think that's where Bartels, in his book Unequal Democracy and also a couple of other political scientists like Hacker and Pierson in the book Winner Take All Politics make the following argument--not sure how true--that essentially the campaign finance pressure has been quite decisive for Democrats. So, Democrats who were supposed to take the opposite position to Republicans on some issues, sort of felt this campaign pressure and they didn't take those positions. I don't know how convincing this story is, but I think it may or may not be one reason why the competition channels for this influence of money and politics may not have worked as well as it should have. Let me give you three issues where I think in every case there was a failure of political competition. Either because it's in the nature of human beings, or because there is just less competition and politicians can exploit that in ways that are not good for the rest of us. My story, not unrelated to yours: I look at a combination of Rajan's and your story. Here's three issues. Issue number 1: When a large financial institution is about to go bankrupt, what should we do? The answer since 1984 is almost always: let the stockholders lose all their money and let the creditors and bond holders and lenders get all their money back--100 cents on the dollar. That's the decision we have consistently made. It has been a bipartisan--shockingly to me--that that's always a good idea lest there be financial instability. That's case number one. Agree entirely. Case number 2: Is it a good idea for home ownership in the United States to go up? Around the mid-1990s there was a huge push from both Democrats and Republicans, more Democrats, but when Republicans got more empowered they pushed it too, that said: We should try to increase the home ownership rate. We can argue about Freddie and Fannie; let's put that aside for the moment. What is true is that when this push was made, the home ownership rate in the United States started a steady increase, which in areas that were particularly supply-constrained, hard to build new houses, resulted in large price increases. Who was in favor of that? Some sinister people, people who had a self-interest--not the right word--people in the real estate business. Also people who could profit from that, people on Wall Street that would allow people to invest in those homes. Also people who cared about the poor--the Rajan argument--people who cared about people who didn't have access to home ownership, who felt that was unfair. Beautiful consensus across party lines, across interests of different sectors. And it was cheap--no budgetary costs at the time. Forgot the third one. Oh, the bailouts. When we had a choice to funnel money directly into these institutions that had made bad investments, there was again a bi-partisan consensus. Not: Oh, I'm helping my friends who are rich donors or in the financial sector; but: This is good for the country. People who were able to convince themselves of that, if you want to give it a nice sheen. If you want to give it an ugly color, they were helping their rich friends. But in those three cases, there was no political competition. The only people who voiced dissent from that were either on either the fringes of the parties or outside the party structure, who said: These are bad ideas. How could that recipe fail to create disaster? I don't disagree with much of what you've said. I think on the house ownership thing, I agree with you that artificially inflating home ownership rates, especially through such things as mortgage tax credit which I think is the really bad idea, decreasing our taxes and giving it back in a distortionary form--I agree with all of that. But research people have done are these two interesting papers: by Neil Bhutta with the Federal Reserve Board, a graduate student at MIT. He finds, he looked at both the Community Reinvestment Act and certain areas--goal provision, kind of a key provision; Fannie and Freddie goal process lowering minority areas. What he finds is those have very small effects. Two interesting papers; we'll see if they stand up. I agree that I don't think the Community Reinvestment Act was decisive.
50:32But we do have this fact. The rate of home ownership in the United States, which had been stagnant--and this is where I think Ragnan's thesis is relatively important in terms of political pressure, although again I think there is an entrepreneurial side to the politicians as well. The other thing we didn't talk about: The timing is also a little strange for the Rajan hypothesis. Of course, timing-based arguments are not easy. You can go around them by invoking long and variable lags. But if you look at the data, the big increase in inequality, both for the bottom and the 90th percentile and the 50th percentile, is actually in the 1980s. It's certainly not in the late 1990s. In the late 1990s and the early 2000s, both the bottom and the middle are doing reasonably well. So you need the story that the inequality holds a twenty-year delay. It couldn't have been the increase in inequality during the 1990s because that was trivial or in fact non-existent. It was the inequality in the 1980s and early 1990s that holds it. It just took a while to build up. Long and variable delays. I'm with you on that. Coming back to the behavior of the politicians: I think the media is a key factor in making sure that when politicians take positions that are heavily influenced by a small group or by lobbying that these actually get enough attention and reaction to it. The problem is that the way we correct politicians' behaving is by voting. But what do the campaign contributions do? They influence the vote in a very strong way. Like a vicious circle. Do we have good evidence on that, by the way? On what part? On the power of money to influence elections. It seems logical. Obviously people can buy more ads. On some level, it's overwhelming. The other point I would mention is that name recognition has benefited incumbents in recent years because of I think the lack of competition induced by campaign finance reform. There is a lot going on there. I don't know of any convincing evidence that shows that more money has a causal effect. But it seems extremely plausible. We have interesting evidence that having information from different sources has an effect. Interesting paper by Stefano DellaVigna and Ethan Kaplan on the Fox News effect, exploiting the fact that certain areas got Fox News Cable at different points; and they find, not a very, very large but a sizeable effect that having access to Fox News on Republican Presidential vote share. There is evidence from David Stromberg and Jim Snyder on how politicians are responding to their media coverage, paper exploiting the fact that some politicians are in the coverage area of different states, so they don't get covered in local news; and they get covered very differently than those who are in other areas and who therefore news about them are more easily available to their voters. Graduate student at MIT, Leopoldo Fergusson, uses same strategy to look at how much the media counter the effect of lobbies, and he finds some evidence consistent with the fact that there is some interaction between media coverage and politicians who are getting a lot of money, especially money from some specific Political Action Committees. So there is some evidence building up, but not enough at the moment to suggest how to design so that the democratic process works better. Great empirical opportunity here. My simple test for whether it's important is simply how much time and energy politicians devote to electing it. They are specialists. Not a matter of why aren't they using every waking hour on this.
56:18Talk about taking either your variation on Rajan's thesis or some combination. What do you think we might do to make this better? Very related to the last set of issues we just talked about. I'm not in favor of a very big top-down intervention. I think we have to find ways of encouraging the existing political processes in the United States to work better. It's about making sure that money politics doesn't become even worse in the United States. I think some sort of campaign finance reform would actually help. I don't view that as a big intervention. We have gone in the other direction, United case--we might have undermined checks on campaign contributions we have for politicians. But I think we have to make sure that different parts of the population are involved in politics and are informed. Best example we can so that the political process, democratic process, works as healthily as it can. Point to an important political argument: I think transparency is hugely important. It's true that when media uncovers a scandal or exposes something, it's not sufficient to stop it, but I think it has an effect. Interesting question: During the weeks before the AIG bailout, Hank Paulson, the Treasury Secretary, talked to his successor at Goldman Sachs, Lloyd Blankfein, I think two or three dozen times. Now, I'd love to know what they talked about. My joke--I made this on the program before and I apologize to my listeners--I don't think they were talking about their kids' summer vacations. Just trivial idea: Wouldn't it be interesting to know about who walks in to a politician's office or who they talked to on the phone and for how long? Do you think that could be publicly available? It's not, of course; but do you think that could be a healthy thing? I just have to wonder. Access is so important. Why is it, in a world of campaign finance reform, the CEO of Goldman Sachs or Bear Stearns or Merrill Lynch--their ability to donate directly to a politician is extremely small. Why are they so popular? One answer is they can direct the contributions of their employees. Interesting question of what's actually happening on the ground. It would be great to get an expose written by an anonymous staffer. I think in many of these cases, we are talking about the influence that comes not only with money but also with expertise. It's another aspect of the problem. Wall Street has a sort of monopoly on the expertise; more of a monopoly than its true expertise justifies on financial matters. So, when Paulson wants to get an idea about what's going to happen to the financial system, he calls Lloyd Blankfein or Jamie Dimon. But what he is getting of course is not the objective truth, but truth filtered either through their perspective or shaped on the side so it fits the interest of their company. I think that's an important part of the influence process. It's not directly lobbying, but it's a related thing. Who has access is determined, who is the expert is determined by the rich and powerful and the interest parties. The cheerful version of this is the glass is half full. Just think how few people are able to exploit that connections. CEOs in many industries are not connected and actually have to make a living, can't have input like that. Maybe we should be grateful it's only the financial sector that's got this power. I totally agree with that. I think there are issues here to watch out for; U.S. political system has shown, to use Rajan's term, fault lines of its own in this process. But on the whole I'm still an optimist that the United States still has some of the strongest institutions in the world and the extent of overall corruption has been limited. Revolving door policy for politicians that I find distasteful, but few politicians have used their power to enrich themselves. Pleasantly surprised by the way that the several commissions recently have come up with sensible proposals recently about how to tackle the budget deficits and so on. Not received overwhelming support by the Obama Administration; not received bipartisan support. But still, the political system is not stuck and not in the pocket of one group or another. Optimistic we will come out with a few scars rather than all of our lips broken.

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