Russ Roberts

Frank on Competition, Government, and Darwin

EconTalk Episode with Robert Frank
Hosted by Russ Roberts
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Robert Frank of Cornell University and author of The Darwin Economy talks with EconTalk host Russ Roberts about competition, government and the relevance of Darwin for economics. In a lively and spirited discussion, Frank argues that because people care about their relative standing with their neighbors, standard conclusions about the virtues of competition are misleading. He argues that competition is often wasteful and he suggests directions for tax policy and other forms of government intervention to take these effects into accounts.

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0:36Intro. [Recording date: September 8, 2011.] Book makes case for government regulation on libertarian terms. You challenge those of us who have a free-market bent to confront what you say are contradictions in our viewpoint or possible contradictions. It's also an indictment of anti-government arguments, generally. I want to start with that indictment and then turn to your defense of government intervention. You start the book by arguing that we are in a terrible mess-you call it paralysis--because of an anti-government mentality and ideology. What's the argument there? I think it accelerated when Ronald Reagan came onto the national stage; but the last several decades have seen a crescendo of anti-government rhetoric, that if we could just get government out of the way, everything would be fine; government is the source of the problem. Grover Norquist's famous quote: I don't want to eliminate government; I just want to shrink it to the point where I could haul it into my bathroom and drown it in the bathtub. I think there is a general skepticism of government, and so I think when there are circumstances in which government is really the only actor poised to take effective action against a problem, we are not able to move quickly. We are not able to move at all, oftentimes. I think it's true that certainly since the 1980s there's been a rise in philosophical defenses of free markets; and you can attribute that to cultural phenomena, the work of Milton Friedman, F. A. Hayek, and certainly in the last couple of years Hayek has been on the rise. But it doesn't seem to have mattered very much. That's the part I find troubling and mystifying about the argument, as you present. For example, you say in the book on p. 51: "For now, the most pressing issue is that although many extremely important tasks remain to be done, government has no money." And yet government spending is at an all-time high. Certainly at the Federal level, and often even at the state level, where you talk about problems in California due to Proposition 13. Yes, Prop. 13 limited property taxes, but it didn't stop government spending. So, where is the evidence that this rhetoric has any real impact on the size of government or the scope of it? Tax collections now are probably at the lowest point since 1950 as a share of GDP. It's true right now government expenditures are fairly high as a fraction of GDP, but that's almost entirely a consequence of the automatic expenditures that are triggered by a distressed labor market. We've got Medicare payments, Medicaid payments going out in much larger volumes than normal, unemployment insurance. The high expenditure levels now are not a consequence of a rising share of GDP going to government. They are really a temporary aberration that reflects the depth of the current downturn. Well, there are some automatic stabilizers, but that $820 billion of stimulus wasn't part of that. We are spending $3.6 or $3.7 trillion this year, some of that due to the recession. But certainly--let's go back to pre-recession, 2005-2006. Again to take the state level: spending in California was dramatically high; Federal government dramatically high. It was historically in the ballpark--it was toward the high end of peacetime spending as a proportion of GDP before the recession lowered that denominator. I'm going to argue, and I'll get your take on this, that government does too much. It hasn't shrunk, and that anti-government [?] hasn't had, in my mind and we can debate it, virtually zero impact on the real world. It's restrained some stuff, but I don't see that that free market impact has had much of an effect on the big picture. Instead, government has expanded to do a bunch of stuff it doesn't do very well. If you look internationally, I think we're really at the low end of the scale in terms of economic activity accounted for by government. That's true. The national health sector is very large in the United States. It's mostly private. In most countries it's public, so that's part of the difference. But if you look just at the growth in government spending, here it's been quite modest compared to international standards; and I think that's got to be a reflection in the end of the kind of anti-government we're talking about. The question is: Is that a good thing or a bad thing? I gather you think it's a good thing that government expenditures have grown more slowly here than they have elsewhere. People here are generally not happy with our government; we are quite suspicious of our government. I think the ranking of the United States on the Transparency International's scales of corruption in government--we rank 21st on that scale of corruption among nations. Where do you want to be? Every year there are lots of countries where people think they are doing a good job? Typically the kind of countries somebody would think about moving to if somebody's stuck a gun to their head and said you can't live here any more, you've got to choose another place--those countries would be at the top of almost anyone's list as a place to move to. The countries at the bottom of the Transparency International's list are countries you wouldn't want to move to, I wouldn't want to move to--Haiti, Afghanistan, Somalia. The countries that have weak, ineffective governments are not places anybody would want to move to. That's true. And as you point out in the book, there's a correlation issue. You don't know which way causation runs. Runs both ways. I think the international comparison is an interesting one. I certainly accept the point, and I think it's true that we have a different culture. The average American views government differently than in many other places, and that is part of the reason we have a smaller government. Historically, we had a different political system. It's interesting to think about why that is, too. I've often wondered why we are so different from the rest of the developed world on that particular dimension. My guess is that it's two things. One, the people who came here to start the United States were people who were running away from government; perception that government was a tyrannical force in their lives. Which it was. They wanted to get away from that. More important than that--I don't think that lasts 200 years--I think you see government acting when people bump up against each other and cause problems for each other. That's really the source of most demands for government intervention in almost every sphere. And here we had the Western frontier for most of our history. When people bumped up against each other and started getting in each other's way it was easy enough just to move west and escape the problem that way. We've run out of options to do that. Now we are going to have to come more face-to-face about the problem of what to do when your behavior hurts me or my behavior hurts you. We used to just run away from that; now we have to deal with it.
8:52Interesting argument. I think the 200-year-ago problem that you mention, that hypothesis that it was the founding fathers' intellectual heritage: of course, they put in place a set of constraints on government as a result of that feeling, and they did last a very long time. Those started to unravel in the first part of the 20th century, steadily unraveled. We've moved away very much from their vision of what the proper role for government is; and I think that is part of the reason we are more like Europe. You do want to add in state and local spending, of course, and when you do that we are a little closer to Europe than the federal numbers suggest. I also would challenge your argument about the bumping up against each other. That's what we teach our students. We teach our students that the demand for government comes from public goods and externalities. But that's what I see government doing. That's part of my claim that government's gotten too big and gotten away from its core competencies. A lot of what government does isn't to keep us from hurting each other. It's to hurt one of us at the expense of, to benefit, somebody else. And it's that cronyism that a lot of us who are anti-government, as you describe in the book--that's what motivates us. I'm with you on that, and the question is: What do you do about that? I think there are countries where that doesn't seem to be the perception. I'm sure there's some rent-seeking that goes on everywhere. I'm not that naive. But there are countries where I think the perception is that the government, civil servants, are there, they are competent, they are doing their best to provide high-quality public goods at a fair price for society. There's not this deep, deep skepticism that seems to exist of government here; and I think you just have to see that as the fruits of a very long-standing effort to build a good government, weed out corruption, structure institutions in a way that provides checks against abuses of government. Here we've not really embraced that task. We've sort of taken a negative view toward government. Smart people, ambitious people often don't want to serve in the government because it's not a post in life that's entitled to much respect in our society. That's different in many other countries. That's true. You have to ask yourself: Do you want to have a government? Yes and no. There's no society on earth that doesn't have one; if you didn't have one you'd be invaded and pay taxes to someone else's government, so that's not an issue. And if you are going to have a government, you want to have a good government; and that takes a lot of work. I definitely agree with that. The main thing that explains the kind of abuses that you and I find so troubling is that we've allowed our system to become so heavily dependent on campaign contributions that, sure, people are voting in a way that doesn't serve their constituents' interests. They've got to cater to the people who are funding their campaigns or they'll be unseated in the next round. I think if you really want to build a better government, that's job 1, to focus there. But I don't see anybody stepping up to meet that charge. I'm a skeptic on that. I think the ability of the government to hand out goodies is a Constitutional constraint. So, the current system is awash in money--we agree on that. The question is why. The answer is obvious--because of people trying to steer the system toward themselves or their ideology. Not always so pecuniary. But the question is what can you do about it that would be effective? If you have a government that's going to spend $3.7 trillion and you tell people they can't contribute to it, would there still be the influence that you and I don't like? And a lot of it is not monetary--it's subtler and stranger things. The role of the Fed, for example, in awarding large sums of money to large financial institutions through its policies and behavior--Ben Bernanke is not running for office; campaign contributions can't have anything to do with it. It's a subtler form of influence and lobbying that's disruptive. Well, we agree. I hope it ought to be a project we could each get behind. That project of building a more honest and effective government. We can agree on that. I think that's a huge part of what distinguishes where we think government can be effective. I think you are a little more optimistic than I am. I'd rather see government get better at what it does well rather than expand what it does.
14:11Let's talk about some of the big issues in the book, other than this issue of ideology and mentality. The title of the book is The Darwin Economy, and you have some provocative things to say about Charles Darwin. Why is Darwin relevant? Talk about what you see as the insight Darwin had into competition that's relevant for economics? I start with a prediction that I won't live to see whether it comes true or not: I predict that if we were to poll professional economists a century from now about who is the intellectual founder of the discipline, I say we'd get a majority responding by naming Charles Darwin, not Adam Smith. Smith, of course, would be the name out of 99% of economists if you asked the same question today. My claim behind that prediction is that in time, not next year, we'll recognize that Darwin's vision of the competitive process was just a lot more accurate and descriptive than Smith's was. I say Smith's--I really mean Smith's modern disciples. Neoclassical economists. I think Smith was amazed that when you turn selfish people loose and let them seek their own interests, you often get good results for society as a whole from that process. I don't think anybody had quite captured the logic of that narrative anywhere near as clearly as Smith had before he wrote. So, it's a hugely important contribution. Smith, however, didn't say you always got good results. He was quite circumspect about the claim. He seemed amazed that you often did. His reservations about markets, though, mapped very closely onto the kinds of reservations you still see from pundits on the left. Markets would be great, I think he would have argued, if they were truly competitive. However, there were, he wrote, actors with lots of market power; whenever they got together their conversations would inevitably turn to conspiracies, to fraud, to bilk their workers or customers; so you needed to have governments to rein them in again. Exploitation of people with their market power. He was particularly interested in reining in their ability to use the government, which is where I think the left and I part company. That's a fair point. I'll certainly grant you that he wasn't exactly on the same page as today's left. But he understood that they were as self-interested and grasping as any. The question is: What's the best way to protect people from that? I think you need to add that it was not Smith's vision of mankind that they were selfish and grasping. Absolutely not. You've read the Theory of Moral Sentiments; so have I. Not too many economists go back and read that these days. He knew full well that the economy would grind to a halt if people didn't have some moral fiber out there in the market place. And they care about altruism and charity and helping others and being respected by their neighbors and all kinds of things besides just money. You go back and read Smith--it's amazing his insights all across the spectrum have held up. Where I think he missed, or at any rate his modern disciples have missed a key feature of competition was--he saw clearly in a way that I don't think others do yet, that competition favors individual actors. That's what it does. Correct. Sometimes in the process it helps the larger group, but there are lots and lots of instances in which competition acts against the interests of the larger group. Familiar example from the Darwinian domain is the kinds of traits that have evolved to help individual animals do battle with one another for resources that are important. Think about polygynous mating species, the vertebrates; for the most part the males take more than one mate if they can. Obviously the qualifier is important; if some get more than one mate, you've got others left with none; and that's the ultimate loser position in the Darwinian scheme. You don't pass your stuff along into the next generation. So, of course the males fight with each other. If who wins the fights gets the mates, then mutations will be favored that help you win fights. So, male body mass starts to grow. Not without limit, but well beyond the point that would be optimal for males as a group. The bull elephant seal weighs 6000 pounds. They fight with one another four or five hours on the beach; they leave one another bloodied and exhausted. One finally can't continue; the victor claims the harem with 100 cows and the mutation that made him a little bit bigger and therefore in the winner's slot in that fight ends up in the pups of all those cows. So you get this runaway arms race that makes males too big from the perspective of males as a group. They'd be much better off if they could push a button and be one third their current body mass. But that's not an option. There are other traits that mimic the invisible hand story. So the gazelle is fast; it got to be fast because it was chased down by cheetahs for the whole of its evolutionary history; if you weren't fast you got eaten. A mutation that makes an individual gazelle faster is good for that gazelle, but it's also good for the gazelles as a group as it spreads through their population. So, sure, you get lots of results in the marketplace, too. There's a cost-saving innovation, somebody introduces it and does really well; then others begin to copy it and it spreads throughout the marketplace and the competition then drives the price down to the new lower cost made possible by the innovation; and the consumer benefits from that once the dust settles. Ultimately. You get Smith's story in broad stretches of market activity. I think anybody who doesn't understand the beauty of that narrative and the power of it to explain why there has been so much material progress in the last 200 years just is missing a huge component of human history. That's a hugely important story. As a sidenote, I think it's about 2/3 of what economics has to contribute to humankind and it's striking to me how little we convey that mystery and power to our students. Students just get out of our courses; they don't know that markets have that unbelievably powerful capacity to get things like that done.
22:13But that's only part of the story for you. I think you can't stop there, and that's why Darwin eventually will have a much more prominent place in economists' thinking. There's lots of stuff in the marketplace where what counts is not how well you do, not the absolute quality of your performance, but the relative quality of it, and competition does spawn, as in the case of big antlers in the bull elk, large body mass in elephant seals, many analogs to those arms races that we see in the market. Look at the financial service industry. They are hiring the smartest people we produce in the university system. Their task is to figure out when a price will move faster than the other people who are trying to solve that same problem. They've invested tens of millions of dollars in supercomputers; they've crunched the numbers up, down, left, and right, and the one who gets there fastest with an accurate price prediction makes a bundle of money. But that's not social product. That's just money somebody else won't make. And those same people, all those best and brightest, 45% of Princeton's graduating class takes a job in the financial services industry, the last year we have data from before the crash. Those are really smart people who could be doing something that you and I would benefit from; you and I are not benefiting when they help the market in derivative securities. Or help come up with an algorithm to help predict when the price is going to move ten seconds before the second fastest algorithm does it. But Goldman Sachs's Chairman, Lloyd Blankfein, assures me they are doing the Lord's work! And I bet you are not reassured by that. It's funny, because I used to be. I used to take that story you just told me and I'd say: I disagree with you. It's true that these are small movements in prices that people make money off of, but that's good because these prices send signals and it's important that the right prices be sent, and the allocation of capital is crucial for productivity. I agree completely. The problem is that we just spent a few trillion dollars on our housing stock, which suggests that there's something deeply wrong with the allocation within our financial system. It could just be a mistake. No, it's not a mistake at all. Influence of money in the political system--the banking industry got deregulated; that was in large part I think because of ties politicians had to people in the banking industry. The banking industry got an incredibly high rate of return on the donations made to the Congressmen and Senators who acquiesced in the deregulation of the banking industry. But once you started making credit available on the terms they were, then I think the Darwinian account gives you a very tidy narrative of how events unfolded. How? The theoretical apparatus that Alan Greenspan brought to bear, to think about that same collection of activities, left him high and dry. He was flabbergasted. He testified that he was shocked that people behaved the way they did and been so irresponsible. He wouldn't have been shocked at all if he'd followed the literature about how individual and group interest just don't coincide. I have to give a different interpretation of Greenspan's testimony. I paid close attention to that, because it was a rare moment when someone said he was flabbergasted, confused, or wrong. He said at the end of that testimony: I have to reexamine my beliefs. And he is portrayed, as you portrayed him, universally as a free-market ideologue who refused to regulate when these excesses occurred. The problem with that interpretation is he wasn't that much of a free-market ideologue when it came to bail out banks. He was a cheerleader. So, I don't view him as much of a free marketer. He used free market rhetoric often, to justify, say, not regulating the derivatives market. He said: Oh, no, those markets, have to leave them alone. And yet when large creditors found they weren't going to collect their money, he bailed out those creditors. He supported the Mexican bailout, which was a bailout of American banks and others. He supported the Long Term Capital Management--it wasn't a bailout by the government but the orchestration of a rescue of people who had lent money to Long Term Capital Management foolishly. He socialized the losses. You are right about each of those points. The deregulation people point to--there was some deregulation, but government's hand was still involved in that market. And where we agree is the political influence of those institutions. Of course, there's a different story, which I don't agree with: they were crucial, we had no choice, we were standing on the edge of a precipice if we had let Mexico fail or Long Term Capital Management; there would have been this horrible ripple effect. So, those people--no one stands up in front of Congress--here's what they never testify. They never say: Well, yes, I supported all those policies because I was getting a good deal from the people who kept me in power. That you never hear. They always say: I had to do it, save the country, had to protect the credit markets from spiking. But to me it's a pretty nasty story.
27:43But look at the dynamic that was underway in the housing bubble. That's where I think the Darwinian perspective shines relative to the Smith's-modern-disciples' view of that market. How old was I when I bought my first house? I was in my late 20s. I remember at the time I had to come up with 25% of the purchase price before I could buy that house. I remember my first house, too; same deal. Saving, doing without, but we did it. And buying a smaller house than you'd prefer. That's right. We skimped. But we did it. We were never in any danger of not being able to meet our mortgage payments, fortunately I was steadily employed throughout that time. But if we hadn't been able to pay our mortgage, it wouldn't have been a calamity for the bank because the bank would have taken possession, sold it for more than I owed on it; nobody would have been panicking or running for the exits as a result of any of that. And the reason for that was that the regulations required strict vetting of the mortgage applications; they required large down-payments. There was stability in that system. Once you lifted those restraints, you can make more money in a rising market by lending more money out. It's just the standard leverage argument. And so banks saw they could bundle these securities and sell them; they could move a lot more credit if they would relax the standards. So, you think about the homeowner who is trying to decide what to do--and here's where I think the Darwinian insight comes in full bore--they are letting people borrow more to buy houses; that means people like me, earn the same income I do, can pay more for a house than before they started relaxing those credit terms. How does that affect me? You could say, and it has been said: I should borrow prudently and not be affected by it. But that's where I think the social dimension of our existence is so crucial, and it's the one that the invisible hand account doesn't take fully into the picture. So, I'm a parent; I have two small kids when I bought my first house. My main concern was that they go to a good school. And what's true in every city, everywhere in the world, is that the good schools are in the more expensive neighborhoods. You may be an exception you can find somewhere to that, but as a general rule that's the way the world works. Some variance, but on average that's true. True in France, where the average expenditure per pupil is the same, no matter what the real estate prices are across different areas; and the kids are on the same page and the same curriculum all year long. Still, the schools in the good neighborhoods are better, if only because the kids who go to them are advantaged. Better learning environment. Every parent wants that. If you are in the middle of the income distribution, say, you are as a parent at least have the goal of sending your kid to an average quality school. We'd think ill of you if you didn't have at least that ambition; probably you'd want to do better than average. But if you want to just meet the standard, you've got to buy a house that is in the middle of the price distribution for your area. Others like you are spending more because the banks are letting them spend more. So what's your choice? You can either borrow more than would be comfortable for you to borrow and match that spending and hold your spot in the 50th percentile, or you can say: No, I'm going to be prudent. In that case it's your kids who will go to the schools that have reading and math scores in the 20th percentile and have metal detectors out front. We're not going to look down on a parent who says: I'm going to borrow; I'm going to go to a better school district; we'll worry later what to do if we don't have enough savings for retirement, if we are not able to meet the mortgage we'll get a second job and make ends meet somehow. That's the way the housing bubble unfolded. It wasn't just people with visions of sugar plums dancing in front of them, vaulted ceilings and granite countertops. It was people trying to keep up with what others were spending so they wouldn't fall behind in terms of where their kids went to school. That was part of it. Account offered by the Two Income Trap book that was out about 7-8 years ago: where does the second salary go? Elizabeth Warren and Amelia Tyagi--how parents could make ends meet on one salary back in the 1950s and 1960s; now parents are in over their heads on two salaries. They pointed out that the extra salary went into a bidding war for better school districts. That's part of it. I think what's missing from that story is why banks were willing to lower those down payment claims from 20% to 10% down to 3%. And that initially started with government in the 1990s to encourage home ownership and liberating Fannie and Freddie from the requirements that they only went to safe people with 20% down. Those were factors that mattered too. Absolutely. So that went to a flood of financing that wouldn't have occurred in a Smithian world. Now, it's true that as the prices started to rise, the private sector, without Fannie and Freddie's help, contribution with the subprime part of it. But it wasn't just the subprime. No, that's my point. In the expensive housing market. No, I think the right makes the mistake in blaming the subprime problem on Fannie and Freddie. The subprime problem was overwhelmingly the investment banks' funding it. Although Fannie and Freddie bought a rather significant portion of their paper. But you could always say somebody else could have bought it. It was so attractive at the time that their purchasing 20% and 30% and sometimes more of the mortgage-backed securities is irrelevant because other investment banks would have bid for that. But I don't know.
34:23I want to take your point about the bidding up of housing prices and the school issue, because you use an example in the book which is a very clean example of how a Smithian like myself looks at the world; and then you make the case that I am missing something. I want to take that and let's talk about it. The example you use is whether firms offer the right amount of safety in the tradeoff between safety and compensation. So talk about that example, and then you can tie it back into the housing. Because that's the way you tell it in the book. Here's where I think both the left and the right in the way they spin nowadays miss the essential forces that are going on in these decisions. So, the left will say: We need to regulate safety because powerful employers would otherwise force their workers to work under unconscionably dangerous conditions. That's an argument that I think clearly fails what I call the no-cash-on-the-table test. Safety is a cost-benefit question. A lot of people object to that way of thinking about it, but there's no way to think intelligently about safety investments if you don't weigh costs and benefits. If you talk to somebody who says we shouldn't be talking about safety decisions in cost-benefit terms, here are two questions I would suggest you ask. Did you get your brakes checked on your way to work this morning? Most people would say: No. But a tiny handful will say: Yes, I did. Second question: Do you plan to get them checked again tomorrow? No rational person would say yes to both of those questions. You check your brakes once a year or whatever the standard is you adopt because it's just too expensive to check them every day or twice a day. You weigh costs, you weigh benefits; you make accommodations just because safety isn't the only thing you care about. You get risks down to a prudent level and then you spend the money you save by not focusing all your effort on getting them down further, but on other things you value more. And that's wise. No one disputes that. That's absolutely proper. The only accommodation a person could make to that kind of problem. Now, one of the reasons I think people have trouble with have trouble with this issue on the left--I think there's other reasons; you talk about in the book this idea that people aren't maybe aware of the risk. That's always a possibility. In some cases; a general problem that we face. But I think the issue people struggle with is they want to know whether their car is safe. And the economist's perspective is: It's not a 0-1. It's not safe or unsafe. No job is safe or unsafe. There are degrees to safety and the more safe you want it to be, the more expensive it is. So, once you say that, there's a tradeoff. So people would say: I want a safe job; no job should be unsafe. But of course the only safe job is the one you don't go to. Many don't understand that point and they want to regulate safety because they think if you don't regulate it the employer is going to take advantage of the workers. Because of greed; they want to make more money. This story is a very powerful rejoinder to that claim by people on the left. So, what would Smith say to that? Well, look: Safety devices in the workplace cost money. If you value one at, let's say $100 a week, the guard on the saw blade that will keep you from getting your hand from being cut off when you are working in this factory, you'd pay $100 a week to have the protection it offers you. It's worth that much to you. The cost of putting one on there, let's say, is $50 a week. Now the pundit on the left wants to say we have to require that it be installed because otherwise the powerful firm would just refuse to install it because he has power. What that claim completely belies is the obvious objection that the employer won't want to have that saw without a blade guard because he could pay you $100 less a week without it. You'd be willing to move to a job that paid you $75 dollars a week less rather than stay in your current job but refuse to put a saw blade guard on there. So, there are forces in the marketplace that will push the employer to install a safety device on a machine where the benefit exceeds the cost of it just because you would have an incentive to move otherwise. If there's no place you could move to, he'd still do it because he could cut your salary and you'd agree rather than continue working with the conditions that didn't suit you. That's where I think the left's view of this problem utterly fails the no-cash-on-the-table objection. If the employers were doing what the left says they are doing, there would be cash on the table. Another employer could come in and cherry-pick the best workers at a dangerous factory just by installing safety devices that were worth more to their workers than their cost. The other part of that story of course is that a safety device that is too expensive won't be installed. That's right. They will install the ones that are wise to install and fail to install the ones we wouldn't want to install. And that story points you to the level of safety that will emerge in an employer-managed workplace that would be exactly the same as the level of safety you'd see if individuals were self-employed. They would confront the same cost-benefit question whether to put a saw-blade guard on the machine they are working on; and they would compare the costs and benefits the same as would happen under market competition.
40:57But you argue there is more to the story. That's the story the left doesn't understand. What I think the right doesn't acknowledge is that it's not just absolute value of safety versus absolute value of wage income. If you think about the worker's decision--should I take a riskier job--well, I can get more money if I do. Why would I want more money? Well, I want more money because maybe the extra absolute quality of the goods I buy will give me additional utility. That's the standard Adam Smith story. What's really important that's left out of that story is you value the extra income not just for the extra absolute consumption, but also for the extra relative consumption. So think about a worker who takes a riskier job, earns $100 a week more in salary; that's $100 dollars a week he can take and bid for a house in a better school district. He's got now some leverage; he can move his kids up in the hierarchy. That's since that's a decision that any other worker is free to take, too, the equilibrium in that game is one in which all workers sell more safety than they would as individuals. And the extra money goes into a bidding war for the houses in the better school districts. And when the dust settles, the only thing they've managed to achieve by that is to bid up the prices in the better school districts. And they've got less safety than they would have chosen on a desert island in isolation. So the fact that they might want to endorse safety regulation--they know things would want to be better if we were all working under better conditions. So we are all going to regulate. That's the only way we are going to get there. It's like Tom Schelling's example of the hockey players, who when they have the right to skate bare-headed and yet they would always vote unanimously in a secret ballot for a rule requiring helmets. And his explanation was always exactly parallel. When you are free to take your helmet off you get a competitive edge by doing that. The other side's got a match because they don't want to lose a competitive edge. The equilibrium is everybody skating without a helmet. Everybody facing more risk. The only way you solve that problem is to have a rule. You can't just post a sign in a locker room saying: Caution, skating without a helmet could injure you. They know that. It's the fact that that competitive edge trumps that worry about safety. I think there are two ways to get to the helmet law. And by the way, it's a rule, not a law. It's voluntarily imposed by the league. You are free to formally do. I can see that point. But I think the deeper point is there is a second way to get to that, which is culture. Elinor Ostrom's work in the Tragedy of the Commons, shows that different ways and norms evolve to solve these problems. And in her case, the tragedy of the commons. To take an example, when I was a kid, if you wore a helmet riding a bike you'd be laughed at. This would be 1963, say. I was 9 years old. If my parents, and as I've mentioned on the show before, if we rode around on our cross-country trips--I lay down in the back window in the flat part behind the back seat; and we used to fight, my sister and I as kids, before my brother was born, we used to fight over who would get the window seat. And that didn't mean who was sitting next to the window. It meant laying down on the back shelf. My parents thought nothing of that. Today if you did that, you'd be viewed as a candidate for having your kids taken away from you by Family Services. Because you are abusive. Which was better? Which was better? The old days or now when if your kid is not strapped in they will give you a ticket? Well, I don't need the ticket. My claim is there are two ways to get to a world where kids are safer. And there are two ways to get to world where hockey players are safer. Two ways to get to a way where everyone wears a bike helmet. Every 9-year-old today, almost every one of them, wears a bike helmet. And it's not because there is a law. It's because the cultural norm has evolved that says that if you don't do that, you are a bad parent. Having said that, there are other ways to solve these problems.
46:04I completely agree, and sometimes doing it informally in that way is better. Not always. I know. So, I am going to try to create the claim it's almost always, and I'll use your safety example, the worker housing story. Let's say I agree with you. And I certainly do agree with you, by the way, that some of my demand for higher income is not going to work out the way I think it will. I'll even concede another point which you make in the book which you don't make in our conversation: Sometimes you make more money, you take the harder job, you take the less safe job; and it lets you buy the bigger screen TV or the bigger house, and it's not just this fact that we're a 0-sum game for the good schools or a limited number of spots. It's the fact that money doesn't always make you happy. So, I agree with that point. And Adam Smith, in The Theory of Moral Sentiments, preached that point. He didn't want the government to solve it. He wanted to encourage people to think more carefully about how happy they'd be if they traded away their leisure or their serenity for a harder job. Well, he also proposed taxes on various luxury items. He did. Because he thought if people consumed less of them it wouldn't be a big sacrifice. That's correct. You could use the revenue for useful things. That's correct. So, let's concede that point; we agree on that. Where we disagree, by the way, on that piece of the story is I think it's absurd and a horrible form of public policy that if you want to a good school you have to buy a house in the neighborhood of that good school. I'd get rid of the public school system; I'd get rid of the mortgage deduction. That would reduce some of this. Certainly getting rid of the school system's attachment to neighborhood would solve some of that problem. I think that would be a better way to solve it. I would applaud each of those efforts, but I would caution you not to be too optimistic about severing the link between where you live and how good the school your kid goes to. Why? I just think there is a very powerful demand on the part of the people who position to secede from the school system. Just be able to go to school close by and convenient. Good point. But I'm not sure that would change--if that's the only thing going on, if we had a private school system and the government is out of schooling, it's true there would be a correlation between housing prices and quality of school, perhaps, but for a bunch of reasons, but it wouldn't be the one we are talking about--that the only way to go to a good school is to live near it. But let's put that to the side. Here's the more interesting issue for me. I'm going to concede your point. I'm going to concede that, given the constraints of the public school system, it is certainly true that we have created--a tragedy of the commons, an externality, what you call an inefficiency--that in my trying to decide the tradeoff between safety and compensation, I'm forced, through my own self-interest to pursue a mix that is not the ideal, because the extra income doesn't necessarily buy me what I think it's going to buy me. So, let's say that's true. Here's my two challenges to you. The first one is: What's the magnitude? That's a crucial question. When you talk about the relative importance of this Darwinian versus the Smithian competition, relative versus absolute improvements. So, if it's a small magnitude, it's not so important. If it's a big magnitude, it's important. First thing I point out is that if you look at the secular trend, meaning the trend over time, there's a long steady fall in mortality and injuries. The workplace has gotten safer and safer in the United States long before the government got involved, Occupational Safety and Health Act (OSHA) 1970. So the Smithian forces are still pretty powerful. I don't deny that for a moment, by the way. Safety is a normal good; we are way richer than we used to be; and one of the things you want more of when you get richer is safety. And you and I work in jobs that are way safer than required by OSHA regulations. And if you look at that secular trend over time, part of the reason fewer people die on the job is we take safer jobs. Fewer people work in the mines, factories, more at desk jobs. But even within the dangerous jobs it is safer. And that trend started before regulation. I think the fundamental issue, and I think what really distinguishes--so we could debate how big these factors are. The biggest problem I have is that even if I concede your point, which is significant, where is the evidence that government is going to pick the right level of safety? So, you don't want to let the invisible hand pick it. Okay. I understand the argument. The invisible hand doesn't pick the perfect mix. Why would I think government could do it better? And how would it possibly do that, given the possibly-set "right level" of safety you are worried about? There could be all sorts of interesting design issues in the question of how to regulate safety. If you think there's even a theoretical case that the market level might be suboptimal. I'll grant you all the objections you'd be inclined to make about how ill-equipped OSHA might be on a case-by-case basis. And how it might listen to the more powerful interests. Yes; you would need to evaluate whether the proposed solution was going to be better than doing nothing. I think that's always got to be the test for any government intervention. I have a constant challenge to persuade students that they are not done when they have merely succeeded in demonstrating that the current equilibrium might not be socially optimal. That doesn't mean that any old intervention is going to make matters better. You've got to begin with the assumption that government is imperfect, too, and whatever intervention they mount might be worse than doing nothing. That's a valid point. Injury taxes--the fact that we have a workman's compensation program that's experience-rated. There are sort of more flexible, price-based ways to stimulate the provision of additional safety that do not prescribe in command-and-control form and possibly run up against a lot of waste of that familiar sort. That's all properly on the table for discussion. I'm just trying to achieve a much more modest objective, which is to say we need to have that discussion. I think so many on the right say: Government has no right to even consider intervening in workplace decisions. It's very powerful rhetoric that the right has. Why should the government step between me and my employer? We are free individuals. Why can't we sign a contract where I agree to accept the work and whatever risks go with it freely of my own accord? And the employer agrees and I agree? Who else is affected by that? That's a pretty powerful argument when you hear it, but what it leaves out is when I make that choice, I get a leg up on others in my ability to bid for the house and the better school district. So, others are involved in that choice. No doubt. Therefore, it's proper to think about whether there is anything that can and should be done. That's my objective here. I don't want to say this intervention necessarily makes matters better. It doesn't. I think the left needs to be far more attentive to design issues and regulation and less presumptuous that intervening will make matters better no matter what.
54:47Let's come full circle. We've left a lot of issues undiscussed; maybe we can come back and do another one. Issue raised earlier. My counter to that would be: Well, we have a track record of what government's done. And it hasn't done very well. A lot of what government does in the name of helping the consumer, restraining various things, actually rewards politically powerful folks rather than the goals that you and I would like it to do. And so, my challenge to the left, and to you on this issue, and I would add in a related issue of government spending generally, is: I think the biggest challenge is, if you are going to make the case that the government should have a broader role, you've got to convince me that it can do it more effectively. Take an example you mention in the book a number of times. You argue in the book in multiple places that we need to spend more on infrastructure. But government spending on infrastructure has been rising for the last 25 years and that's before the stimulus spending and whatever the President proposes tonight--we are recording this on Thursday, September 8, 2011; the President is going to make a speech tonight and I think he is going to propose some infrastructure spending. So, you can argue that there are bridges and roads that need work; but for some reason, spending an ever-increasing amount of GDP has failed to do it effectively. I think the challenge is: How do you get government to spend it's money wisely? And if you could do that, you might get me to be more cheerful about when government gets bigger. So, we want a more effective government. So how do we do that? Do we have any evidence that we know how to do that? Well, we know that some governments are, as we said at the top of the conversation, are viewed by their citizens as effective. People have very positive attitudes toward their governments and the role they play in their lives. I think it would be worth studying what's the difference. What do they do that we do differently, and try to learn about that. Because again, I don't think the option of having no government is one that anyone would favor. The interventions I push in the book, by the way, are very much in the spirit of trying to give people the maximum amount of flexibility to decide for themselves how to respond to the externalities that are causing trouble. The main policy intervention I push in the book is to scrap the income tax altogether. It's a tax on savings in addition to a tax on consumption. It's a relative subsidy to consumption. As you say: Get rid of the mortgage deduction, get rid of all these features in the tax code and raise the revenue you need from a steeply progressive consumption tax. You report your income to the IRS, the same as now; you save during the year--you know how to do that, too, through 401Ks and similar accounts. The difference, income minus savings, that's what you spent during the year; and you don't pay much tax on that if the number is small. But as the number grows beyond $1 million, $2 million, $3 million, the marginal rate on the next dollar you spend can rise to much higher levels than we have under the current income tax. And that indirectly would be a push toward greater safety. You know, you would have less spending on mansions by the people at the top if they had a steep marginal tax rate on extra consumption it would be more attractive to put the $2 million you would have spent on a new wing for your mansion, put half of that into your savings account tax free and build a smaller addition to your mansion. If you and others did the same thing, then when the dust settles you'd discover you won't be any less happy than if you'd built the bigger wing because it was the social context that made the bigger wing seem necessary in the first place. You wouldn't have to spend $10 million on your kid's coming-of-age party if you were a billionaire; $9 million would be good enough. Or $2 million. And the kids wouldn't be any less happy. The standard would just shift accordingly. So that's a tax change that I think people on the right ought to be in favor of that. In fact, I wrote an article about it about 15 years ago and by return mail almost I got a nice, warm letter from Milton Friedman. And Milton said: Look, I don't agree with you that the government should be raising more revenue now. And this was back when the budgets were edging in the surplus, so it was not the same circumstance we are in now. But he did say that if the government needed more revenue, the tax I proposed would be the ideal way to raise it. And he enclosed in his envelope a reprint of his article from the 1943 volume of the American Economic Review, where he had proposed an expenditure tax as the best way to pay for the WWII effort. So, I think there is some common ground here. You want to use the price system to solve problems when you can. Not detailed, prescriptive, bureaucratic regulation, I think the right has a rich set of insight along those lines that the left can learn from. But the right needs to learn too, that individual interests expressed in unfettered markets doesn't always produce outcomes that are best from the perspective of the group. And that's the Darwinian understanding of competition that I think is currently lacking in our view of things. I'd concede your point that sometimes we choose things that aren't good for us as a group but the question is whether we can improve on them. I would certainly prefer a consumption tax that replaced the income tax, rather than augmented it. I think our disagreement would be on the steepness of the progressivity in the size of the rates, right? Because I think we probably would disagree on how much revenue should be raised. But I think the underlying point we overwhelmingly agree on is setting prices to let people steer themselves, rather than that bureaucratic top-down approach. I think what economists can do as technocrats, which is very limited, but what we can do effectively is to offer to the public those schemes and possible ways of solving problems that people maybe haven't thought of. Using prices in effective ways. The problem is the political system is not always so interested in that. The SO2--sulfur dioxide--tradable permits is a rare moment. When we have broken through--remember 30 years ago when that was first proposed, they were saying the economists should let rich firms pollute to their hearts' content by buying permits. The bizarre model of firm behavior implicit in that remark--that firms want to pollute. We've made some progress. It was a huge success story. Congestion pricing, when we've tried that, it's been a huge success story. I think that's the margin we want to join hands and work on.

COMMENTS (43 to date)
Robert Kennedy writes:

At around the 30 minute mark, the guest said "And the reason for that was that the regulations required strict vetting of the mortgage applications; they required large down-payments." I don't think that is true, is it? 25% down payments were not a regulation, were they? My understanding is that they were a by-product of the fact that most mortgages in those days were held by the original issuing bank, who was rightfully interested in ensuring that they got their money back. And it was only when residential mortgages became securitized, and therefore allowing the risk to be sold, were lending standards relaxed.

John Scott writes:

So we need more government to solve externality problems even though most of government spending is dedicated to socializing gains and losses--making private problems into external problems.

And obviously we need more government because other countries have more government.

And obviously we need more government for goods like heath care. After all, the problem with the US healthcare market is that the private system failed, not the government system--right? The government system makes up around half of of Dr. Frank's "mostly private" health care system.

Let's not talk get into triumphs of government education.

What a thoughtful worldly philosopher Dr. Frank is.

W.E. Heasley writes:

Maybe the “why” regarding the advent and perpetuation of big government [politicos through the mechanism of government] in the U.S. in the early 20th century and the consequential backlash against big government [advocates of smaller government] in the later 20th century can be found in the 1988 Milton Friedman essay entitled John Maynard Keynes. The essay was republished in the 1997 spring edition of the Richmond Federal Reserve Economic Quarterly. The following appears in the essay on pages 20 and 21. Friedman wrote:

“Keynes was exceedingly effective in persuading a broad group—economists, policymakers, government officials, and interested citizens—of the two concepts implicit in his letter to Hayek: first, the public interest concept of government; second, the benevolent dictatorship concept that all will be well if only good men are in power. Clearly, Keynes’s agreement with “virtually the whole” of the Road to Serfdom did not extend to the chapter titled “Why the Worst Get on Top.”

Keynes believed that economists (and others) could best contribute to the
improvement of society by investigating how to manipulate the levers actually or potentially under control of the political authorities so as to achieve desirable ends, and then persuading benevolent civil servants and elected officials to follow their advice. The role of voters is to elect persons with the right moral values to office and then let them run the country“.

Hence “Keynesianism” to the politico is the holly grail of government intervention. Stated alternatively, The General Theory is of no matter to the politico, it’s the political-economy of Keynes that sets the stage for politico intervention. The intervention is likely based on Thomas Sowell’s identification of politico arguments based on “the way things ought to be”. Hence we end with big government as merely a summation of constant intervention based on the way things ought to be.

The back lash to the cabal of intervention [big government through politicos] being associated with the “result”. That the summation of constant intervention based on the way things ought to be [good intentions] generating measurable and noticeable undesirable results.

Big government also becomes a situation of “society” becoming mixed up with “government”. That to those advocating big government, government becomes society and society becomes government the result of which dictates constant intervention.

Likely Friedman also explained the big government “result” rather succinctly:

"The fundamental principle of socialism is that its is appropriate to use force to organize society, to take from some and give to others. The government has nothing to give. The government is simply a mechanism which has the power to take from some to give to others. It is a way in which some people can spend other peoples' money for the benefit of a third party - and not so incidentally themselves". - The Invisible Hand in Economics and Politics, Milton Friedman, Institute of Southeast Asian Studies, 1981, p11.

Michael Rooney writes:

The comparison about using a saw guard or not is good as far as it goes. What would Robert Frank and Russ Roberts each say about the protection that miners should receive? Miners typically can only work one mine unless they are willing to move which costs them too much to usually actually move. Miners often grow up in a mining community and see their prospects as limited to the mine.

Should they be protected by government regulations and regulators or should we take away the regulations?

This type of podcast where the guest has very different views from Russ' views are the best podcasts in my opinion. Both sides of all issues is better than one side.

Thanks,
..michael..

niav writes:

I am a bit intrigued by Mr. Frank's proposed tax on spending using an increasing rate as the spending goes up (presumably on luxury goods and services).

Wouldn't an entrepreneur then optimise its tax return by living rather frugally while making his or her money, and once that "ok I have enough to live in luxury" moment is reached just move abroad, spend it there, forget all about uncle Sam?

At the moment there's no such incentive. Surely some people change country because of too high taxes, but leaving that aside, if you're taxed while making money there would be no reason to leave later. Since you paid the tax, you might as well stay there and enjoy the benefits of your work. In a spending tax system, I'd consider it a powerful incentive to make the money (which would be much quicker with no income tax) and then bail out.

And we can just as easily think of schemes where money moves abroad (and it's spent abroad), it's masked through accounts and companies and it would be extremely difficult for the IRS to check a rich person's real spending levels.

I think the proposal is one of those things that would work if everybody would do it, but that is not the case. Quite the contrary, should the US implement such a tax system, the other countries would benefit precisely by not adopting it.

PS: I am also puzzled by the outright (and unchallenged) claim that it's bad for males in certain species to be very big. What is "too big"? Who decides? Surely if "too big" would be bad for the species, evolution would balance it out at some point? Actually, doesn't it do that already? Elephant bull males are big, but they aren't skyscraper sized, so there was some evolutionary effect in action that prevented such a "bigger is always better" evolution implied by Mr. Frank.

niav writes:

Oops I apologise profoundly for switching the names in my previous post. Although I am a faithful listener to the podcast and should have known better, I copied & pasted the name out of fear of misspelling, and ended up with copying the wrong one! A correction would be most gratefully appreciated.

[Fixed--Econlib Ed.]

Stephen Parsons writes:

Regarding the mention of a desired change to a consumption-based tax near the end of the episode, recall that the "FairTax" (H.R.25 / S.13) is ready and rearing to go. It's even progressive, through the "prebate" feature, without maintaining today's burdensome (and, some say, intrusive) income reporting requirements. (cf. the guest's suggested expansion of reporting to include both income and expenditures.) But sadly, although I am hearing more positive consideration of such a system lately (when it's considered at all), it still seems unlikely that the current tax system with all its economic and social inertia--not to mention its entrenched political interests--will go away any time soon.

Steve writes:

Great interview, many good points.

As for consumption tax though: its sounds like a good idea, 'push people to save more.' But what does that mean, how does that happen: "save more?" Early in the interview you were talking about how corrupted the financial sector has become. That was one of the more convincing arguments for a socially detrimental arms race. Encouraging people to save more would just pump more money into the financial system. Wouldn't the growth distortions be even larger in that case, the bubbles worse?

The building of "extra wings on a mansions" may not be the most productive economic growth possible, but it is better than building houses nobody wants to buy, that is even more useless. The financial system is making investments that are not tied to social and economic benefit. Unless that is fixed saving more will just steer us even more poorly than overspending on consumption. We might encourage the enriched financiers to spend less of their bonuses on frivolous luxuries, but meanwhile they would have a larger pool of money to burn through competing with each other. Heads they win tails we loose: so play that game less! Savers would get larger returns, but too many people are left behind and meanwhile larger portions of the economy are steered by few rich investors and a more powerful financial system.

Economic growth should raise all ships, but more and more it is being used as a pump to raise only a few ships at the expense of the tide itself.

paul corrado writes:

Great Podcast. thanks!

Russ Loomis writes:

From a partially educated laymen. The one question I came away with from the discussion was, what if the banks had to keep or were on the hook for the loans they made? What if the government was not involved in housing at all (no tax incentives either)? Wouldn't the banks or lenders have every incentive to vet who they were loaning to if they implicitly knew their well being was connected to the quality of the loans they made? Some insight on this would be very helpful to me.

Thanks Russ, learning a lot from your podcasts.

Mark Crews writes:

Russ, another 5 star show, just as good as any of the Munger episodes. I've learned a lot from listening to you, and your show has reminded me why economics was my favorite course in school.

It might just be me, but I think you do a wonderful job of challenging your guests' narrative w/out being confrontational. I'm not completely sold on your Chicago/Friedman/freshwater/Hayek-ian ideology but you have given me food for thought of the course of the many podcasts.

I would love to hear more from Mr. Frank. If it had been a debate, I wouldn't call it for either side, but I think he definitely held his own.

LOVE the show, keep up the good work!

PS: The Hayek/Keynes rap video was brilliant. Or should I say, KEYNES/hayek...

Two points:

1.I don't see the analogy between helmets in hockey game and worker safety. Why would workers compete by not wearing helmets? Wouldn't a worker that takes appropriate precaution be more valuable to an employer?

2. The story that the gains a worker makes go into useless bidding up of the price of housing does not imply that the solution is to take those gains away from the worker. Suppose we lived in a country where the only way to advance was to corrupt public officials (not far from reality in some parts of the world), would you then still conclude that it would be better if those workers did not have additional gains?

TMS writes:

Thanks for a great podcast.

He keeps referring to this idea of bidding up "houses" and other items based on what others have. Is he ignoring the supply side? It's not as if there are a fixed number of houses that exist.

Mark Crankshaw writes:

It is my understanding that Professor Frank makes the claim that, in recent decades, an "anti-government" mentality and ideology is responsible for a "paralysis" of government, thus preventing the US government from resolving some of US social and financial problems. While he posits several historical causes for this rising distrust in government, I would put forth another.

Frank draws a comparison with respect to trust in government between the US and other nations--"typically the kind of countries somebody would think about moving to". These countries are un-named, though I suspect he is referring to Scandinavia, France, Germany and perhaps wealthy English-speaking countries such as Canada, Australia, Great Britain and New Zealand. He further states that "the countries that have weak, ineffective governments are not places anybody would want to move to."

In my view, a primary cause of the rising distrust of government in the United States stems from the fact that, demographically, the US is vastly different than the more trusting countries that I suspect Frank is referring to. The other countries are geographically smaller and much more homogeneous. What brings together "Americans" as a nation? It certainly isn't race, ethnicity, and religion as it is for the un-named nations. Increasingly, it isn't language, lifestyle, custom, values or even culture. When I ask myself: "What makes me feel closer to the average American than the average, say, Canadian?"-- I can think of nothing other than vacuous symbols and meaningless rituals.

What has occurred in recent decades in the US is a total fracturing of US society along racial, ethnic and religious fault lines and that US politics increasingly reflect these fractures. This was less so under the New Deal coalition that lasted until roughly 1980.

However, since Southern Protestant evangelical whites have left the Democratic Party for the Republican Party, the two dominant political parties are now vastly more homogeneous than before the break-up of the New Deal coalition. In the US today, ones' ideological inclinations in great measure reflect ones' racial, ethnic, and religious identity. (Example: http://pewresearch.org/pubs/2067/2012-electorate-partisan-affiliations-gop-gains-white-voters) Since ones' ideology (and political preferences) is bound up with ones' static racial, ethnic or religious identity is should not be surprising that there is increasing political inflexibility and dogmatism.

If politics fall along racial,ethnic, and religious lines then it becomes easier to view "the other" as intractable political opponents who seek to gain at your expense. I firmly believe this view has merit, that, when politics fall along racial, ethnic,or religious lines, when there are no shared values or ideology in a polity, that there is very good reason to view political opponents with suspicion. They really are likely to be seeking political gain at your (you being their "out-group")expense.

Since government is a tool that is utilized by ones opponents as well as ones allies, it is a huge gamble to empower or trust the State. A government powerful enough to help is certainly powerful enough to harm. This brings me back to Franks' claim that "weak, ineffective governments" result in bad outcomes and therefore governments should be "strong and effective". If you see these governments as I do, corrupt kleptocracies, than as shake-down artists they are both strong and effective. Wishing for a "strong and effective" government only makes sense if one believes that they'll use that strength for good and are effective at achieving good. That the State is inherently (or even likely) good is not my null hypothesis...

Tim writes:

Great podcast Russ. I do enjoy them when Russ and the guest disagree.

It is not all that clear how much government Mr. Frank is proposing. I am more libertarian leaning but feel that there are some useful regulations. How far does Mr. Frank need to go to correct for Darwinian competitive issues? I don't think we need to go as far as Western Europe which he holds up as an example. We might even be able to reduce the size of the current US government and get the job done.

Tim

Dave writes:

Russ,

Re: bike helmets. I actually believe that this change in norms was brought on (or at least accelerated) by law. I was 13 years old in Montgomery County when they enacted a helmet law. Up to that point, my friends and I never wore bike helmets. And when the law was passed, we all stopped riding bikes, even though we were three years away from driving. Wearing helmets just wasn't cool (cut me some slack, I was 13). Years later, wearing bike helmets was the norm because the kids had starting riding bikes with the law in place. That's a bit anecdotal, but many places put bike helmet laws in place in the 1990s and 2000s, and that may have been the catalyst to what you witness today. It's possible that the change in norms would've happened eventually anyway.

Here's a link with bike helmet laws and when they were passed. I think you're point about social norms often reducing the need for formal laws is often correct, but bike helmets may be an inaccurate example.

Rutger writes:

I found the destinction between Darwinian and Smithian competition interesting. The fundamental differences were not so clear to me however. What gives the inefficient Darwinian outcomes like the bull elephant seals (zero sum game situations, absence of trade?)? The podcast mentioned externalities, but these are related to trading that does not seem to apply in nature.

Endy Tjahjono writes:

Great episode! I got many insights from the discussion.

It makes me want to relisten past podcasts with Robert Frank.

BTW, which other podcasts discuss tragedy of the common?

Jonas V writes:

I found this podcast interesting in many was even though I for most of the part disagree with Robert Frank.
When I heard him talking about countries where people have high trust in their goverment I believe he was partly thinking of the Nordic countries. I would say that it is true that people do have high trust in their government in those countries.
However, when you look at what people think about the EU in the same countries trust is very low. With the on-going concentration of power to EU we will most probably not have the same trust in the future.

Ethan writes:

I'd like to correct a factual inaccuracy on infrastructure spending. Russ mentions towards the end of the podcast that "...government spending on infrastructure has been rising for the last 25 years and that's before the stimulus spending... but for some reason, spending an ever-increasing amount of GDP has failed to do it effectively".

The facts are that public investment in the United States in 2010 (including stimulus) was 3.5% of GDP. In 1985 it was 3.8%. Going even further back to 1965, this same figure was 5%. (Data from the Bureau of Economic Analysis NIPA tables 3.1 divided by table 1.1.5.)

There has been a secular decline in the amount of our national income that we have been devoting to public investment since the 1950s. Thus the declining quality of our infrastructure is no evidence of government inefficiency, but rather evidence that you get what you pay for.

Wesley writes:

I quite enjoyed this podcast. Especially applying Darwin to economics. I was wondering if more concepts of biology can be applied to economic theory. It strikes me that an economy looks more like a ecosystem than a machine.

Could ecological measurements such as species richness and biodiversity not be used to analyse an economic system?

After all, nature is best at allocating scarce resources without any waste. When we as stupid humans interfere with it, disastrous consequences usually follow.

Russ Roberts writes:

Ethan,

I was relying on the data here which came from a David Leonhardt column in the New York Times that argued we're spending more as a percentage of GDP but spending it poorly. In the data I was using, the variable was defined as "Government Investment in Physical Infrastructure." The numerator from your data is presumably drawn from line 35, NIPA Table 3.1, "Gross Government Investment." I will try to find out the difference between the two.

Todd Moodey writes:

The podcasts with Professor Frank are always interesting. Thanks Russ. Although I was a student of Professor Frank's at Cornell in the mid eighties, I found his argument linking the house bubble with school-choice incentives not to be compelling.

I can well understand how it might be a factor in driving up housing prices in locales with school systems of known high quality, such as Manhattan Beach, California. But how does it explain the buidling of entire new communities in places such as Riverside County? Buyers might have some reason to believe that the existing educational infrastructure is satisfactory, but on what basis could they believe that the quality would remain unchanged in light of the dilution of the infrastructure or additions to it necessary to accomodate the larger populations? And if their primary conideration in the first place was good schooling, why wouldn't they look to rent in areas with high-quality schools, or buy less-expensive homes and seek private-school options for which proximity isn't so important?

Russ Roberts writes:

Ethan,

Line 35 from the BEA NIPA accounts, Gross Physical Investment includes equipment. That might include computers and other stuff we wouldn't call infrastructure. Still trying to find out.

Your comment reminds me of the importance of how things are defined.

But here is a nice study from the CBO on physical infrastructure that was done in 2008. The categories examined are Highways and Roads, Mass Transit and Rail, Aviation, Water Transportation, Water Resources, Water Supply and Wastewater Treatment.

The study shows that federal spending on infrastructure has grown steadily in real terms but not as dramatically as state and local spending on infrastructure. As a percentage of total federal spending (not GDP, but spending), federal infrastructure spending peaked in 1965, fell, climbed and fell again until maybe 1988 or so and has been fairly flat through 2006, the latest data available when the study was done. Again, this is as a percentage of federal spending.

It turns out that GDP between 1988 and 2006 grew slightly faster than federal spending. So you're right, spending on infrastructure as a percentage of GDP is down, not up. But it's close to flat. My claim from the Times article (that I mentioned in my earlier comment) seems to be wrong. But I'll stand by the point that our biggest challenge is spending money wisely. Read that New York Times article. It may be that they defined infrastructure incorrectly (or just differently than the CBO did) but the main point that the money is spent poorly is probably harder to refute.

Sebastian writes:

A very enjoyable podcast! Minor and relatively off topic nitpick. You once again mention the Mexican bail out as a bail out of US banks and lenders.

While that may have been part of the case, you don't mention the disastrous effects that the peso crisis was having on the Mexican economy and population. Moreover you are ignoring the fact that the entire crisis was started by, basically, unfounded jitters regarding Mexico's political stability and the incoming Zedillo administration(which was quite astonishingly competent as it turned out).

Putting those into the context of the bailout adds a national security/foreign policy dimension to it that almost certainly existed in the minds of policy makers at the time.

This article by Ziets is a very brief but interesting summary of the events at the time. Incidentally some podcasts on Mexico and its evolution over the past half century would be really fascinating. They're one of the clearest examples of a state that was actually faced with strong Malthusian problems, for one thing.

Beyonder writes:

I guess the question I would put to Professor Frank about the schools example is: Given that we need to allocate the best schools to someone, isn't allowing the market to run its course one way of ensuring that the spots at the best schools go to the people who value them the most?

If spots at the best schools are going to people who (indirectly, through their housing choices) are willing to pay the most for them, isn't this because they value the spots the most, and are in the best position to put them to good use?

Seth writes:

I have the same comment as Robert Kennedy. I don't believe the 20% down payment (until Dodd-Frank) was a regulation, was it? I thought it was a norm that evolved to a) screen folks who have demonstrated enough financial discipline to be responsible homeowners and b) reduce the price risk the mortgage company took.

Also, it seems Frank doesn't understand the difference norms and norm-based laws and laws designed by the elite that do not match with norms.

Russ, I thought your bicycle helmet norm was a great example. I also liked the one about riding in the window shelf. While there are laws restricting that behavior, these laws reflect the norms that were already emerging from experience.

Russ Roberts writes:

Sebastian,

Of course there was an attractive story to tell alongside the other one. And we were told that the creditors of Bear Stearns had to be rescued for the good of the country. Both stories could be true. I'm sure there was some benefit to the rescues. I focus on the costs because people often fail to notice them and those costs are quite large and tangible. After the rescue of Mexico's creditors via a loan guarantee, officials boasted that because the guarantee never had to be invoked, the rescue didn't cost taxpayers anything. My claim is that the rescue reduced the prudence of creditors and helped create the mess we're in, costing taxpayers hundreds of billions of dollars.

More from me on these themes, here. You also might want to listen to this podcast with Bruce Yandle on Bootleggers and Baptists.

Sebastian writes:

Russ, I listened and enjoyed both those podcasts.

I completely agree that the various creditor bailouts had the effects that you ascribe to them. I just take slight issue in focusing on the bootleggers so much and completely disregarding the baptists in that particular case.

The role the Mexican bailout(s) had in building up to the recent crisis is undeniable but having partial responsibility for that(and how would we quantify such a thing?) might still be a price worth paying if it meant preventing another lost decade in that country. (the baptists in the various US financial bailouts had a much flimsier leg to stand on, in my opinion). This is not meant to attack your argument at all, it just goes on a tangent from it.


Anyway this just distracted from my main point which was: if you have the interest, time and opportunity I would love to listen to a podcast, at some point in the future, on Mexico; a country that is much talked about but, I feel, not really well-known in the US and one with a truly fascinating political economical history.

xian writes:

these r always the best conversations...

real give and take...

but with hayek on this...

as p krugman reminds us from hayek's "road to serfdom"

"But there are two kinds of security: the certainty of a given minimum of
sustenance for all and the security of a given standard of life, of the relative
position which one person or group enjoys compared with others. There is no
reason why, in a society which has reached the general level of wealth ours has,
the first kind of security should not be guaranteed to all without endangering
general freedom; that is: some minimum of food, shelter and clothing,
sufficient to preserve health. Nor is there any reason why the state should not
help to organize a comprehensive system of social insurance in providing for
those common hazards of life against which few can make adequate provision.
It is planning for security of the second kind which has such an insidious
effect on liberty. It is planning designed to protect individuals or groups
against diminutions of their incomes."

Jay writes:

So our government is riddled with rent-seeking, while a few European governments are perceived to be less so.

What about... let our government prove that it can be more like the best governments in the world, then we can give it more discretion. But Frank seems to say, "Just trust them. Give the government more power, and we can work on making it better."

Raja writes:

Sorry, but I'm appalled to see so many positive comments on this podcast. Guests like this add zero value to the Econtalk program. If I want to hear burnt out hippies or loyal Marxist footsoldiers I can tune in to any media outlet, anywhere, and get it from the nonstop barrage of pro-state propaganda. I tune into Econtalk because it's one of the few (count em on one hand) pro-liberty media options out there. That's what makes this program good - principled differentiation - not faux-and-balanced everyone-all-the-time mediocrity.

To say "making govt more honest is a project I'd like to join you on" displays a stunning level of intellectual dishonesty/disability. Govt is based on force and lies - it is dishonest by design. In fact the greatest trick govt ever pulled was convincing the world they aren't criminals. But like the meth/crack addict, their supporters keep crawling back for one more hit...

Nick writes:


The eurozone governments strikes me as a bad examples of model governmental systems at this time- considering the absolute financial calamity set to wipe out both the governments and the union currency. At the core of the crisis is the fact that western Europe had been living on massive deficient spending for many years to prop up their massive bureaucracies and social goodie programs.

Whatever the faults of the american system, we are orders of magnitude better situated than Frank's "pro-government" western Europe.

Jonathan writes:

Russ,

I thought there was a great opportunity to mention that regardless of how free market Frank thinks Greenspan was, the facts are pretty clear. He was the Chairman of the Fed, a body that sets interest rates in a currency that is fiat, in a fractional reserve banking system. None of these things are free market notions.

Is it not more plausible when considering the financial crisis that it is a flaw in the monetary system itself rather than the specifics of each nations regulatory/government policies? Speak to an American and you hear that it was linked to deregulation of the banks, FNMA, MBS etc but speak to an Irishman and you will hear it was the fault of the with property developers influencing politicians and the Euro. There is a more basic cause.

I think Frank's analogy on seals (heaviest seal beats up the competition and steals all the girls ... just like capitalism...therefore government has to correct this flaw) is a false one. Businesses don't win by using force nor do consumers have to buy their products/services.

Thank you for these podcasts Russ, I suspect your influence is much wider than you realise. Keep up the good work,

Jonathan.

Patrick writes:

A fantastic interview. Russ, I really appreciate your ability to respectfully disagree with guests who hold views different from your own. It was particularly refreshing to hear both you and your guest concede to each others arguments on a few occasions.

My own political/economic views are still to the left of yours, but I am learning an immense amount from your podcasts.

Regarding bicycle helmet laws, you have an interesting point that social norms play a stronger role than laws in enforcing safer behavior. A similar change in behavior is clear on the ski slopes here in Colorado, and I don't think there are yet any laws mandating helmets in recreational skiing.

However, in the closely analogous situation of seat belt laws, reflecting on my own behavior and those of my friends and family, it seems to me that there was an interaction between laws and the fear of opprobrium in markedly increasing the rate of seat belt use. Might not a law be justified if speeds the rate of development of a positive behavioral change, even if in the end internal conditioning and social pressure are the main enforcers of the behavioral change?

andy writes:

I am very surprised by the last point of your Mr. Frank - congestion pricing. He is saying that congestion pricing is a good way to do things, yet the 'school problem' is just an example of congestion pricing. Congestion pricing serves to..well..solve the congestion problem.

In the case of schools it serves to add an incentive to create better schools - you can choose to pay a million for a better house or to play a million to create a new school; which in itself shows that the problem probably wouldn't be that big.

Let's suppose that the school system is really free; then you have congestion pricing for the good schools; which seems to be, according to Mr. Frank - a problem. What is the solution? Well, the obvious solution is not to let parents choose the school..for example to tie the place you live to school. Now the result is...congestion pricing in the price of houses, which actually seems to be even less efficient. And because congestion pricing seems to be a problem (and not part of the solution), we need to stop people in participating in congestion pricing. But because congestion pricing is there because of a congestion (which is a problem), stopping people to take part in congestion pricing seems to be telling them to pretend, that the congestion (problem) doesn't exist.

In my opinion the analogy with game theory (and helmets) should include the assumptions of this model; and I believe the assumptions would likely break, given that you can redirect the money from congestion to an alternate use that would actually help you solve the problem.

As for the helmets in sports: the current example is the paragliding community view on uncertified gliders. The technology progressed so far that some gliders which seem to be really demanding have significantly higher performance; the proliferation of this type of gliders culminated in 2 deaths in the recent world championship.

Before this championship some companies were already pushing serial (certified) wings, there were already official competitions being organized that required certified wings. Some competitors declined to take part in the world championship precisely because of the incentives to use a dangerous wing. After this world championship was effectively cancelled, the FAI banned uncertified wings on FAI Category 1 competitions (the big ones); the FAI Cat 2 (the majority of comps out there) organizers could decide any way they wanted. Some decided one way, some the other. Actually there are quite many organizations making competitions, the other being PWC(Paragliding World Cup), which decides it's own rules.

For a long time there was not such a marked step in safety vs. performance; it used to be that faster wings were less stable, therefore it wasn't actually that much faster to fly them. Unfortunately the new wings seem to have the bad probablity distribution, that you are very fast and stable, except that in a small number of cases they become totally unsteerable.

There are problems with acquiring certification though. The certifications are used by pilots to asses, if the wing is appropriate for their skills. Although the manufacturers generally have incentive to push higher performance wings through the lowest certifications possible, the incentive is not that high; there is not much reason to try to lie to your customers. Unfortunately, the certification requirement for the competition wings suffer from the certification incentive alignment: neither the competitor, nor the manufacturer actually want the certification process to work correctly. The competitor is very likely aware of the characteristics of the wing and if he wants to win, he wants his wing to have the certification stamp and performance; not neccessarilly the safety and performance. I have heard that it is not a such a big problem to push an unsafe glider through the certification process; it's that nobody has an incentive to do it right now. I suspect the highest category of the certification will completely lose it's meaning for non-competition pilots, if they do it that way.

Now let's get back to the government regulation: if we give the government the power to ban sales of any of these product/ban organizing competitions using these products/set the rules of the competitions, would it solve the problems I mentioned? It seems to me these powers are totally tangential to the problem; what you would get is actually conservation of some very unsatisfactory state, albeit maybe safer.

AJ writes:

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Robert Wiblin writes:

I found myself mostly agreeing with Frank on this one. Count be as a supporter of a progressive consumption tax! Economic efficiency and egalitarianism all in one.

I think Dr Frank has missed the point of Smith altogether, and has also missed the important difference between markets and biological competition.

Smith didn't only express surprise at the way individuals produce wider social benefits just by pursuing their own interests. He also explained why it happens, thus taking away the mystery. People can discover new efficiencies, and the existence of personal economic freedom gives consumers a choice and so they choose the most efficient providers. Overall efficiency increases, there is a widespread incentive to do things in the smartest possible way, and wastefulness has nowhere to hide, so we all get better off - just not necessarily all at the same rate. That is Smith's key insight, and it is not anywhere in Darwin. It's born out by the facts and Dr Frank doesn't seem to disagree with that. So his Darwin vs. Smith angle is very strange.

The "Darwinian account of economics" is practically an oxymoron and it began to grate on me as the podcast continued! It means that I have to talk in response about "biological Darwinism", which is utterly redundant.

But here goes... in biological Darwinism, some individuals have genetically determined characteristics that make them less likely to successfully procreate, and so they don't procreate and those characteristics die out.

We now know (in far more detail than Darwin) exactly how this plays out. The "body plan" is fixed for the entire lifetime of an individual organism. Sexual reproduction involves a mixing together of two body plans to make a new unique plan for the offspring to work from, but as soon as, say, a bat is conceived, he's stuck with a single genetic plan that determines the shape of his wings, his ability to navigate by echolocation, and many of his habits, hobbies, likes/dislikes, turn-ons/turn-offs and so on.

The problem in drawing analogies here is that we have an understandable (I think admirable) tendency to identify with the plight of the individual animals. So we think how awful it is that the unlucky individuals never procreate, perhaps dying before they get a chance. There is no way for them to change plans in mid-lifetime. They're doomed!

Now compare this with economic development. Do I inherit a way to make living from my parents? Is my economic plan fixed for my entire life, with no opportunity for me to make course corrections?

Of course not. Some simplistic descriptions of market economies talk about entire companies "dying out" and of course that does happen. But there's another option: companies can change their plans! So can individual people. I sometimes discover six new efficiencies before breakfast.

So the analogy between Darwinism and a free society is actually very weak. Suppose we deliberately strengthened it: companies have to publish their business plan as they are formed, and then it is illegal for them to deviate from it. That's it. If it appears to not work very well, they have to wait to go bust.

That is, Darwinism can only describe the behaviour of a very stupid economy, one that could only develop significantly on a geological timescale (tens of millions of years), instead of the two or three centuries that the market produced Western wealth (or indeed the few decades in which it has produced China's wealth.)

The only analogy between culture and natural selection that might possibly work is if we imagine the units of selection as being not individuals, nor companies, but just ideas. Some ideas get copied and survive, while ideas others are discarded and die out, and good riddance to them.

And so we've arrived at Richard Dawkins' notion of "memes", units of cultural selection. An interesting idea, but not often the most applicable description of a real-life scenario, e.g.:

"Human beings are just arithmetic's way of making copies of itself."

So maybe Richard Dawkins will be the hero of the economists in a century's time! But not Darwin himself.

Something I forgot to mention:

"You wouldn't have to spend $10 million on your kid's coming-of-age party if you were a billionaire; $9 million would be good enough. Or $2 million. And the kids wouldn't be any less happy."

This is a revealing insight. Essentially what he's saying is that if someone "consumes" $10m on a party, they'd be very unlikely to get more than $2m of value (if that). The kids only have one mouth to feed each, and their palettes are no more sensitive than anyone else's, they only have a certain number of hours in which to get drunk and dance, and they almost certainly can't tell whether they're drinking "good" or "bad" wine. Beyond a certain level of spending, there is no marginal benefit.

But in that case we'd have to conclude that those who insist on spending $10m must be effectively giving away at least $8m to the caterers, musicians, dress designers, marquee rental companies, etc. in return for nothing. And all of those businesses employ people who are not billionaires and certainly could use the money.

Is that really a bad thing?

Or to put it another way: though we need to encourage average people to save, would it really be a good idea to encourage billionaires to save?

Or to put it yet another way: when you have stark inequality that ranges by a factor of a million, is it really meaningful? The billionaires are never really a million times better off than the thousand-aires. Just as the man who buys the $1000 pair of designer jeans is perhaps not 50 times better off as a result than the man who buys a $20 pair.

Is it really a bad thing that people with more money than sense are freely able to part themselves from their money? Indeed, that they are encouraged to do so?

I say let them spend it! They're practically giving it away.

rovesciato writes:

In response to the earwicker directly (i assume)above: I think the fundamental argument of the podcast was that most people would be either extending credit or consuming the surplus of a second income on the 8 dollars out of 10 such that no additional wealth is being created by the transaction making the 8 dollars merely a transfer payment which is only more efficient than a tax insofar as there is bureaucratic waste and changes in incentives. The price mechanism as I'm coming to understand it is much more robust than this chimeric trickle down nonsense. that 8 dollars could be put toward anything from direct entertainment (as opposed to the socially comparative kind) to an ergonomic chair to a 401K, transferring the energy of economic activity from flipping houses and packaging home mortgages to making and improving these other wealth creating products. For the millionaire the case is more dire: the 8 million could have gone toward venture capital or the cash reserves of a bank extending wealth creating loans.

rovesciato writes:

some other observations: regarding the question in response to the identification of market failures: how do i know that the government will do better? I often wonder in response, how do i know that the government will do worse? The track record is bad, granted, but this is not an indictment of any one specific intervention. if 9 are disastrous and 1 effective you may not have an argument for a managed economy but you certainly have one for the use of government directive in correcting market failure; even if there is a negative incentive created by that directive it may be that it is preferable to endure that negative than continue with the market failure, or more likely, there is a relative benefit of the directive over the negative incentive until the negative incentive has time to build up and then the relative benefit reverts back to living with the negative created by the market failure. Just as there is creative destruction in markets may there not be a type of creative destruction in the solution to problems by government directive? The practical problem of government is that of influence and corruption, not so much that it is inherently destructive (although I don't think it can be argued it is an effective wealth creator). It is likely, as well, that wealth created by markets in a society with no government would lead to incentives for influence and corruption that would undermine its own success, that is, markets enable human beings in the creation of government.

also, i sense that the all powerful game changing quality of markets may be over asserted, as the language of this statement suggests, when battering about a major society wide directive like that of mandating education. whatever the problems with that mandate today the initial or effective surge that occurred when policy pushed American society from zero to eleven, so to speak, may have had a real effect on wealth creation that markets themselves cannot be assumed to have engendered in so timely a manner. We shall perhaps have something of a crude test as the emerging economies, particularly India and China, move from export economies dependent on drawing in foreign wealth with cheap labor to dynamic "middle class" economies that feed off the creativity generated by their own demand. The biggest current obstacle to this is a skilled workforce; the demand for the skills is vast and under supplied, particularly in India, primarily for cultural reasons. If the emerging markets struggle to supply themselves with enough skilled workers to maintain growth it may be argued that the relatively sudden supply of skilled workers, for the time, around 1900 lead to the manufacturing booms of the the first half of the century.

Scott writes:

Russ,

In the past I've commented on your podcasts criticizing the show because too often it's an hour long chat between two people who share the same views. Here I gotta give credit where credit is due. This was a great podcast and I enjoyed hearing both sides of the argument.

One thing I need to bring up though (in response to Frank's money-left-on-the-table argument) is that economists too often assume that workers and capital can easily migrate to a better situation. In the case of workers who face adverse conditions this is usually not the case, and this is exactly why they are most vulnerable. Many small town economies are dependent on one or two companies often in similar industries. Because these companies have strong leverage, government regulations are often the only way to keep them honest on safety and environmental regulations. It's hard for employees to organize and say "you need to invest more in safety equipment or we're gonna quit and look for a job in the next town."

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