Russ Roberts

Daron Acemoglu on Inequality, Institutions, and Piketty

EconTalk Episode with Daron Acemoglu
Hosted by Russ Roberts
Continuing Conversation... Rob... Continuing Conversation... Dar...

Daron Acemoglu, the Elizabeth and James Killian Professor at the Massachusetts Institute of Technology, talks with EconTalk host Russ Roberts about his new paper co-authored with James Robinson, "The Rise and Fall of General Laws of Capitalism," a critique of Thomas Piketty, Karl Marx, and other thinkers who have tried to explain patterns of data as inevitable "laws" without regard to institutions. Acemoglu and Roberts also discuss labor unions, labor markets, and inequality.

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0:33Intro. [Recording date: October 6, 2014.] Russ: Now, your paper, "The Rise and Fall of General Laws of Capitalism," is a critique of both, in general, the idea that there are general laws; but in particular, you are taking aim at Thomas Piketty's book, Capital in the Twenty-First Century. He was just recently a guest on EconTalk, discussing the book. And at the heart of your critique is a failure, you claim, on Piketty's part to take account in institutions. Explain what you mean. Guest: What I mean is that at some simple level, if you want to think about how economic outcomes, economic variables are determined, you know, if you go back to the way that we think about it, the way that we teach in our basic economics courses is that we talk about technology, supply side of the economy if you want to think about it that way. Preferences, the demand side. But there's always something that puts the two together. And in the basic, simple economic model, we have perfectly competitive markets or some sort of Cournot oligopoly. But of course reality is much more complicated. Government actions, actions by powerful groups in society through non-market means--bargaining, coercion, rent-seeking--all of those are in general part of this ensemble that put preferences and technology together to generate the outcomes that we care about. And broadly speaking we would refer to these as institutions, but [?] something else, but by institutions generally that's what we mean. And they have a life of their own. Not only do they matter; they also change. They change in response to the distribution of political power in society; they change in response to technology; they change in response to political demand coming from various quarters in society. And I think generally trying to formulate strong laws of how the capitalist system is going to evolve. Not that I am a big fan of the word 'capitalism,' by the way. Those laws are generally formulated for capitalism. Those sorts of laws generally ignore the role of institutions--both their impact but even more importantly their endogenous evolution. Because institutions make these sort of simplistic predictions much harder, because they mediate how these different sides of the market come together. Russ: Now, before we go any further, I want to defend Piketty. And then we'll get into the details. It's kind of a thrill for me--I don't get to defend him very often. So--I would argue that in his book he talks a reasonable amount about institutions. In fact, while I was reading his book, I knew that I was going to be interviewing you, and I came across a couple of quotes that suggest that he was at least sympathetic to your approach. I'm going to read one of them:
In order to understand the dynamics of wage inequality, we must introduce other factors, such as the institutions and rules that govern the operation of the labor market in each society. To an even greater extent than other markets, the labor market is not a mathematical abstraction whose workings are entirely determined by natural and immutable mechanisms and implacable technological forces: it is a social construct based on specific rules and compromises.
And I would argue that you could have written that paragraph, more or less. Guest: Right. Russ: And he has a few others like that. It's not the only one. There are not a lot of them. But how would you defend your critique against that quote? Guest: No, I think, you know, what I should say, and we should be more explicit about this, is not that Thomas generally ignores all sorts of factors other than capital and labor. But that these are not an integral part of the main arguments of his theory, in the same way that they weren't part of the main argument of Karl Marx's theory. At some level you can read Marx as a formulation of many important institutional dimensions of society. But when it comes to it, at the end, Marx's predictions are very much derived by abstracting from the various different effects of the institutional factors. But in particular, if you take all of the statements that Thomas makes, which include what you have just read, or in other places he puts a lot of emphasis on minimum wages for example or some [?] taxes--you know, you would say, yeah, all right, of course there are; he's suitably cautious in these things. But at the end of the day, the major predictions, the major force of his approach, which is that it's going to be the gap between the interest rate and the growth rate that is going to determine both the capital share and inequality in society, and these are the major forces which we have to understand about the revival or stability of the capitalist system, I think that's where institutions make no appearance. And, whenever institutions are sort of mentioned, such as wealth taxes or sometimes in the quotes[?] almost social norms that regulate the pay of the super-managers, etc., they are very much an outside construct. They are not part of what is changing and what needs to be explained. And that's what I am sort of drawing, we are sort of drawing the parallel to Marx, where, again, all those, there is an important institutional element in Marx, in particular his view of the Communist economy is an institutional one at some level--there is going to be a change from the capitalist to the communist or socialist to the communist. But his understanding or his explanation of how the capitalist system works in some sense is largely determined by some fundamental economic and accumulation force. Russ: I totally agree with that. I think there's some thoughtful analysis along the way. But when it comes to the bottom line it gets sort of pushed away, or ignored, or unemphasized. I think that's part of the problem with the book. It's not my main problem with the book.
7:33Russ: But let's continue. I want to start with Marx, because, as you do point out, Piketty's book is a, in some sense, there's certainly a wink if not a nod to Marx. In the title: the title of his book is Capital--In the Twenty-First Century. And Marx's book of course was called Das Kapital. So there is certainly a--and he writes a lot about Marx in the book--he certainly sees himself in that tradition, that grand tradition, not just focusing on capital but also in deriving general rules. So I thought it would be useful, certainly for me, and for our listeners, to hear: What were Marx's general rules? And what went wrong with them? Guest: Well, I mean I think Marx much more than Piketty had a very complex social theory, developed over many, many, many, many writings; and then put together in various different volumes--most importantly in Das Kapital, the first volume; and then posthumously, somewhat, some of them by Frederick Engels--Engels' and Marx's cooperation. So, anything you are going to say about Marx is going to be a simplification. But I think, doing that simplification, going along with that simplification--I would say that Marx had a conception which, in my opinion, and James Robinson's opinion, minimized [?] role. In two different ways. The first one is that his overall conception of how social, political, and economic outcomes were determined was a very materialistic one, in which, although in some of his works for example--most notably in the "Eighteenth Brumaire" he does talk about autonomous political factors--so the coup of Louis Napoleon Bonaparte, etc.--at the end of the day he had a conception in which the base, the economic relations, determined everything else. So, though it is important, according to Marx to talk about political factors, those are very much shaped by the economic currents of the time and [?]. And, taking his cue from this overall framework, or historical materialism if you want to think of it or a simplified version, sort of, materialism, he did articulate several strong predictions or tendencies about how the capitalists work. In the paper, we emphasize three of those. One of them is the, sort of the general law of capitalist accumulation as he viewed it, which is about what's going to happen to real wages. See, here, Marx is a little less than fully specific. He does sometimes talk about real wages being [?] stagnant. But at all improvements in output and productivity go to capital, and sometimes the weaker form where, you know, the share of national income captured by labor declining over time, even if wages freeze from time to time. He does then talk about something else that's very well known, in Marxist economics: the general law of declining profits. And then later, he also talks about the general law of decreasing competition, which is, you know, the move toward monopoly capitalism--another one of the themes that post-Marxian economists have emphasized a lot. Russ: And those predictions didn't turn out so well. Why not? Guest: They did not. They did not. And I think, you know, the first one we know best. In fact Marx wasn't totally off target when he was writing. When he was writing was one of the most challenging things that people were aware, even if they did not have high quality data that we now have access to, is that, you know, there were a lot of things going on in the economy. The technological infrastructure of the economy was being totally revolutionized. And there were big monies being made by certain investors in corporations. But wages were stagnant or perhaps not doing so well for certain portions of the population. So out of this, Marx said, Look, labor is not going to benefit from all of these things, because this is all part of the nature of the capitalist. But, you know, that was happening in a given, particular, political, social, and technological context. The political and the social is actually very important, because when this was taking place, the balance of power in society was still very much a remnant of the old feudal time. Democracy was certainly sort of beginning to develop in Britain, with the First Reform Act, but was in a very, very embryonic form--was certainly not very active, and there wasn't representation in much of the rest of the Continent. And over time, so this balance of power started changing with greater democracy, greater franchise, greater representation, better organized labor, all sorts of regulations that changed how the pie would actually be divided. But even more importantly, the social and the political context determined the two most important factors shaping wages: human capital and technology. Together with these institutional, political institutional changes, came a whole revolutionary set of changes in the education. So, education ceased to be an elite activity, or the sons and daughters of the very prosperous, privileged part of the society-- Russ: Mostly the sons-- Guest: The sons, yes, that's right. Russ: At that time. Mostly the sons. Guest: Absolutely, absolutely, yes, that's what I should have said. Guest: And became basically available to the masses, although the whole sort of mass [?] movement in Europe and Britain did take a good part of the 19th century. And this was part of the super-rapid increase in the supply of skills during the 19th century, unprecedented relative to the past. Not that there weren't some very specialized skills. The British artisans were very skilled. There were pockets of highly skilled artisans and specialized workers in Continental Europe. But the whole work force became much more educated. And then, secondly, and perhaps even more importantly, for wages: the general environment, the institutional general environment, continued to support creation of better and better technologies and the scaling up of the employers that were willing to use that technology because they could outcompete their competitors, the incumbents in many cases, without very strong protection for these incumbents from the political powers. Big change, in some sense from the 18th century, for example. And with their ability to borrow, the financial markets, to patent and use and sell their innovations. So the whole sort of infrastructure of what we now view as the market economy got formed and developed in much of the 19th century. As this happened, the demand for labor increased; the demand for skilled labor increased. And all of these things kept pushing wages up. And in fact, somebody writing without so much reference to Marx, but just writing about trends in the second half of the 20th century, the most remarkable thing would have been the very steady increase in living standards over the last 100 years.
16:26Russ: Correct. And I think--let me--I want to push against both Piketty and your analysis. It seems to me that overwhelmingly, that rise in the living standards is due to two factors. Three. Maybe two and a half. And then I'll let you add--and then I'm going to see is left for institutions. So, we have the technological change. Which in itself is endogenous. It's a bit of hand waving to suggest it just sort of happens. That technological change certainly, as it goes along, requires, for it to continue, the application of capital. And that capital accumulation, which leads to technological change, leads to enormous improvements in productivity. And then the question becomes, for the Marxists: Why doesn't capital retain all the profit that it could? And I would answer that the main reason it doesn't isn't institutional. It's merely competition. Now, that is competition among profit seekers--entrepreneurs, corporations, etc.--forces them to share the gains with consumers, and then in turn with workers. Competition to acquire both customers and workers. Now, I will accept the argument, and I'll let you flesh it out--unless you want to push it in a different direction--that institutions determine how that competition plays out. Certainly that's true. But I think that role of competition in forcing--that's the right word; I don't think it's the best word but it's the only one I've got--forcing capitalists to share that bounty of that higher productivity with the general public, is the story of 1850-2014, even in the middle of this recession. And I'm curious what you think. But I don't understand about Piketty, and we can talk about this later--is, capital to me seems to be a crucial ingredient in the standard of living of the masses; and I don't understand how wars, which lower the amount of capital, are therefore good for the rest of us, but even though they are bad for the top 1%. I think they are bad for all of us. Not just the fact that people die, but because it does destroy capital. But just on your argument: what's the role for institutions in my story? What am I missing? Guest: Okay. So, I think you've got it absolutely right. I am 100% agreeing with you. Which is that what happened from 1850 is that technology moved apace. Human capital improved. Technology and human capital together created more and more demand for labor, pushed up marginal product of labor. And because labor markets were increasingly quasi-competitive, let's say--and I wouldn't go to say as far as saying they were competitive-- Russ: I don't know what that word means. Right? Competitive. It doesn't-- Guest: Well, what it means is--I'm not saying that wages were equal to the value of marginal product of labor-- Russ: Of course. Guest: But they were scaling up with the value of marginal productivity. Russ: Yup. Guest: So these factors together explain why the share of labor essentially remained constant together with GDP (Gross Domestic Product), wages increased and in some places actually share of labor increased faster than GDP. But what I disagree with you is the counterfactual. You are making the statement conditional on the institutions, in particular labor market institutions supported by the political institutions as we saw in the United Kingdom and in parts of Continental Europe. But those labor market institutions, supported by the specific social and political institutions of that time, were actually the exception in human history. And if you think about how labor markets worked, in much of Continental Europe, before and at the time of the French Revolution, in the United Kingdom actually, in the 17th century, 16th century, it would have been very, very different. And for instance, take places in which there was labor coercion. At the time that this was happening, or, you know, shortly before then, you still had labor coercion in many different parts of the world. And in those parts of the world there were huge swings in the value of marginal product of labor. For example, you had sugar prices fluctuate a lot and improve and increase the value of marginal product of labor of slaves in Jamaica and Cuba and Haiti. That did not translate into increases in the wages of labor. Russ: Great point. Guest: [?] example. But that didn't [?] because this was not in the context of a market economy. They key thing, and that's the institution part and that's why I think it's very important when I say that the Marxist theory and Piketty's theory don't have a role, or don't have an organic role for institutions: I really mean the evolution of institutions also. The crucial part is that these institutional structures, what was going on the labor markets, the representation of labor, the Chartist Movement and then the Trade Unions in the United Kingdom that represented the labor's interest, developed together with these more competitive, quasi-competitive markets, and led to an equitable distribution of the gains from economic growth--those same gains would not have been distributed equitably if Europe still had the institutions of the 1700s or the 1600s.
22:11Russ: Fair enough. And it's a great point. I do have a question though about modern improvements to the standard of living. I used to ask, when I would teach non-economists--law students or law professors or journalists or judges. I would ask them: Why is our standard of living in America higher than Mexico's? And I would often get the answer: Because we have a minimum wage and they don't. Yeah. Don't laugh. It's a common answer. And it's not a bad answer if you haven't thought about it a lot. And I would never laugh out loud, I want to say on the record, when I heard that. But the reason you laugh is that argument is very hard to sustain. There is not a lot of evidence for it. Guest: I don't mean to laugh--you know, I think if you want to explain why that certain types of workers in the United States have much lower wages than those workers in France, minimum wage is an excellent answer. Russ: Yes. That's correct. Guest: But I think, before you can get there you need to have a much greater institution parity. As you do have, with some important differences and distinctions between France and the United States. And that brings more, greater technological parity. But when you are comparing Mexico to the United States or Peru--you are [?] mistake-- Russ: Not going to work. Not going to work. Guest: Yeah. There are much more important first-order factors. Russ: Right. But the next argument you would hear is that we have unions and they don't. And I think that' a commonly held--let me make the argument more generally. When you ask, why was the 20th century so great in America overall despite a horrible depression, two world wars--lots of challenges? Why did it turn out so well? There are a lot of people who believe that it was the social legislation of the New Deal, the minimum wage, Social Security, certain bargaining laws for labor, Robinson-Patman, other types of innovations--I hope I had that right in terms of the timing--that forced capital to share the gains with labor. I just don't see that argument--empirically. I understand the argument, the idea behind it. In think empirically it's very hard to sustain that. Guest: Well, I disagree and I agree. I think my view is that, you know, think of it this way. So, I'm going to caricaturize my own view, but I think the view is [?]. You talked the competitive labor market. I think that competitive labor markets are actually a quite difficult thing. Nobody actually has an interest in a competitive labor market. Everybody would like to be a monopolist. Everybody would like to form coalitions with their friends and the people with whom they have some overlapping economic interest. And, with those coalitions, force for certain noncompetitive elements. So, at some point in human history you are going to find yourself close to the extreme of the slavery system that I just mentioned, where coercion is very strong. And even when coercion is not as strong there is huge imbalance of power because employers are monopsonistic; workers are in poverty or are being forced into poverty. For example, as in South Africa before the fall of apartheid. It's not just that you have coercion, which apartheid did exploit it. But also apartheid, as part of its existence, reorganized the entire labor force, pushed workers into these bantustans where they could not survive on agricultural, so that they would become cheaper labor for mines or for other white-controlled employers. In other periods, you are going to have, as you have had, getting a little weaker, but in parts of Continental Europe where unions are going to be so strong and employers are going to be so weak; so now you are going to have a situation and a wedge [?wage?]--unions are going to push for excessively high wages for their own members at the expense of other workers and at the expense of capital innovation in the economy. So, therefore, I cannot answer the question as to whether unions are good for the functioning of the economy or not. It really depends on what side of this tradeoff we are, or what side of this sort of balance we are. So if we are on the side of the balance where we were at the end of the 18th century, then I think it was important for the labor movement to play an important role, to balance that out. If you are where you were in Portugal, for example, in the end of the 1990s, perhaps it is good for unions to become sort of less able to push for innovation curtailing and business sort of killing high wages. So it's really the balance of where you are. So, I think--do I believe that it was important for Britain to have its labor movement become more well organized, more powerful, in the mid-19th century? Yes. Do I think that it was important for the United States for labor to become a little bit organized--it never became as organized, but at the beginning of the 20th century, so that some of the worst abuses, especially in terms of safety and child labor and other things that were going on in some marginal parts of the labor market, but not unimportant parts of the labor market in the United States? I think those were important. But I also don't think that you can generalize this to say that everywhere and under all circumstances you should push for stronger unions. Nor do I believe that the minimum wage or the Social Security legislation per se were that important for understanding the development of wages, development of living conditions in the United States--as you have already hinted at.
28:37Russ: So, one of the reasons I like talking to you is that you make me think about these things. You challenge my preconceptions. I'm going to give you one more, and then we'll move on. Because I find this extremely interesting. And I take your point about balance. But here's my puzzle. I have a cleaning woman who comes to my house with a crew of three people once a week. She speaks pretty good English. The three people she brings, they don't speak English very well. They don't have a union. Their bargaining power seems to me very limited in the way that bargaining power is talked about as an important art of labor market outcomes. They make a little over $23, $24 an hour--which is about, roughly three times the Federal minimum wage--I don't know what the state minimum wage is. Guest: These ladies--ladies do make? Russ: Yeah. Each one. Guest: Wow. Very good. Wow, great. Russ: Well, it's hard to clean a house; it's hard to show up every time, every week on time; it's not pleasant work particularly; but if you do it well and you do it diligently, you make--you don't get any benefits; it's not great; it's hard to work 2000 hours a year doing it; you have travel time between things. It's not great. But their kids can go to college, actually in the United States, which is unbelievable; it's hard for them to get into more expensive ones sometimes or to be able to afford them. But they have a very different life here than they have in the countries that they came from. And the question I always as is: Why do I pay them three times the minimum wage? And it's not because I'm a nice guy. I wish it were. I like to think I'm a nice guy. But I pay them three times the minimum wage because if I don't, they don't come to my house. They have better alternatives. So, to me, competition, all this stuff about bargaining power and institutions, I don't see why it's so relevant. It seems to me that the technology--I'm going to come back to my original point: The supply and demand thing kind of powers through a lot of things. Guest: Okay. So, I think in your labor market, it might turn out that way, that $23 an hour, there's so many employers that are individually willing to hire these labors, that competition is able to take care of it. I think in many parts of the United States, despite the fact that the United States is as close as one gets to that, you know, peak of the balance that I just described, I would worry that the head lady will charge you $100 an hour, and then-- Russ: I'm sure she takes a disproportionate share. I don't think she divides it equally. Guest: And then will give each one of the other ladies $6. Russ: That could be. By the way, she drives a nicer car than I do. Guest: And that's because they are afraid that if they object to that, they are illegal or they have some other reasons to be afraid, and she is going to either drop them entirely or she is going to complain about them to the authorities. So they are in a very, very unequal, difficult bargaining position. And that the $100 that you are spending actually gets captured by the intermediary. And in fact, if there was better safety laws, perhaps these ladies would be compensated for doing some of the difficult job; or if there was, miraculously a better system in which people could not be taken advantage of in that way, their wages would be closer to the true value of their marginal product and as a result they will work even harder and we will have a more efficient and even a more liquid market. You know, one could tell stories. I don't know how the labor market in your area for cleaning ladies works. But I think the issue is that there are many pockets, even in as modern an economy as the United States which still in this day and age we are very [?] these issues. Still there are unequal labor relations. And you go to, you know, [?], the United Arab Emirates or Saudi Arabia, where migrant workers, who are paid so much better than they would have been paid had they stayed in Bangladesh or Pakistan or the Philippines, still are highly abused. And you can always say: Well, you know, labor demand, technology are going to take care of it. But it's a very slow process; and sometimes it doesn't because of the regulations, political power. Money is, all of them are on the side of the wealthy sheiks and princes in Saudi Arabia and the United Arab Emirates. So, you know, it's a very, very unequal sort of fight, or unequal economic struggle between the migrant workers and their wealthy, powerful employers. Russ: I suspect that the labor market for cleaning people in the Boston area is very similar. But I take your point, especially with respect to how they are compensated within the group. I don't know. I may try to find out. Let's move on to Piketty. Guest: Let me know if you do. Russ: I will.
33:31Russ:Let's move on to Piketty. So, Piketty has some general claims, and you talk about some of them in the paper that are a little bit on the technical side and don't lend themselves very well to audio. So, I'm going to leave those out. I'm going to focus on the big one. So, his biggest claim, the one that is the centerpiece of the book, is what he calls the central contradiction of capitalism: which is that the rate of return on capital, which he calls r, is going to almost always, or often is going to be greater than g which is the growth rate of the economy as a whole, and therefore holders of capital will see their well-being rise at a faster rate than the rest of the economy. And therefore inequality will grow inexorably. So, is that a fair summary, do you think, of his work? Guest: I think it's a very fair summary. Russ: So what's wrong with it? He treats it often as if it's just a mathematical truth. What's wrong with it? Guest: Well, I think there are several things wrong with it. I will classify them into four things that are wrong. First one is that the fundamental contradiction of capitalism is actually something that's implied by economic efficiency. So, in fact I think calling it a central contradiction of capitalism does create a little bit of a smoke-and-mirrors sort of thing. I'll come to that. Second, that to see this as an inexorable producer of inequality is at least theoretically--and I'll come back to the empirical part--wrong because r, the interest rate could be greater than g and that might still be consistent with stable inequality, decreasing inequality, lower inequality. Third, in focusing on r minus g in my opinion you are leaving out all of the more important determinants of inequality, all the institutional ones that we already talked about or those that come from other aspects of institutions[?] such as social mobility, for example, which I think is central. And then fourth, empirically, r - g doesn't do such a great job in explaining inequality or equality trend. So, those are the four things. Should I run through them? Russ: Yeah, let's go. Go for it. Guest: So, first of all, r - g actually, you know--this is a small point, but let me start with it. And this is a technical point but I think it's an important one. In economics, in growth theory, we call economies that do not satisfy r > g 'dynamically inefficient' economies. Because there is something fundamentally distorted about them. And in particular, if r were ever less or equal to g, less than g, let's take less than g, then you could actually make everybody better off in the economy without making anybody else worse. And that fundamentally the problem is that-- Russ: How? Guest: if r is less than g, that means that you are not properly compensating people for saving, which is an important economic activity; and as a result the economy generates too much capital. So, r minus g is a situation in which the economy has excessive amounts of capital. And it would be better for everybody else if it actually consumed some of that capital. And so, dynamic efficiency, what we sort of impose or expect the market economy to generate under fairly weak conditions, immediately leads to r > g. So, rather than being a sort of a newly discovered fundamental fault line of the market economy or the capitalism economy, r - g is exactly what market economy should generate. And generally does generate; although there are periods in which economies do go into dynamically inefficient periods.
37:57Russ: Okay. So then--I'm going to take you off track for a minute; we may come back to the other three. But if it's actually a good sign for productivity and for the size of the pie, which is what dynamic efficiency is getting at, that phrase: if it's good for the growth or size of the pie, that r is greater than g, doesn't that mean that people who hold capital will see their nest egg, their savings, growing at a very high rate? And I'm just a poor wage earner; I'm just growing at a rate g if I'm lucky. I'm getting Piketty's story: international growth averages--sometimes it's higher, but in the developed countries it's usually between 2 and 3%. That includes population growth. So, productivity growth is 1-2%. And so that's the best I can hope for as a worker: I get a little booster throughout my life, but somebody who inherits money, they're getting r, so they are growing at a bigger rate, 5%, 7%. Doesn't that mean that the distance between the wage earner and the holder of capital is going to grow and grow and grow and over generations get even worse? Guest: So that's exactly my second point. So, the first one was that r - g is, it actually should be positive; that's quite basic economic theory we teach to all our students. And the second point is that r - g being positive doesn't actually imply increasing inequality. Yes, you're right--Thomas is right; and Thomas of course knows all of these things and in parts of the book he suitably caveats them. But let's take the most extreme version of the Pikettist position rather than Piketty's position, which would be: Yes, r - g is positive; that means that capital earners are going to have much, much, much, much higher, faster rates of growth of their wealth than workers. Well, that doesn't follow. That doesn't follow for several reasons. First of all, it's the case that not everybody is a capital owner all of the time. So, many people are saving for life-cycle reasons, or across generations they are saving to pass on to their kids, who are going to have lower earning potential. And if that's the case, you are not going to have that the translation--you are not going to have a direct translation of the rate of return on capital to the wealth of the capital owner's [?]. Russ: Plus-- Guest: More general point is that social mobility breaks this link between return to capital and where the capital owners are going to be. Social mobility here, I'm taking it a little bit broader than what we normally mean, which is that by social mobility we normally mean social intergenerational mobility. And we have quite a bit of that in the [?] economy. But here, I actually mean even more than that the fact that in your 40s you are going to be a very high earner; and then in your 60s you are going to live off the savings that you accumulated during your working. So all of those together imply that the link between, the gap between r and g and inexorably rising wealth inequality is tenuous at best. Russ: Let me extend your point, which is something we didn't talk about when I discussed this with Piketty. Which is, of course everyday people own stock as well. They have access to r through mutual funds; because probably the most--many of my guests changed the world in many kinds of ways. But I interviewed Jack Bogle, the founder of Vanguard, and what he did is he democratized the access to capital through Vanguard's indexed mutual funds. It's an incredible revolution, really. Now it's true that not every single worker has access to it, but many, many do. And certainly more than, say, 50 years ago. And that's a wonderful thing. And Piketty ignores that. Of course, the other thing he ignores is that, as Bogle would point out, if you take what's called a buy-and-hold strategy and you buy a broad-based mutual fund, whether it's Vanguard's or somebody else's, you will do very well. You will earn the so-called market rate of return--pre-tax, of course. And you have to pay taxes on it--something Piketty often ignores. But pre-tax, you can earn that rate. Very few people's portfolios grow at that rate. For one reason, they diversify: they buy other things that are safer. Because there's risk in r, which is also often ignored. And secondly, they make mistakes. They get over-enthusiastic about return. They try to time the market. They waste a lot of money in fees. And we see the empirical evidence of this is overwhelming. You don't[?] have to do a study. You just have to look at what happens to rich people over time. They don't stay so rich. Not just they themselves, but their families [?] this over time, over generations. Guest: I think that second important, that's the important point, the second one you made, because I think Thomas is actually quite aware of that point. But he has a comeback to that, which is he would say--he doesn't emphasize this in the book although he doesn't articulate the criticism but he does respond to it at some level. He says: Capital income is very unequally held. So, capital is very unequally held. So, capital income, you know, yes, sure, the average worker does hold some stocks, true, Charles Schwab or Vanguard. But you know, it's very, very-- Russ: It's a small amount. And it's not a hedge fund; you can't get the return that hedge funds get. Of course many hedge funds go broke. Guest: But even if they were to get the same return-- Russ: Start with a smaller amount-- Guest: 99% would hold, you know, 50%, 60% of the capital stock, according to this view, and then the top 1% would hold 40% and then of course the return on capital would disproportionately go to the top 1%. But the key thing is that: Who is in that top 1%? If you look at who is in that top 1%, that changes over time. The people who are in the top 1% today, many, a large fraction of them were not in this top 1% 30 years ago. Russ: Yeah. His answer to that--I don't fully understand. I pointed that out to him. But his answer is: At the rate--when he points out that the rate of growth of the top 1% is growing, I say it's not the same people. And he still says, oh but this can't go on forever; eventually, even if the people are continually leapfrogging each other, I think he views it as somehow alarming that at some point in the future, the people, whoever they are, in the top 1%, will have too much political and economic power. Guest: Well, that's a different point. And we'll come back to that. And then I'll want to come back also to this issue--there is a little sleight of hand there, which is--again, I'm not sure whether I'm reading all of Thomas's statements accurately, but if my reading is accurate, he's saying: Look, capital is so important, capital is [?], capital is going to be the driver. But actually he's quite well aware, and his data from both the United States and France quite clearly show that the increase in inequality is not a capital phenomenon. It's a labor income phenomenon. So therefore what he's saying is that, sure it might be that's it's been labor income that's been driving the increase in inequality over the last 50 years, to an extent that we had not seen in the beginning of the 20th century, in the first half of the 20th century, or the 19th century. But it remains the case that in the future it will be capital that dominates. Russ: Great summary. Guest: We don't have any evidence for that. Russ: Yeah. That's a great point. I think that's exactly what's right or wrong about his analysis. With the caveat, as my listeners know, that I think the rise in labor inequality is grossly overstated because of demographic changes in the United States, because the analysis is households, not individuals; and there's been big changes in household formation and destruction because of divorce and delay-to-marriage date. And as a result when we see that trend it overstates the actual trend. But let's put that to the side, because that's a statistical issue.
46:44Russ: Let me get to a different point about the labor-income inequality. You can come back, make whatever the point you were going to make. I apologize. Guest: Okay. Yeah. Sure. You get to run this. You can take it wherever you want. Russ: I try not to take too much advantage of it. But you're very polite. You fault him for just "presenting the data." I think one of the reasons his book has been so successful-- Guest: Well, that's the point I want to make, actually. That's my fourth point. Russ: Yeah. Make that point. Because on the surface, it seems like a selling point. All he does, it's just the facts, ma'am, just the facts. Guest: Well, let's come back to that. Can I--Let me cover the third one very briefly-- Russ: Yeah, go ahead-- Guest: and then we can come to the fourth one, which is essentially the one that you're making. The third one is that even if you ignore the first two points that I made or if you take account of them but think they're not of course the end of the world for this point of view--but this point of view ignores the fact that there are so many other important determinants of inequality than r - g. And we try to, in the paper we try to illustrate that for example with the trends in inequality in Sweden and South Africa. And you can see quite easily there are huge changes in inequality in both of the countries over the 20th century. But none of it is related to r - g. None of it is related to wars or destruction of capital. So, they, are all deeply institutional. They are related to the formation of the social welfare state in Sweden. They are related to the nature of the apartheid regime which held black wages down but redistributed them among whites; and then the collapse of the apartheid regime, and so on. So that's a third one, which is that the focus on r - g might sort of involve throwing out the baby with the bathwater. The really interesting stuff left out. And then the fourth one is exactly the one that you made, which is: What does the data show? So, Thomas is doing a fantastic job of digging new data that is quite informative on a set of questions about economic [?] inequality. Together with Emanuel Saez and Tony Atkinson and a number of other researchers, he's been at the forefront of using tax returns data to shed new light on age old questions of inequality among economists and labor economists. But the literature has always been a very empirical literature. Which is that if you make a claim, then you look at the data not just in terms of the statistics, but you also provide the "relevant correlations" or the regressions--first starting with ordinary least squares regressions that sort of document what the correlations are. And then you worry about causality--what causes it? Is it really x causing y, or z causing x and y, or y causing x? So somehow surprisingly at some level, Thomas never does that. He sort of lays out the data. And he says, here are really interesting patterns. And I go with him totally--these are really interesting patterns. And he gets full credit for bringing those patterns to the attention of millions. But on the other hand, he then takes the next step, and he says, Well, here are the patterns and these are explained by r - g being positive and here they are explained by the World Wars, and here they are. But how do we know that? Russ: Had do you know? Guest: Have we done the cross-country correlation? Over-time correlation? Across households correlations? Or regressions? He never takes that step. And then, when you actually look at the data--for example, you do a very, very simple sort of correlational analysis and you say: Well, is it really true that in years or 5-year periods or decades during which r is greater than g, inequality increases? No. The data don't show that. So the data are quite clear that there doesn't seem to be a big correlation out there between r - g and inequality, top income share, or anything like that.
51:06Russ: So, I want to come back to that. Because I think that's the central thing--it's a beautiful point. It's really what economics is all about: it's about complexity, and the challenges of trying to parse out causation. Which I think we have mixed success at. But before I do that, I just want to let you make one more comment about something else you note in the paper. Which is: You fault him for focusing on the top 1%. What's wrong with that? Isn't that important? What's your critique there? Guest: Oh, it's absolutely important; absolutely, absolutely important. But it's one of the many important things. Again, let me give the example of South Africa. South Africa is a case study in inequality. One of the most unequal countries in the world. It's been so for quite a while. But it's not about the top 1%. It's about blacks versus the rest of society. Or whites versus blacks and coloreds throughout the apartheid period. This is just like a beautiful political economy analysis; every aspect of South African society, from marriage to education, from labor market laws to political representation, they are all designed in order to keep blacks relatively poor economically, and make sure that whites get the lion's share of economic gain. But you are not going to see that with the top 1%. In fact, top 1% share declines throughout the period of the apartheid. So, if you just looked at the top 1% you'd say, well, this economy is doing well; the elite must be getting weaker over time. Russ: Part of that is a sort of a presumed focus on a zero-sum game. Which I think is--as you of course point out, and as he would point out: he understands it's not a 0-sum game. But when you talk about shares relentlessly you tend to get people's minds focused on it being a 0-sum game. And therefore you tend to miss some things. Guest: But I think there is one aspect in which I think Thomas is right, Thomas is right. As well as things like poverty--what's the bottom 10%, how the bottom 10% is doing. How is the median doing? The Gini coefficient, which Thomas hates but which is still a useful diagnostic. As well as all of those, we should look at the top 1%, both because of the many different dimensions of inequality that we should keep track of[?]. But there is an important element about top 1%. It might sort of ring alarm bells in our mind, which is that it is possibly, probably--probably--related to how dominant the economic elite in society are. So, if you have that the share of the top 1% is increasing very rapidly, it is right for us to worry about, as social scientists and for journalists to worry about in their investigative journalism role, about whether the society is being increasingly dominated politically, socially, and economically by a very small fraction of the population. So for example if the top 1% is becoming very, very rich at the same time as somehow--[?] sounds has some eerie relevance to the United States--if somehow money becomes more and more dominant in politics. That, you might actually worry about it, and you might say, Well, you know, top 1%'s share increased from 15% to 30%, and around that time, a lot of that money started flowing into politics, and then people like Sheldon Adelson are able to sort of finance particular candidates and then with very clear economic agendas about how gambling should be treated, etc.--well, that could be something quite problematic for the society. It could be quite dangerous for society. So we should actually think about this. But as my explanation here suggests, that we should really worry about the political and institutional aspects of it. Not just look at what's going on in the tax returns, but really think about the resilience of the institutions--which are the fault lines of the institutions?
56:22Russ: Well, when you talked earlier--we're almost out of time; I want to bring us back to the beginning of your conversation, and I'll let you close us out. But you talked earlier, you said it's ironic--you didn't say it was ironic, but I was thinking it was ironic--that Marx was writing at a time when wages were stagnant; so we saw that he presumed that tomorrow was going to be like today, which is like yesterday; and therefore, there was going to be this perpetual stagnation. And he of course was writing this on the verge, on the cusp of the greatest leap in individual living standards that human history has ever seen. Kind of ironic. I remember being, in graduate school in the 1970s when very wise people whose names I won't mention explained how Microsoft--excuse me, IBM; I'm two generations ahead, one generation ahead--how IBM is a threat because they have a monopoly. This was a very long-running Department of Justice case, that pretty much, by the time it finished, IBM was almost irrelevant in the markets that were being discussed. And then we were told that Microsoft was a monopoly, and of course that also was a long-running case that turned out by the time it was done to be totally irrelevant. And you wonder whether people who make these grand pronouncements are doing so right at the time when reality and other market forces, other factors that are not observed-- Guest: It's called mean reversion, or Galton's Fallacy. Russ: Yeah, that's--thank you for giving it a little bit of an air of sophistication. But, having said all that, you, I know, are worried about inequality. I'm not, so much. I am worried about the political part; I am worried about the financial sector directing resources to itself. I think there is some inequality that's very bad. But I'm much more worried about opportunity. I'm much more worried about anti-poverty, and I'm much less worried about people who get really rich providing things that make a lot of people happy. So, tell me where you stand on this issue. Do you think-- Guest: Well, I think my view is not actually that different. But I think probably the emphasis is a little different. So, I think it's very useful to distinguish three roles[?rules?] of inequality. Or, three sorts of judgments that one can, and should, have about inequality. One is, holding everything else equal, how bad is it that the allocation of resources in the economy is more unequal? So, do a thought experiment; we hold everything else the same, but then we take a little bit of money from everybody below the 90% percentile and again give those money to the people above the 90% percentile. What is our economic judgment? Well, I think most people would be: That's not a good a good thing. You'll have some egalitarian judgments and so on. And you might have a social welfare function, diminishing returns in it, that once somebody has a lot already you don't want them to get more. Etc. But in general of course in reality not everything else is held the same. When you increase inequality you also encourage certain types of activities more, certain types of activities less. So I think we have to take all of these things into account. And I think it's a complex decision. And probably many people would be a little bit against inequality in this dimension. Some of them would be very against. But we have to find a way of aggregating these preferences. The second dimension I think is much more important; and you sort of somehow separated that but I think it's not as separable. Which is: equality of opportunity. I think most of us would be very troubled by an economic and political system where if you are born into a rich family you go to such schools and form such networks and get such a leg up in life that you are always going to be the boss. You are always going to have the most privileged position in life, even if you are not talented. Even if you haven't worked hard. Even if you haven't done anything. Just because you are born in the right family. And I think sort of the view that many people have is that as we make inequality greater, we also make this equality of opportunity harder to achieve. And I think there is some truth to that. For example, if you look in a world in which there are credit market constraints, then, you know, you can have easily a situation--this is I think the truth, reality in many developing countries--poor people cannot afford to go to school. And for people who live in neighborhoods that don't have schools, villages or poor neighborhoods, or they don't have high quality schools. And as a result, social mobility, equality of opportunity very strongly suffers. And in a situation like that, if you do indeed want social mobility, if you do indeed want equality of opportunity, then it might be one of the important levers to actually try to do something about inequality. But, if that's the case--now it's a parenthetical comment--who cares about top 1% inequality? Are we going to make equality of opportunity for blacks in our inner cities who are clearly suffering from this, for Hispanics, for poor people in the least educated socially economically most disadvantaged part of the United States if we take some money from Bill Gates and Warren Buffett and give it to millionaires, so the top 1% declines? Of course that's totally irrelevant. The right thing to focus on is really poverty; it's really opportunities available to people at the bottom of the income distribution. And top 1% share is quite irrelevant. Russ: Well, it's ironic, because Bill Gates--that seems to be my word of this episode; I apologize for overusing it--but it is ironic that in your example, you mention Bill Gates. Bill Gates is desperately trying to improve the schooling system. I don't think he's very good at it, but he would love to see smaller inequality by boosting the bottom, as would I think almost everyone in the world. It's a great idea. We need a better school system. But that has nothing to do with the amount of capital that the rich hold or the power that they have. Guest: Right. And then the third element--and then I think you agree on this also but perhaps you might think about it as a little bit more separable than income inequality, is political inequality. I think many people, again perhaps not everybody, but I think an overwhelming majority of Americans would think that a system in which only a handful of people have political voice and the rest of us are like sheep is not a good system. One man, one vote, in reality, our politicians[?] are accountable and representative to all of us. I think that's the sort of system that we want. There is a concern, and I think it's a real concern, that as the rich become richer and richer, unless there are the right sort of institutional checks--competitive elections, open political system, the right sort of punishments and social norms against political corruption and political backroom deals--I think there's a real danger that the very, very rich might become politically so dominant that they can start tilting the system to their favor. And we in the United States, we are seeing some of that. So I think that last element is the one that I already mentioned. That's the one where the top 1% is important and we have to watch out for it. But that's a deeply institutional political economy channel. Russ: Yeah, I totally agree. Where we might disagree is where I want to see that improve is by limiting the power of government. And the people who tend to be worried about inequality often want to increase the power of government. And I see that as a hopeless strategy. The idea that we can make government more powerful so we can reduce inequality to me is, to be honest, a little bit naive. Guest: Well, I think it's--you know, again, I think it depends on the specific historical context that we are in. So, you are certainly right: if you are thinking about exploitation--again, let me go to an extreme case like the apartheid state or the slave plantation or the feudal system--government power is the main method of the wealthy and the powerful to exploit and extract from the rest of us. But if you are thinking of the Gilded Age, the end of the--so, the age of the robber barons--then we have a system there where these trusts are so powerful economically and are so able to use the legal system that they crush any opposition. They are able to sort of maintain their monopolies at the expense of creating greater entry, greater variety, lower prices for the consumers. So in that case what you need to do is, you need to do standard antitrust regulation. But to be able to do the antitrust regulation, you need the government to become stronger. Which is exactly what the Progressives actually achieved during that period. I think the biggest achievement of the Progressives was the political reform that made the Senate more accountable. But also the whole sort of antitrust apparatus--that, I think is very important why Marx's third prediction about increasing concentration didn't pan out. Russ: I guess I'm a little more skeptical than you are antitrust legislation does what economists thinks it does or want it to do. Guest: Oh, I mean, I am totally willing to go along with you that antitrust regulation often does get misused. And there are many distortions. But again in some extreme situations where the economy is becoming [?] monopolized, I think it certainly is very important, the way that society itself will monitor how economic power is [?]
1:05:23Russ: Well, we're over time. Why don't you close by talking about Piketty's book generally? Do you think it's an important book? Guest: Absolutely. How could anybody say that it's not an important book when you look at the impact it has had? I don't know how many copies it has sold, but you know, it must be in the millions. And it has transformed the debate; it has opened new debates. I think it's fantastic. I mean, it is true that it sort of became unusually successful partly because it did tap into a deep angst that people were already having about some of these issues; and it is building on decades of research in labor economics on inequality that many people were showing these striking inequality trends that existed in the United States that contrasted with some countries in Continental Europe, for example. The contrast between the United States and Scandinavia and France. And he built on all of this, and advanced that debate in many ways, and made lots of people interested in that debate. So there's a lot of things for us economists to sort of write more about. And that's the spirit in which James and I have written our piece--like the really interesting hypotheses that he had, we have to respond to it. And I think all of those are a great service and we should be all grateful to Thomas. What he's trying to do is a difficult one, and I think that probably is a balance that everybody has to sort of think about what's the optimal balance. He--what many economists or social scientists, especially economists do, is that, you know, we write academic papers to advance new ideas. And then we write popular pieces to sort of popularize those ideas, or introduce those ideas to a broader public or policy-makers, etc. So, Thomas tried to do both in the same volume. And I think there is a tension in there; and I think it's not clear what part of it is a scientific, academic statement about comparative statics or the effect of x on y empirically, and what part of it is an appeal to his readers, his natural readers, that: I really think there is something deeply unfair about this and I really think it's x that's important even if the data is not there. I think those sort of statements are also fine, but when the two are mixed sometimes I think it's not as easy to parse what is what. And that's the spirit in which the institutions are mentioned. Yes, minimum wage is important, the wealth tax is important; but if you look at his theoretical model, they are not at the center of it, and that's what I was trying to say at the beginning. So that's a good point to end it.

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COMMENTS (24 to date)
giuseppe Paleologo writes:

One elementary observation about this podcast (and the previous one with Acemoglu): one may disagree with Acemoglu or not, but his attitude toward inquiry and his methodological openness are admirable, as well as his urbanity. He is trying hard to represent accurately dissenting opinions, and even presents objections to his own arguments. There's always a sense that he's telling you "that's where I am at with my understanding right now". Even if it does not transpire in the podcast, his papers are equally eclectic, drawing from history, empirical research, and pure theory.

If all debates were conducted with this tone (especially on blogs and public debate venues), their quality would be greatly elevated.

Regarding Russ's skepticism about the impact of regulation on monopoly behavior:

Looking at the irrelevance of high-profile cases by the time they conclude is too narrow a view from which to conclude that anti-trust regulation is itself irrelevant to the accrual and exploitation of monopoly power. In my experience (inside many technology companies, specifically), the *awareness* and fear of potential prosecution permeates the culture once companies become large enough. Collusion, corruption, and monopoly exploitation—and what, as an individual employee, to avoid doing—are central topics in even first-day orientation activities in many large companies. Relative to other areas of interest, and to the past in these areas, where enormous energy is spent figuring out ways to game the system and maximize returns, monopoly power is something average employees in real corporate cultures are taught to fear, not to exploit. The effect of regulation in this way is not visible in court cases, but is profound, and I believe a huge reversal from the counter-factual scenario (and the status quo from the gilded age) where there were few regulations and this was just another knob to turn to win the game as a player in a given market.

...the *awareness* and fear of potential prosecution permeates the culture once companies become large enough.

You're right about that, and it is definitely a negative factor for the economy. It hinders innovation.

I happen to have a friend who, in the 1960s, got a job with AT&T in their (then) Manhattan headquarters. His new boss told him that AT&T wasn't making any money off a large industry; agriculture. So, he looked into that, and found that the number one concern with almost everyone was inventory control--supermarkets back in that day had huge backrooms where they stored replenishment items for when the consumers took food off the shelves. They re-ordered from the wholesalers by mail (I still have a copy of my friends report to his boss)!

He also quickly found out that while AT&T had the communications technology to solve this problem--what we know as bar coding, today--IBM had the computing technology needed. I think it obvious what problems with the Justice Dept that entailed. Also, companies like Heinz were worried about being seen as conspiring with their competitors. The concerns in Detroit for the auto industry were even stronger, and kept the Big 3 from adopting as early as they could have.

One might object that, well we got bar coding eventually, but....

But if you are thinking of the Gilded Age, the end of the--so, the age of the robber barons--then we have a system there where these trusts are so powerful economically and are so able to use the legal system that they crush any opposition. They are able to sort of maintain their monopolies at the expense of creating greater entry, greater variety, lower prices for the consumers.

The above from Acemoglu is every bit as dubious a premise as any from Piketty. He doesn't know that Rockefeller and Flagler created their 90% market share by rationalizing the transportation and refining of oil? That the price of kerosene dropped by 80% for consumers?

Bogart writes:

I agree with the guest that his 4 issues are very legitimate critiques of Piketty but I think he is ignoring the elephant in the room which is that the banking elite can simply steal as much money as they please through inflation and use it as collateral for extending leverage. It is that leverage that allows the huge gap between r and g. Absent central banking, the large over leveraged banks would have either failed or changed their business practices.

I completely disagree with the guest that voting is good and that monopoly is bad. The facts are that voting is a terrible way to change the government and that the only thing Anti-Trust saved us from is lower prices. The ultimate anti-trust case against Standard Oil came to fruition when Standard Oil had a monopoly position of 60% of the oil business and a rapidly declining market share. The reality was that the break up of Standard Oil was more about the battle between the Rockefellers on one side and Teddy Roosevelt-JP Morgan-Rothchild Alliance on the other.

A very interesting point made by the guest that I disagree with was the point about the direct election of US Senators and how that helped the populace. This action completed the theft of power by the US Federal Government from the States that started in the Ante-Bellum period of US History. That year 1913 was a really bad year for the Average Joe Persons in the USA with the creation of the US Federal Reserver and the direct election of US Senators.

SaveyourSelf writes:

In past econtalk-forums, I have complained when guests brought up the term, “institution.” I could not find a consensus agreement on its definition so I worried that varying interpretations of its meaning could cause miscommunications. This podcast was no different in that Dr. Acemoglu’s definition at the start of the interview was unintelligible even after several readings. However, this podcast was different because Dr. Acemoglu gave lots of examples from which I think I have been able to deduce his definition.

To begin with, in every case where Dr. Acemoglu used the word “institution” he was talking about some sort of coercion. The level of coercion is one of the assumptions of Ideal-Markets so I thought perhaps “institution” meant market-assumptions. But in the middle of the podcast Dr. Roberts said that competition was not an institution and Dr. Acemoglu didn’t argue the point. So “institution” cannot mean market-assumptions. So I thought maybe “institution” just meant the general level of violence or coercion in a society, but Dr. Acemoglu’s examples are very specific. He points out at various times in the interview government, unions, capital owners, robber barons, gender, and race as all being institutions at different times and places around the world.

So “institution” refers to specific point sources of coercion in a society or market. They are always—necessarily—groups of people, but not always large groups of people or majorities.

SaveyourSelf writes:
@37:57 Dr. Acemoglu said, “His data [Piketty] from both the United States and France quite clearly show that the increase in inequality is not a capital phenomenon. It's a labor income phenomenon…So therefore what he's saying is that, sure it might be that it's been labor income that's been driving the increase in inequality over the last 50 years...But it remains the case that in the future it will be capital that dominates.”
Now I think I can see Acemoglu’s point. He agrees there is inequality. He notes that in Piketty’s data it is due to differences in occupational income. He just does not think the income differences necessarily imply a problem. If those differences are due to the influence of a coercive-institution, he thinks that understanding and addressing the institution is a better approach than trying to reduce the inequality through other means.

@16:00 Russ Roberts said, “That technological change certainly, as it goes along, requires, for it to continue, the application of capital. And that capital accumulation, which leads to technological change, leads to enormous improvements in productivity.”
Based on what I learned from last week’s podcast, I don’t think capital accumulation leads to technological change.

@ 37:57 Dr. Acemoglu says, ”Let's take the most extreme version of the Pikettist position rather than Piketty's position, which would be: Yes, r - g is positive; that means that capital earners are going to have much, much, much, much higher, faster rates of growth of their wealth than workers. Well, that doesn't follow.”
Acemoglu explains this is because capital ownership changes over time, social mobility exists, and savings dissipate when people stop working. I would like to add that marginal returns diminish as capital accumulates.

Capital requires maintenance. The more you acquire, the more it costs to maintain it. Thus, at some point, acquiring more capital paradoxically makes you less wealthy. The top one percent should be pitied, not envied. They are enormously above the “golden rule level of capital accumulation” and even beyond the point where their marginal returns are entirely negative. The only reason they “appear” to maintain that much capital is because they are NOT maintaining that much capital. They have farmed it out to enormous numbers of other people—who theoretically still have positive marginal returns on capital—through exchange markets like the stock market. In the event that the capital owners ever withdraw out of those markets, however, they are exposed to the full, mammoth weight of their capital’s depreciation. They have to consume that capital, and fast, or else it will consume itself. And it makes almost no difference if it was earned through sweat equity, a winning lottery number, an inheritance, or capital gains. Depreciation, the steady march towards entropy, is a physical law of the universe. It is up there with gravity. Piketty is ignoring something really, really fundamental in nature.

[Comment edited by commenter request. --Econlib Ed.]

Ben Smith writes:

Thanks Russ!

Another great episode. Appreciate all the hard work you put into these and the respect and intelligence you display throughout your interviews.

Mort Dubois writes:

" Their bargaining power seems to me very limited in the way that bargaining power is talked about as an important art of labor market outcomes. They make a little over $23, $24 an hour--which is about, roughly three times the Federal minimum wage--I don't know what the state minimum wage is. Guest: These ladies--ladies do make? Russ: Yeah. Each one."

Russ: by your subsequent description, it sounds as though you are dividing the amount of money you pay for housecleaning by the time it takes to clean the house by the number of workers, and assuming that this amount ends up in each worker's pocket. This is highly unlikely. Are you willing to clarify whether you asked these non-English speakers how much they take home per hour as opposed to guessing?

How much do you pay to get your house cleaned?

I've hired low-skilled immigrant workers before, both directly and by paying for their services through a contract manager. It would be very surprising that they would be paid $23 an hour, even in DC. But quite likely that YOU pay that much for them.

I pay $13 an hour for unskilled immigrant labor in Philadelphia, both when I hire direct and when I went through a manager. The manager was keeping $5 an hour and paying the worker $8 an hour.

James Linder writes:

Interesting as always - would love to hear Taleb weigh in on 'Capital in the Twenty-First Century'.

...since the comments for the interview with Daphne Koller are closed, I'll ask here: can anyone recommend an entry level micro class on Coursera?

Ajit writes:

I don't think the guest intentionally realized this, but I thought his use of the guilded age as support for the argument that inequality can lead to policy subversion was contradictory. After all, while the robber barons had the reputation of being rapacious, that didn't stop the overall political movement to flow towards unions and organized labor anyways. In fact, despite the massive growth in inequality, one could argue today's policies are far more reflective of what the common man believes should be done than say an oligarchy of the top 1 percent.

Clegg writes:

I'd like to weigh in, along with Jonathan, about the effects most of us don't see in a high-profile antitrust case. I am a Chicago-trained IP/antitrust attorney, so I bring no Harvard-school bias in favor of government intervention to this discussion.

BUT, I must take issue with Russ' suggestion that these cases are irrelevant by the time they are done. It was my job, as a young attorney on the team that convinced the DOJ to pursue the antitrust case against Microsoft, to pursue as many guerrilla actions as possible against Microsoft on behalf of our technology clients.

We represented folks like Apple, Sun, Netscape, Borland, etc.

I was tasked with using the looming threat of DOJ intervention to force Microsoft to reverse this or that anticompetitive policy. And our efforts yielded tangible, lasting results. Several major technology companies you know today (not just the ones I mentioned above, obviously) would not even exist if not for those efforts. Google? Nope. Facebook? Nope. The Internet, as we know it today would likely not exist. The web browser might never have broken free from the underlying operating system (Microsoft was in the process of tying the browser to Windows). Cross-platform enabling technologies like Java (again, Microsoft was successfully tying Java to Windows) would not have created a path for the landscape of competing operating systems and, quite frankly, the world we now enjoy where the underlying operating system has become commodfied.

Don't get me wrong. The Internet was coming, but it would have been a heck of a lot easier for Microsoft to extend its domination into everything Internet. That's where we were headed. Only Internet Explore can reliably serve up web content? Only Microsoft's e-greeting cards can get through the spam filter in Outlook? Only Microsoft's development tools can reliably create the most robust mobile and web applications? This is what using monopoly power to extend dominance to other markets looks like.

Not much has ever been written about the pre-DOJ efforts, because they all happened behind closed doors and most of the resulting agreements, including one of the largest patent settlements in US history, were protected by confidentiality agreements. But that doesn't mean they didn't happen. Just the threat of DOJ intervention opened several closed doors before the DOJ ever got involved. And even more once they did get involved.

I will admit that many of the people with whom I was fortunate enough to work on that case have now gone on record saying that the case was probably unnecessary. So, mine is not the only interpretation of those events. Furthermore, my take on things may sound self-aggrandizing, placing as it does so much emphasis on what was essentially the "ground game."

But there was a lot of corrective action happening in the lead up to and early days of the DOJ intervention that rendered the outcome of the case less critical than it might have been. I argue that those correctives are partially what created the appearance that Microsoft's decline was inevitable. take on things may sound self-aggrandizing....

Believe me, it does. But thanks for verifying that I was correct all those years ago to have argued that Microsoft's competitors were cynically using the Justice Dept. to win things in a courtroom, they couldn't in the marketplace.

Clegg writes:

...thanks for verifying that I was correct all those years ago to have argued that Microsoft's competitors were cynically using the Justice Dept. to win things in a courtroom, they couldn't in the marketplace...

Your point is an interesting one. The entire point of a regime like antitrust is to use regulatory enforcement to affect market outcomes that market actors cannot otherwise achieve, precisely because of the concentrated market power of a monopolist like Microsoft.

So, I will agree with everything you just said, other than the adverb "cynically."

It sounds silly saying it now, but we were true believers. I sometimes laugh now at how black and white the world seemed to us then, but we felt the stakes were much higher than a simple market tussle.

But, you know what? Everyone likes to think they are doing something important. And aren't we all the heroes of our own stories? So, I can't really prove the motives of all the people I worked with and all the companies I represented. People are complicated and motives are often a bundle of sticks rather than a single, unified position.

I share your suspicion of government intervention. I did then, too. We certainly disagree bout whether Microsoft presented a special case, but I really don't think it is necessary to impute cynical motives to the pro-intervention side in order to make sense of our actions.

Ajit writes:

My parents hire house cleaners. They pay 60 dollars for roughly three hours of work. They live in the bay area. I think that's the going rate for reliable and trustworthy cleaners.

TKList writes:

[Comment removed pending confirmation of email address and for policy violations. Please read our Comment Policies. Email the to request restoring your comment privileges. A valid email address is required to post comments on EconLog and EconTalk.--Econlib Ed.]

...because of the concentrated market power of a monopolist like Microsoft.
Which had nothing to do with it. It was simply that Microsoft produced the products that the consumers wanted. When that changed, say when Mozilla and Google Chrome came along, the consumers switched.

Pretty much the direct opposite of what the DoJ claimed was impossible because of 'lock-in' to Microsoft's inferior product.

Clegg writes:

...Which had nothing to do with [concentrated market power of a monopolist like Microsoft]. It was simply that Microsoft produced the products that the consumers wanted. When that changed, say when Mozilla and Google Chrome came along, the consumers switched.....

Many people unfamiliar with how Microsoft was operating see it the way you do, Patrick. That's because so much of the abuse happened behind the scenes and, more importantly, under the hood of Microsoft Windows. Microsoft wasn't only producing products consumers wanted; it was also sabotaging potentially competing products and forcibly tying new innovations, like the web browser, to their own operating system. In short, using their market power in the desktop OS market to control ancillary markets like browsers, development tools, productivity software, and more.

Let me give you some examples. One of my clients created the first e-greeting card offering. Quaint to think of it now, but they were hugely popular. Oddly, MS Outoook's spam filter would always snag competing e-cards, like those of my client, but never snag Microsoft's own e-card offering. To consumers like you, it looked as though MS simply made a better e-card service. But they were intentionally using their control over the email client built into Windows to sabotage competitors in the ancillary e-card market.

Another client made software development tools that people used to write software for the Windows operating system. On a regular basis, MS would secretly change the inner workings of Windows in ways designed to break my client's tools, while their own development tools division was given advance notice of these changes. As a result, MS development tools were more reliable and worked better. Was it because MS simply made better tools? Or was it because MS was using its control over the desktop OS market to size control of the development tools market?

Yet another client made productivity applications. Same story.

Netscape's browser - the very browser technology you now know as Mozilla - suffered a similar sort of sabotage. But after the antitrust case, competing browsers enjoyed more freedom and there has been a remarkable blossoming in both the browser market and the web layer in general. Why? Because the OS layer was allowed to be commodified - the very process that MS was using its monopoly power to prevent.

These things are not well publicized and the technical aspects are quite difficult to explain, so it appears to those unfamiliar with the case or the technology that MS was simply providing products that consumers preferred. Obviously, I've argued that wasn't entirely the case. But I find myself arguing against a counterfactual that is hard for people to conceive. So, it's no surprise if you remain unconvinced.

That's ok. As I said, even some of those who believed as I did back in the 90s have since been persuaded that the march of progress would have left MS behind eventually whether or not we intervened.

SaveyourSelf writes:

Patrick R. Sullivan wrote, “It was simply that Microsoft produced the products that the consumers wanted.”

Some of it, sure. But I remember being distinctly surprised and annoyed that I was forced to set up the explorer web-browser when I installed a newer version of windows. Come to think of it, having to install a new version of windows every 3 years was super annoying too. Microsoft was definitely doing things—and still is—that I, a consumer, did not want or appreciate.

Am I hearing echoes of the 'applications barrier to entry'? Thomas Penfield Jackson said that the 70,000 that ran on Microsoft were such.

How many apps are there now for an iPhone, half a million?

The entire justification (intellectual, anyway) for the U.S. v Microsoft anti-trust suit was that we were 'locked-in' to inferior Microsoft products, and (as Gary Reback's White Paper put it) all progress would come to a halt. How quaint.

Saveyourself, No one said Microsoft's products were perfect. None are. The only interesting question is, are someone else's better?

Dr. Duru writes:

Loved this podcast. Daron Acemoglu is one of my favorite of your many outstanding guests. He is perfectly measured and humble yet extremely insightful.

Gregory writes:

One of my favorite interviews. Replayed it multiple times. Could use some clarification on the use of the expression “institutional factors.” In some contexts I took the meaning to be synonymous with organizations or cooperative organizational arrangements. In other contexts it sounded, to me, like the term references broader constructs, i.e. the institution of private property rights. So when Acemoglu states “the institutional general environment, continued to support creation of better and better technologies and the scaling up of the employers that were willing to use that technology because they could outcompete their competitors” I’m unclear on how to interpret the use of the term institution.

Russ, you make the point that “…the main reason it doesn't (capital retain all the profit that it could from the higher return on R) isn't institutional. It's merely competition. Now, that is competition among profit seekers--entrepreneurs, corporations, etc.--forces them to share the gains with consumers, and then in turn with workers.” I think I get your meaning. That returns on R, in a competitive environment, are not captured by owners of capital but sacrificed in the name of growth i.e. retaining and capturing better workers and keeping prices lower to gain market share. Am I getting that right?

Jim Gatti writes:

The following SEJ article suggests that the furor over inequality is truly a tempest in a teapot:

"Levels and Trends in U.S. Income and its Distribution: A Crosswalk from Market Income towards a Comprehensive Haig-Simons Income Approach"
Philip Armour, Richard V. Burkhauser and Jeff Larrimore

Fred Schenck writes:


Does each cleaner get $23/hour or does the boss (who drives the better car) get the lion's share?

More importantly, are taxes being paid?

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