GDP has always been flawed. It’s missing home production, and underground production, and leisure, and the flow of environmental services.
But, our hope has always been that what it’s missing is roughly in proportion to what it measures. If this is true, then GDP is still a good measure of overall value.
Except for consumer surplus. GDP has always missed consumer surplus, And this didn’t seem to matter much … until the internet started turning lots of measurable GDP into not-so-measurable consumer surplus.
Think about a music file that you obtain for something less than its retail price. The value to you is the same, but almost all of that value is now surplus instead of revenue for the music industry. This means GDP actually falls when you pirate a song.
And yet the well-being that GDP is supposed to measure actually goes up when society pirates songs. The reason is that as price falls, we move down along the demand curve. Yes, we’re reducing measurable revenue to the industry, but we’re increasing the triangle of consumer surplus in two dimensions: both the price we would pay but no longer do, and the number of people who find it in their interest to obtain and enjoy the song at the lower price.
N.B. I do recognize that there is a broken window fallacy that’s also involved with pirating music, but that’s not my concern here.
Anyway, I think I’ve got you convinced that there’s something new going on with consumer surplus. Now consider this video. This is a serious short film, and I’m sure the creators thought nothing of what it says for macroeconomics.
Did the two girls get something of value? Yes, I think it’s obvious they did. Does it enter into GDP? Of course not. That’s problem one.
But there’s a second bigger problem. How did they produce that value?
Hmmm. Let’s play macroeconomist. The girls combined labor, capital and technology to create value. What’s the labor? I suppose it’s the girls’ time (posing, clicking, tagging, texting, and harvesting the enjoyment that follows) and the time Kirsten Dunst is actually being photographed.* But what about the rest? The phones and the internet are capital. Now, there’s technology involved in both of those too, but it’s sort of boring for my purposes because it’s extant technology.
But what about Kirsten Dunst? Is there more to her than labor? If so, is she capital or technology? I think she’s a little bit of both, perhaps even quite a bit of both, since she’s a lot more important to producing this bit of value than anything else.
She’s definitely capital in that she’s productive, and her productivity will depreciate if not cared for. A name will help with this idea; how about “Dunstware”. I think it is fair to say that an actress like this would be very concerned about the potentially rapid depreciation of her Dunstware.
But she’s also technology: a productive, non-rivalrous idea, that can be used repeatedly without being consumed. Call this “Dunstfulness”. This picks up the idea that you’re never going to be in a photo with Kirsten Dunst unless she brings her Dunstfulness with her; photoshopping is still possible, but then it’s really a form of technological spillover in which someone can use Dunstfulness without necessarily having permission to do so.
That’s mind blowing. Could you, just a few minutes ago, have conceived of a person’s … personness … as a form of technology?†
It’s get’s better. Dunstfulness is a technology for which there are network externalities that aren’t even based on production. Consider a theorem. Yes, it has network externalities because it can be used repeatedly to create new value. Dunstfulness is better than that: she can repeatedly create value (in the girls’ friends) without be used at all.
So, Dunstfulness is a technology that should be measured with our national wealth. And, it’s capable of helping to produce something valuable that should be measured in our GDP.
Further, our GDP, which does measure all the production values that go into creating Dunstware, and is clearly not going to measure the long-term investment made in creating Dunstfulness. And yet, no doubt, a lot of people along the line involved in that no doubt envisioned their work as an investment in Dunstware or Dunstfulness.
* Can we even use the word “photographed” for what happens in the video?
To control for the weirdness of the real world, they did this as a lab experiment. In these experiments, subjects enter for free and play for real money that is proportional to their performance.
They simulated taxes. Subjects got to keep the after-tax money they earned.
They did this with the same people in two environments: one in which taxes were simpler (had less rules to follow) and one in which they were more complex (had more rules to follow). The subjects’ outcomes would be the same across the two environments if they were able to follow all the rules.
They found that subjects behavior was closer to optimal when the tax system was simpler. Basically, subjects left money on the table when the tax system was too complex.
It gets worse. Then they added an identical rule to each tax system — making each setup a little more complex — and had the subjects play again. Now, put on your thinking caps: in the simpler system, the marginal increase in complexity from an identical change will plausibly be larger. What they did was actually go from 2 to 3 tax rules, and from 22 to 23 tax rules, so this seems like a plausible conclusion. What they found was that performance went down under both systems, which isn’t very surprising. What is surprising is that they found that 1) performance got “more worse” (I know that sounds kludgy) with the complex system, 2) poorer performance was concentrated in the people who performed worse before the change, and 3) the measured decision-making time of those people didn’t change much.
The authors conclude from this that they were able to isolate subjects who found the complex system to be beyond their cognitive ability, and that when confronted with a rule change that made that problem worse, these people shut down and ignored the change.
This is a strong case that a complex tax system discriminates against people on the lower end of the intelligence spectrum.
That’s a bombshell: politicians, in collusion with bureaucrats, accountants and lawyers, may have set up systems that discriminate against people who aren’t as smart as they are.
Keep this research in mind the next time someone tells you that a flat tax system is bad, or that a progressive tax system is better.
BTW: In perusing the reference list, I conclude that the strain of literature these authors are targeting is liberal rather than conservative: it falls in the Elizabeth Warren, Cass Sunstein orbit of the Democratic party.
Economists talk about traded and non-traded goods. By this they mean traded across borders.
So cars are traded, and haircuts are not. Typically, goods are very easy to trade, and services are harder to trade.
Now, add a second thought: trade (at least the voluntary kind) is beneficial to both parties. In particular, for the argument I’m making, trade benefits buyers by reducing prices.
Now the third thought. Who spends a greater portion of their income on traded goods? The answer is probably the poor.
That might not be immediately obvious. But, if you think about it, there’s a lot more inequality in spending on goods and services than there is in spending on goods alone. The reason is that for many goods, your utility diminishes very quickly. For example, there’s only so many Chilean grapes you can eat. But, services on the other hand, include things like personal shoppers, concierge services, legal and accounting services, and live entertainment. As people get richer, the consumption of all of those continues to rise long after our consumption of goods plateaus.
There’s actually a pretty simple formula for this that’s taught in the first corporate finance class. The present value of an infinite stream of equal payments is that payment divided by the discount rate.
It’s an approximation, but we could view the profit earned on a cab every day as a constant.
The discount rate takes a little calculation, but some quick work with a spreadsheet shows that a daily rate of 0.01% corresponds to a discount rate of 3.7%. That’s not a bad value for discounting real values when you have a city backing up your license with its enforcement powers.
In that case, $100 per day, discounted at the rate of 0.0001 (so the first number divided by the second) gets you the million dollar price.
The round numbers are convenient: we can quibble about the discount rate, but the round numbers mean that if we double it, we just double the daily profit required to justify the purchase of the taxi medallion.
Now, where does that discount rate mean, and where does it actually come from? The discount rate is the rate people use subjectively, in their own heads, to trade off cash today for cash in the future. No one ever knows exactly what it is, but we can infer from people's actions what they’re thinking. In the business world, managers tend to push for a discount rate that’s consistent with something called WACC — basically, the rate you have to pay to obtain funds (often from borrowing).
I should think, if you could get funds at 0.01% per day, you’re in excellent financial shape. So a really flush investor can justify buying a taxi medallion if they can expect a profit rate of around 16.7% per year (the back-of-the-envelope calculation $100/day profit divided by the $600/day revenue).
But if your WACC is higher, say consistent with 0.02% or 0.03% per day (corresponding to 7.5% or 11.6% annually), then your profit rate would need to be double or triple that.
In the end, all of this makes me think that services like Uber have huge latitude to reduce prices to consumers because, in the conventional business model, consumers are mostly paying for the owner’s medallion.
Thomas Piketty’s Capital In the 21st Century has been a bestseller in America since its translation came out in the spring. It’s being widely touted as the most important book in macroeconomics in decades.
It’s arguable that this is all a load of BS. It turns out no one is actually reading it.
Here’s how we know. When someone buys a book for their Kindle, they can highlight passages. Part of what you agree to when you buy a Kindle is that Amazon can keep track of those highlighted passages. The most frequently highlighted passages are actually shown towards the bottom right of a book’s webpage on Amazon.
For most books, these passages occur throughout the book. And a good sign that people finish the book is that there’s a heavily highlighted passage towards the end.
The thing is, of the 5 most heavily highlighted passages in Piketty’s book, the last one occurs on … page 26. Not one of the top 5 passages occurs in the last 670 or so pages.
There’s actually theory in statistics about the distribution of what are called record values. That isn’t applied here, but having some exposure to it, I’d estimate that 99.9% of readers never get past page 50 before abandoning the book. For example, suppose that (way back when) people started recording the time it took to run a mile, and kept track of each successive record: if the record times stopped going down once they hit 7 minutes … you might conclude a lot of things, but a pretty obvious possibility would be that no one is running that distance at all.
When the rate of return on capital exceeds the rate of growth of output and income, as it did in the nineteenth century and seems quite likely to do again in the twenty-first, capitalism automatically generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based.
When the rate of return on capital significantly exceeds the growth rate of the economy (as it did through much of history until the nineteenth century and as is likely to be the case again in the twenty-first century), then it logically follows that inherited wealth grows faster than output and income.
Knowledge and skill diffusion is the key to overall productivity growth as well as the reduction of inequality both within and between countries.
The sharp reduction in income inequality that we observe in almost all the rich countries between 1914 and 1945 was due above all to the world wars and the violent economic and political shocks they entailed (especially for people with large fortunes). It had little to do with the tranquil process of intersectoral mobility described by Kuznets.
Over a long period of time, the main force in favor of greater equality has been the diffusion of knowledge and skills.
I have a Kindle 2, in which there are no pages, only locations (these are approximately a longish sentence each). Piketty is 13,605 locations long. A page in the hardcover edition of the book is about 19 to 20 locations; the biggest “page” I can show on my Kindle is about 11 locations.
# 1 is from location 88 (0.6% of the way through the book, and I have the second half of that quote highlighted)
# 2 is from location 547 (4.0% of the way through the book, and yes I have that one highlighted)
# 3 is from location 458 (3.4% of the way through the book, and I don’t have anything on that “page” highlighted
# 4 is from location 340 (2.5% of the way through the book, and I don’t have anything on that “page” highlighted)
# 5 is from location 480 (3.5% of the way through the book, and I don’t have that passage highlighted, but I do have two others on that “page”)
To put that in perspective, that’s like getting a text for a class that has they typical 15 chapters in it, and when the books are sold back to the bookstore at the end of the semester, they notice that no one highlighted anything after the first chapter. What would you conclude about a class like that? For my part, I’d conclude that the material wasn’t very interesting, the students weren’t trying hard, and no one was doing quality control to make sure they did.
Currently, I’m at location 1921, and I’ve highlighted 123 passages in the book. And yet I match up with 1.5 out of 5 of the most popular highlighted passages.
It’s a rough conclusion, but an academic macroeconomist, preparing to use the text in an advanced undergraduate class, doesn’t find interesting or worthwhile well over half of what the general reading public does.
I hate to sound elitist, but this doesn’t bode well for the public’s ability to understand macroeconomics even when guided by a book that’s quite readable. I think this is prima facie evidence that the intellectual baggage people bring with them to macroeconomics is huge.
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