Notwithstanding the uncritically enthusiastic pronouncements of many of Smith’s modern disciples, unbridled market forces often fail to channel the behavior of self-interested individuals for the common good. On the contrary, as the pioneering naturalist Charles Darwin saw clearly, individual incentives often lead to wasteful arms races. 104
Stimulus opponents cited fear of deficits as a reason for inaction, but deficits are a long-run problem. No one argued that we could put off maintaining our infrastructure forever. Doing it right away meant doing it more cheaply, which meant smaller deficits in the long run, not bigger ones. Deficits must be dealt with, yes, but the time for doing so is when the economy has fully recovered. 229
Yet credible evidence says that each dollar cut from that budget causes tax revenue to fall by $10, for a net increase in the deficit of $9! 235
In total, these investments have been extraordinarily effective in fostering an inchoate but pervasive sense of anger that has made it all but impossible for government to act. 277
The definition and enforcement of property rights are also the province of government. 282
Countries whose citizens have the most favorable opinions of their governments tend also to be ones with the best public goods and services, the lowest levels of perceived corruption, and the highest per-capita incomes. In contrast, those with the weakest governments—think Haiti, Somalia, or Sudan—typically have poorly functioning markets, extremely low per-capita incomes, high levels of crime and violence, and citizens who regard their governments as ineffectual and corrupt. If forced to choose, most Americans would prefer to live in New Zealand than in Haiti. Differences in the quality and scope of their respective governments are not the only reasons they’d make that choice. But they’re important reasons. 284
The fact that many activities are best carried out collectively means that government must levy taxes to pay for them. Libertarians and other anti-government activists often decry mandatory taxation as theft, but no government could function if forced to rely exclusively on voluntary contributions. Without mandatory taxation, there could be no government. With no government, there would be no army, and without an army, your country would eventually be invaded by some other country that has an army. And when the dust settled, you’d be paying mandatory taxes to that country’s government. 290
If there’s no realistic alternative to living under a government with the power to levy mandatory taxes, our best option is to try to create one that will deliver the most value for our money. We must take seriously the question of how government institutions should be designed and monitored. We should have far-reaching conversations about what public services we want and how to pay for them. Yet we are doing none of those things at the moment. 295
Note: The Solution is not to reject government, not to cripple government, which stalemates it resulting in even more cost, but to make government more effective. Edit
Smith never believed that the invisible hand guaranteed good outcomes in all circumstances. His skepticism was on full display, for example, when he wrote, “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”7 To him, what was remarkable was that self-interested actions often led to socially benign outcomes.
Note: Ask if markets always produce good outcomes in all situations, and show Smith himself did not believe that himself
As John Stuart Mill argued in On Liberty, it’s permissible to constrain an individual’s freedom of action only when there’s no less intrusive way to prevent undue harm to others.13 362
Rewards that depend on relative performance spawn collective action problems that can cause markets to fail. 368
But that account rests on the assumption that extra income is valued only for the additional absolute consumption it makes possible. When a worker gets a higher wage, however, there is also a second important benefit. He is able to consume more in absolute terms, yes—but he is also able to consume more relative to others. 374
Note: Zero Sum Economics – Ask Chris, is it or is it not the fact that the more income one makes, not only can he consume more in relative terms, but can he not also consume more relative to others?
Workers confronting these incentives might well prefer an alternative state of the world in which all enjoyed greater safety, even at the expense of all having lower wages. But workers can control only their own job choices, not the choices of others. If any individual worker accepted a safer job while others didn’t, that worker would be forced to send her children to inferior schools. To get the outcome they desire, workers must act in unison. 382
The fatal flaw in that framework stems from an observation that is itself completely uncontroversial—namely that in many important domains of life, performance is graded on the curve. A professional tennis player’s earnings, for example, depend not on how well she plays in absolute terms, but on how well she plays relative to others on the tour. 398
Note: A Fundamental Objection that economics is not zero sum. The beginning of the building of the apparatus.
Yet many self-described libertarians insist that it should be a sprinter’s right to take performance-enhancing drugs if he chooses. But why should that right trump the right of others to escape the resulting harm? Why should harm be discounted merely because it is indirect?
Shape this into something we can use
The bottom line is that if one adopts any reasonable conception of what constitutes harm to others, the regulatory apparatus of the modern industrial state—in concept if not in every detail—becomes completely consistent with—and is indeed even required by—Mill’s harm principle. 427
But even with federal taxes at their lowest level since the 1950s, 476
The good news, in short, is that there’s an enormous pot of free money available to any society that can bring itself to think more clearly about, and deal more intelligently with, activities that cause undue harm to others. 481
If one producer comes up with a cheaper way of manufacturing a product, he can cut his price slightly and steal market share from his rivals. In the short run, his profits soar, just as he’d hoped. But the loss of market share by rival firms gives their owners a powerful incentive to mimic the original innovation. And once the innovation spreads industrywide, the resulting competition drives the product’s price down to a level just sufficient to cover the new, lower production costs. The ultimate beneficiaries of all this churning are consumers, who enjoy steadily improved products at ever-lower prices. 515
Summery of Invisible Hand in a nutshell.
The libertarian’s faith in unregulated markets rests on several premises. Two of the most important are that consumers are well informed and that markets are competitive.
Starting Point of Libertarian ideology, and premises to bring down. Obviously their first attack is the victim blame. “It’s your own fault” that you don’t know “everything” you need to know. This is satire. None of these people are as perfect as they think they are. No one, no one person, anywhere, really thinks we have the time to research every possible piece of hidden information. Furthermore, we run into the epistemic horizon, you don’t know what you don’t know. You can’t know to do research on what you need to if it is hidden well enough.
But Adam Smith’s invisible-hand narrative also requires some additional assumptions, ones that available evidence should lead any reasonable person to question. One is that people are rationally attentive to all relevant costs and benefits of the various options they consider. Another is that, to the extent that material resources matter for well-being, it’s absolute income that counts, not relative income. Compelling evidence suggests that both assumptions fail in ways that undermine the invisible-hand narrative. The implications of the second assumption’s failure, we will see, are especially problematic. 612
Failure of the rationality assumption might lead people to empower government to restructure the decision environment in various ways that would foster better choices. But the question of how government might respond to those failures is not my focus here. That question has already received comprehensive treatment from Thaler and Sunstein in Nudge. 623
As Darwin saw clearly, much of life is graded on the curve. 630
We can’t pretend to understand how markets function unless we begin with a reasonably accurate portrait of the structure of human motivation. 638
Note: Important – The starting point of all of Economics and policy
The Darwinian framework is the only scientific framework available for trying to understand why humans and other animals are motivated to behave as they do. 641
Here, too, we see the logic of musical chairs: no matter how much money people earn, only half of all children can attend schools in the top half. 672
Note: Zero Sum foundation
In sum, no economic model can hope to capture how markets actually function unless it begins with the assumption that context shapes evaluation in significant ways. 702
But the real reason we regulate is to protect ourselves from the consequences of excessive competition with one another. 712
The implication is that, for well-informed workers at least, Adam Smith’s invisible hand would provide the best combinations of wages and safety even without regulation. Yet that belief is indefensible when people care strongly about relative position. 970
Note: Beginnings of defense against Friedman’s impenetrable argument. Relative position is the hidden gem.
Positional goods are ones whose evaluations are particularly sensitive to context. Since evidence suggests that context matters for virtually every evaluation, a positional good is thus one whose evaluation is relatively heavily shaped by context. In contrast, a nonpositional good is one whose evaluation depends relatively weakly on context. 1503
Adding context to the story matters because the two new terms in the decision are strikingly asymmetric. Having a relatively expensive house matters a lot, if only because it enables you to send your children to better schools. In contrast, having a relatively unsafe job is of only secondary concern. Adding the two relative terms to the traditional account thus tilts the decision sharply in favor of accepting the riskier job. That’s problematic because the relative advantage people seek is mutually offsetting. No matter how many workers accept riskier jobs hoping to move forward in relative terms, there can never be more than 50 percent of them in the top half. 1526
If illusory relative gains are what drove individual decisions to accept additional risk in the first place, those decisions are perhaps better made collectively. Complaining that regulations restrict the freedom of individual workers is thus little different from complaining that helmet rules restrict the freedom of individual hockey players. Yes, they do—but that’s the whole point in each case. 1538
The ultimate measure of success within that framework is the individual’s ability to pass copies of its genes into the next generation. 1547
The antlers of the bull elk, for example, are advantageous only insofar as they help their bearers win battles for access to females, and that advantage in turn depends almost entirely on their relative size. Larger antlers are purchased at the expense of reduced mobility in densely wooded areas, which makes a bull more likely to be killed by wolves or other predators. But greater mobility would be cold comfort, in purely Darwinian terms, if it were purchased at the expense of relatively small antlers, for the genes of such a bull would be unlikely to make it into the next generation. For the bull elk, then, antlers are a positional good and mobility a nonpositional good. And that’s why bull elk as a group overinvest in antlers and underinvest in mobility. 1550
Public goods would also be predicted to be nonpositional by virtue of one of the basic properties that defines them. Unlike private goods, for which quantities and qualities can vary for different people, public goods are provided in the same quantity and quality to everyone. So they cannot be a source of relative advantage. 1586
Note: Most things can be purchased and consumed in relative terms, that is, the more one buys the larger the advantage one gets positionally, relative to others. Not everyone can have the same purchasing power. There are simply some things, we believe, should be available in the same quality and quantity to everyone. For them to play by the same rules and start from the same starting point. You can’t have one person with a certain amount of national defense and someone else with another. everyone should have an equal shot at personal protection. Everyone should have as equal as possible at an equal education and equal access to the sciences and research. Everyone can benefit from the public parks and sciences, not just those who can afford them. Not everyone is going to have the best car. But everyone should be able to use the same roads, get the personal protection, use the same court process, and have access to hospitals. This is true freedom, not the other way around. Edit
Rights to behave in certain ways don’t arise out of thin air. Defending any given right creates benefits for those who value it. But it also generates costs—not just for those tasked with enforcing the right, but also for those whose behavior is restricted by it. 2027
Many libertarians seem inclined to embrace the harm principle when doing so provides them with additional ammunition against a regulation they don’t favor. When the principle seems to support a regulation they don’t like, however, they’re often quick to reject it, insisting that it’s trumped in that instance by some prior right to act in the way they wish to. But the latter tactic forces them to confront the question of where that right comes from. 2036
If libertarians want to stick with their current mix of policy prescriptions, then, they must confront some difficult choices. To continue to reject Mill’s harm principle when it suits them, they must assert that they have the right to take actions that impose substantial, easily measured harm on others even when the actions are of little benefit to themselves. Because such a right would be impossible to defend within the Coase framework, that choice would require them to reject Coase outright. But think what a difficult position that would be for an honest libertarian to defend! If you really care about freedom, how can you reject a framework that defines rights for the explicit purpose of mimicking as closely as possible the outcomes completely free people would have agreed to among themselves? 2044
Far more troubling would be the fact that willingness to pay depends so heavily on ability to pay. How much people would be willing to pay for an extra hour of quiet, or for the right to continue playing music for an extra hour, depends on many things—including their feelings about music, the thickness of their apartment walls, and their work schedules. But willingness to pay also depends heavily on income. Holding all else constant, the more people earn, the more they’re willing to pay to have their way. 2083
Despite these misgivings, many might nonetheless accept the market outcome, because they see no practical way to make use of informal information about intensity of preference of the sort assumed in the example. For instance, it would hardly be practical to allocate goods and services on the basis of what people say about how desperately they wish to own them. 2157
As in other arenas, ACAP feared, the rich would be empowered to buy their way out of the hassles of life, while the poor were forced to endure them. 2216
If public goods can be provided only if a majority of citizens approve of them, a government bound by these rules would not be able to provide the filter. Because it would have to rely on a head tax (one levied in equal amounts on every citizen), it would need to raise $500 from Rand and $500 from Paul to cover the filter’s price. But since it’s worth only $300 to Paul, he’d vote against the project, thus 2529
denying it a majority. So a democratic government could not provide the filter if it had to rely on a head tax. The point illustrated by this example applies whenever the valuation of a public good differs significantly across taxpayers, as it almost always will whenever people earn significantly different incomes. An equal-tax rule under these circumstances would make it impossible to provide many worthwhile public goods. 2532
As Darwin saw clearly, the fact that unfettered competition in nature often fails to promote the common good has nothing to do with monopoly exploitation. Rather, it’s a simple consequence of an often sharp divergence between individual and group interests. 2789
Yet enormously valuable opportunities remain unexploited. The “It’s your money . . .” rhetoric that has dominated recent political discourse has made it impossible even to discuss tax and expenditure policy changes that would create large benefits for everyone. 2794
More egalitarian distributions of resources can be defended not just in abstract moral terms, but also in terms of mutual advantage. 2799
The cognitive frames within which we view taxes have similarly powerful effects on our emotional reactions to them. If we think of being taxed as akin to some unknown person confiscating something that rightfully belongs to us, it’s almost impossible not to react angrily. But taxes are more plausibly viewed through a different lens. As discussed in the preceding chapter, for example, the high average income levels of modern industrial nations would not be possible in the absence of extensive public investments paid for by taxes. That realization begins to chip away at the cognitive frame necessary to support an uncritically angry reaction to being taxed. 2832
People sometimes file for bankruptcy because they failed to work hard and spent recklessly. But in the United States, many more bankruptcies occur when people fall seriously ill or lose their jobs, and with them their health insurance. 2851
Yet some people enjoy spectacular success despite having neither attribute. (Participants in reality TV shows? Lip-synching members of boy bands? Money managers who bet clients’ retirement savings on subprime securities and got out before the market crashed?) 2875
Far more numerous, however, are highly talented people who have worked extremely hard, yet have achieved only modest earnings. There are thousands of them for every person who strikes it rich. The biggest winners tend to be people who are talented, ambitious, hardworking, and extremely lucky. 2877
Consider Microsoft co-founder Bill Gates, for many years the wealthiest man on earth and still one of the top three. He was born in 1955 to a well-to-do Seattle family, attended private schools, and began programming computers at the age of 13. His Seattle high school had a computer club, an extreme rarity at the time, and he also enjoyed extensive access to the computer labs at the University of Washington. 2881
If it or any one of the other events in the sequence had not occurred—if Gates’s high school had not had a computer club, if Kildall’s wife had been willing to sign IBM’s nondisclosure agreement, if Paterson had negotiated with Microsoft more attentively—Bill Gates almost certainly never would have succeeded on such a grand scale. 2905
“If there were 50 in the world, I’d be stunned. I had a better exposure to software development at a young age than I think anyone did in that period of time, and all because of an incredibly lucky series of events.”7 2909
Players born early in the year were thus the oldest members of their team at each successive stage. On average, they were slightly bigger, stronger, faster, and more experienced than their teammates born in later months. Because they were more likely to excel at each stage, they were more likely to be chosen for elite traveling teams and for all-star teams. They were more likely to be funneled into the programs with the best facilities and the best coaching, more likely to receive athletic scholarships, and so on. 2922
Someone is smart either because she was born with genes that made her smart, or because she was raised in a nurturing, stimulating environment that fostered her intellectual development, or—almost certainly—because of some combination of those two factors. 2936
The same is true of someone with an unusually strong capacity and inclination to work hard. That aspect of her character may be partly genetic, and it may be partly a result of the particular circumstances of her upbringing. But whatever the true weights might be, there can be no doubt that someone possessed of these qualities enjoys a substantial advantage in life. 2938
One of the most conspicuous examples is the market for corporate executives. CEOs of the largest U.S. companies earned forty-two times as much as the average worker as recently as 1980, but by 2001 they were earning more than five hundred times as much,12 2979
This new spot market for executive talent has affected executive salaries in much the same way that free agency affected the salaries of professional athletes in recent decades. 3071
But that won’t happen unless we can adopt a new framework for thinking about taxes. Evidence on why people earn such different pretax incomes is clearly relevant for thinking about that framework. 3113
The prevailing framework presumes that people have a natural right to keep the full bounty their talents and efforts command in the labor market. Given the extent to which incomes rest on public investment financed by taxes, that presumption has never made much sense. It’s further undercut by accumulating evidence on the profound extent to which the labor market success of even highly talented, hardworking people depends strongly on random events. And although there may be substantial psychological utility in the common tendency to claim moral credit for one’s own success, the fact remains that even talent and the capacity for hard work are themselves heavily dependent on factors over which we have limited control. 3115
As every economics textbook makes clear, however, a decline in after-tax wages also exerts a second, opposing effect. Because it makes people feel poorer, it provides an incentive to reverse their setback by working longer hours or taking more risks than before. Suppose, for example, that a high roller’s goal were to achieve a standard of living that could be maintained on $2,000 a day. If his current after-tax wage were $250 an hour, he’d need to work eight hours daily. But if a rate hike reduced his after-tax wage to $200 an hour, he’d need to work two additional hours, or else sell his Ferrari. Others might react differently to a tax increase. Because a higher marginal tax rate reduces the opportunity cost of taking additional time off (in terms of forgone after-tax income), it might lead some to work fewer hours than before. Economic theory tells us nothing—absolutely nothing—about of which of these opposing effects might prevail. 3158
Trickle-down theory also predicts shorter workweeks in countries with lower real after-tax pay rates. Yet here, too, the numbers tell a different story. For example, even though CEOs in Japan earn less than one-fifth as much as American CEOs and face substantially higher marginal tax rates, they actually work longer hours than their American counterparts. 3171
The after-tax personal incomes of business owners are simply irrelevant for hiring decisions. 3203
Why Lower Tax Rates on Top Earners Often Inhibit Growth 3224
Richard H. Thaler and Cass R. Sunstein, Nudge, New Haven, CT: Yale University Press, 2007. 4289
For a review of studies of the relationships among local rank, serotonin, and testosterone, see Robert H. Frank, Luxury Fever, New York: Free Press, 1999, chapter 9. 4302
Richard Easterlin, “Will Raising the Incomes of All Increase the Happiness of All?” Journal of Economic Behavior and Organization 27, 1995: 35–47. More recently, Betsy Stevenson and Justin Wolfers have shown that average happiness is also positively related to average income over time within countries, and across countries at any moment: “Economic Growth and Subjective Well-Being: Reassessing the Easterlin Paradox,” Brookings Papers on Economic Activity, Spring 2008: 1–87.
See, for example, Andrew J. Oswald, Eugenio Proto, and Daniel Sgroi, “Happiness and Productivity,” Department of Economics Working Paper, University of Warwick, March 2009, which extends earlier findings by Wright and Staw and that workers with happier dispositions tend to be more productive: T. A. Wright and B. A. Staw, “Affect and Favorable Work Outcomes: Two Longitudinal Tests of the Happy Productive Worker Thesis,” Journal of Organizational Behavior 20, 1998: 1–23.