The Darwin economy

Robert Frank interviewed by Romesh Vaitilingam, 23 December 2011

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<p><strong><a name="ts"></a>Romesh Vaitilingam</strong>: Welcome to Vox Talks, a series of audio interviews with leading economists from around the world. My name is Romesh Vaitilingam, and today's interview is with Professor Robert Frank from Cornell University. We met in London in November 2011, where we spoke about his book, &quot;The Darwin Economy: Liberty, Competition, and the Common Good.&quot; He began by explaining where the title comes from.</p>
<p><strong>Robert Frank</strong>: I've made a fearless prediction that in 100 years time, people like you and me will check Darwin's name when they're asked to fill out a survey identifying the father of modern economics. No one can tease me about that, obviously, since we won't be around in 100 years. But I think it may happen sooner than that, just because I think his theory of evolution by natural selection is really a more general vision of how competition affects the well-being of larger groups. It will eventually be seen as an encompassing vision that includes Adam Smith's invisible hand theory as an interesting special case. My quarrel isn't really with Smith so much as with his modern disciples who think Smith thought that you could just turn selfish people loose in the marketplace and they would compete vigorously to pursue their own selfish interests, and in the process be led as if by the invisible hand to serve the greater good.</p>
<p>Smith didn't believe that it always happens, certainly. He was much more circumspect. But he did believe it often happened, and it does often happen. I think the invisible hand story will endure as an intellectual milestone in human history. But it's not the whole story.</p>
<p>I think Darwin's view was that traits are selected in competition among plants and animals for resources to survive and reproduce.Traits are selected because they help the individual member of the species to go forward and reproduce successfully. Sometimes those traits help with the group as a whole, or large parts of the species. Other times they're squarely in conflict. So keen eyesight in hawks, that's good for the individual animal, it's good for the species as a whole. Contrast that though with traits that evolve for their capacity to help individuals do battle with one another for important resources in the struggle. So the antlers of the bull elk, for example. They are primarily to help males battle successfully against other bulls for access to mates. Darwin saw that males in most vertebrate species took more than one mate if they could. The qualifier obviously is the important step because if some succeeded, that means others don't take any mates at all, which is the real loser slide in the Darwinian scheme of things.</p>
<p>So of course males fight bitterly for access to females. Antlers are the weapons for that particular species. And some mutations that coded for bigger ones were strongly favored in each case. They spread quickly, the mutations accreted.</p>
<p>Now we get animals with antlers four feet across, weighing 40 pounds. That's too big for bulls as a group. Antlers don't grow forever, that's true. Natural selection puts a stop to the growth. There's an equilibrium, but it's not an optimum size when viewed from the perspective of bulls as a group. They'd much rather be half as big, because they're such an encumbrance when they're chased into a wooded area by wolves. They're easily surrounded and killed. If they could take a vote or put their hoof on a red button at the count of three, &ldquo;all antlers shrink by half&rdquo;, they'd have compelling reasons to do that.</p>
<p>It's relative antler size that matters in battle, so it wouldn't affect the outcome of any fight. But they'd all be more mobile. They'd all be better able to escape from predation by wolves. From the perspective of the bulls themselves, that would be a good thing.</p>
<p><strong>Romesh</strong>: So these elk obviously can't do this.</p>
<p><strong>Robert</strong>: They can't do it. No.</p>
<p><strong>Romesh</strong>: But you have these dueling elks on the front cover of your book.</p>
<p><strong>Robert</strong>: Exactly.</p>
<p><strong>Romesh</strong>: How does that idea map onto the social world?</p>
<p><strong>Robert</strong>: OK. So, just as you see parallels to the invisible hand in nature, you see parallels to the exceptions to the invisible hand in the marketplace. If you're thinking about a worker who has an opportunity to earn a higher wage by taking a riskier job, let's say, that's a thing that's been much discussed by economists over the centuries. It's Adam Smith's old idea of compensating wage differentials, really. If the job is less pleasant or more dangerous or noisier or in any other way less desirable to the worker, you have to pay the worker extra to get him to take it. In the case of safety, you can pay the worker extra because if you don't install a lot of expensive safety equipment, it's possible to pay the worker a higher wage than if you did.</p>
<p>There could be lots of deals struck where the employer says, &quot;Look, if you'll be careful then I don't have to install this expensive safety equipment. Then I can pay you extra,&quot; and the worker might very well say, &quot;Yes, that sounds like a reasonable deal to me and we've got a bargain. We're consenting adults. We understand the risks&rdquo;.</p>
<p>We all take risks every day, so we can't say that taking risks is inappropriate.You've got to take risks. Why not let them decide for themselves what risks to take? What happens is that if they do try to take extreme risks in a work situation, the government stands between them and says, &quot;No, that violates the safety laws.&quot; And conservatives, free marketeers, have had a very strong rhetorical point. Well, what's the government got to tell these people who seem to know what they're doing that they can't sign that mutually advantageous contract with each other?</p>
<p>I would find that a compelling objection, except for one thing. The worker's interest when he makes that decision is to get ahead as an individual, but that interest may not be in complete harmony with everyone's interest. So maybe his objective was to earn a higher salary so he could bid more effectively for a house in a better school district. That's in fact the first goal of many parents. Taking a riskier job is very attractive because it helps you achieve that goal. But if other workers make the same choice, if they sell their safety for higher wages, then we're all bidding with extra dollars for houses in the better school districts. And in the end, we succeed only in bidding up the prices in houses in the better school districts. There's still only half the kids are able to go to top half schools in the quality distribution.</p>
<p>It's as if we all stood to see better and discovered, lo and behold, none of us sees any better than if we had all remained comfortably seated. So if the government steps in, as every government on the planet does do, and says, &quot;No, you can't take any more risks than this level that's specified under the safety laws,&quot; that's actually a plus for the worker. It prevents the worker from selling his safety in a way that if all workers do it, they end up no better off than before in terms of the goal they were chasing, but worse off in terms of their safety.</p>
<p><strong>Romesh</strong>: What we're getting into here is what you call, after Fred Hersch I believe, &ldquo;positional goods&rdquo;.</p>
<p><strong>Robert</strong>: Yes.</p>
<p><strong>Romesh</strong>: You think they're far more widespread in the economy than we tend to think.</p>
<p><strong>Robert</strong>: Not every good is positional, and I think I have a very different conception of what a positional good is than Fred Hersch did. He was focused mainly on things that are just in inherently scarce supply, like a home site with a good view or the most powerful position in a corporation, things that not everyone could have. They're socially scarce. Those are important categories, to be sure, but I think more in terms of &ldquo;context externalities&rdquo;, I would call them. Is my car OK? Is my house OK? The answer to questions like that, you can build as many cars, they're not socially scarce. You can build houses, any type you want. They're not socially scarce, but people's evaluations of them are very heavily context dependent. Is my house OK? I lived in a two room house in Nepal when I was a Peace Corps volunteer. It didn't have any plumbing. It didn't have any electricity. The roof leaked when it rained hard. It was nonetheless a perfectly OK house in that context. If you lived in that house here in the UK, you'd be ashamed for your friends to know where you lived. Your kids wouldn't want their friends to know where they lived. It would be a house that was by no stretch of imagination conceivably evaluated as being OK. It's just an inadequate house by the current standards.</p>
<p>If you look at context externalities, they're not here or there, they're everywhere. They're more intense in some domains than others. We know that if people are evaluating their houses, context matters more there than when they're evaluating their vacations.</p>
<p>If you say to somebody, &quot;Would you rather have four weeks of vacation in a world where everyone else had six? Or two weeks of vacation in a world where everyone else had one?&quot; They'll say four weeks. Not because they wouldn't notice that they have less vacation time than others, but they're just not willing to give up that much vacation time just to have a relative advantage there.</p>
<p>And because context matters more in some domains than others, one of the main results of looking at the world this way is you get arms races always that focus on the categories where context matters more. And they suck resources out of the categories where context matters less. In the house and leisure example, people would work longer hours thinking they're going to get ahead by being able to buy a bigger house. Whether that's just because a bigger house would seem nicer, or maybe it's because they want to get into a better school district.</p>
<p>But when they all do that, they discover no gain. If bigness is what they care about, then the bar just got raised that defines what's big. If it's a school district, then they've just bid up the prices of houses in the better school district. It's that kind of arms race that leads to the misallocation. That's why the invisible hand doesn't steer things to the best uses.</p>
<p><strong>Romesh</strong>: Charles Darwin is one of the heroes of your book, but someone else whose ideas you talk about a lot are Ronald Coase. Can you explain the significance of his ideas to your story?</p>
<p><strong>Robert</strong>: Yeah. He is one of my heroes. Certainly the Nobel committee took a terrible risk by waiting until he was in his 80s to name him for the prize. I think that would have been such a travesty if he hadn't gotten it. But of course he's 100 now and still going strong. I think he's the darling of conservatives when it comes to what should we do about activities that cause harm to others, which is really about what my book is about, activities that spill over onto other people. I think conservatives wrongly focused on his insight, which was really an important one, that if we can talk to each other, if we can negotiate agreements costlessly over the table with one another, we can always resolve those kinds of problems efficiently. If you're downwind and my smoke is bothering you, then we can reach an agreement about how to resolve that problem. Maybe it's cheaper for you to move upwind to avoid the smoke. Maybe it's cheaper for me to filter out the smoke. Maybe the best solution is just to do nothing, but we'll arrive at the efficient solution if we can talk to each other.</p>
<p>He was never, ever an ideologue on this issue. His early work made very clear that he understood full well that negotiating agreements like that, in most cases, just isn't practical. In that case, I think the way you want the law to evolve, the way you want property rights to be defined, the way you want laws to be written and regulations implemented is so as to mimic the agreements that people would have reached about these issues if it had been practical for them to talk to each other about it.</p>
<p>If you take that perspective, then a lot of libertarian objections to government involvement in regulation go out the window quite quickly. You can't say, &quot;I've got the right to do what I want to do no matter what you say.&quot; It's always going to be a question of what I should have the right to do. I think many of our libertarians in the US seem to believe they have the right, as long as they don't touch you, they have the right to do whatever they want to do, no matter how little they benefit from it, no matter how much harm it causes to others.</p>
<p>I don't think that's a right you can defend if you think about it carefully within the framework that Coase outlined.</p>
<p><strong>Romesh</strong>: Let's go on to some of the policies that you advocate as a result of this kind of thinking. Perhaps generally talk about the areas that you think the government can step in, in terms of regulation and in terms of taxation.</p>
<p><strong>Robert</strong>: My approach in the book is to try to adopt the perspective of a humble regulator. We know that governments are imperfect. Just because the market's not perfect that doesn't mean that the regulation you cook up to deal with the problem will be better. It might be worse. It often is worse. I'm inspired, in most instances, by lessons from the environmental domain where we first tried perspective, detailed command and control regulation. We would tell the electric companies where they had to buy their coal, what kind of scrubbers to put on their smoke stacks. That was very expensive and cumbersome. We switched midway through that process to a market based approach where we said why is there too much pollution in the air?</p>
<p>It's because firms can put it there for free and it costs money to filter it out. So of course they'll put it to excess in the air. If we charge them for putting it in the air, then they'll suddenly become incredibly clever about finding new and cheap ways to filter it out. When we did adopt effluent fees and cap and change systems, we achieved air quality targets about one eighth of the cost we would have had to incur under the old regulatory trajectory.</p>
<p>In the book I focus almost exclusively on remedies of the sort that try to make behaviors that cause harm to others less attractive to individuals by making them more expensive, usually by taxing them. That doesn't prohibit somebody from doing anything, so if somebody has got a really important stake in continuing to do what he's doing, he can but he pays the fee.</p>
<p>Others that don't have such a stake in causing the harmful behavior, if you don't really need a heavy vehicle you just thought you might like to have one but there's a tax on vehicle weight, then now you've got an incentive to take into account the risk you'll put others to when you buy the heavier vehicle.</p>
<p>Tax harmful behavior is the mantra that I repeat again and again in the book. Mainly the biggest remedy is to tax consumption at a steeply progressive rate.</p>
<p><strong>Romesh</strong>: You talk a little bit about nudge economics which is very popular in governments on both sides of the Atlantic at the moment. How do you see the relationship between the nudge kinds of policies and the more mandated tax regulation policies?</p>
<p><strong>Robert</strong>: Dick Thaler and Cass Sunstein are good friends of mine. I've known them both for years. I think it would be a good thing if almost every recommendation they make in the book were implemented. I know the UK government is taking an interest in it. They're trying to implement many of those suggestions but I don't think the view, which is what the nudge argument is based on, that the bad outcomes we see are, for the most part, the result of stupid decisions people make, I don't think that describes the really seriously bad outcomes that we see out there. Those are more plausibly, I believe, a consequence of the fact that individual interest and group interest don't coincide. They're collective actions problems like military arms races. They don't occur because nations are stupid. They occur because it's compellingly in my interest not to have fewer bombs than my rival, so we each build more bombs.</p>
<p>We don't become more secure as a result of that, but when we reach equilibrium, and it doesn't go on forever, we don't spend three times GDP on bombs. We spend too much on bombs, we've got an inefficient allocation. We should be building more schools and hospitals and fewer bombs. That's why we sign agreements to build fewer bombs.</p>
<p>I think in the safety domain, the nudge approach encourages us to think that people take risky jobs because they don't really know what the risks are. They're subject to availability biases. They think being a roofer is more dangerous than being a deliveryman when, in fact, if you look at the data, the deliverymen die more often than the roofers. It's easier to remember and visualize roofers dying so that's why we make that error. That's not the problem really. If you told a worker, &quot;Look, this job you're about to take is risky. It pays a lot more but it's risky,&quot; he knows it's risky. He's going to take the job because the extra money is going to let him do something important to him, but when everybody does it he won't be able to do something what&rsquo;s important to him.</p>
<p>That's the real reason we regulate safety, I believe. In the consumption domain what you spend has an impact on what I have to spend to achieve my goal. The bidding for the house in the good school district may be the simplest example of that. I want my daughter to feel special on her wedding day, so I put on, what seems in the current context, a special celebration, but because of the surge in income at the top we've seen the standards shift that define what's special.</p>
<p>We've seen CEOs in the US spend 10 million dollars on coming of age parties for their kids. Yeah, they want a special occasion, they succeed when they spend that much, they get a special occasion, but they raise the bar that others have to meet for their own occasions. Now the US family, on average, spends $28,000 on a wedding. That's in 2009, the most recent figure I could find. In 1980 the inflation adjusted figure was $11,000. Nobody could pretend that the people getting married in 2009 were happier because of that extra spending. It was just that the people at the top spent more. That led the people just below them to spend more. There was a cascade. If you don't spend what others like you are spending, then you don't show that you appreciate the significance of the occasion.</p>
<p>You could always spend less, of course, but that's costly too. You could spend less on a house, but then your kids go to the schools where the other kids are in the 20th percentile in reading and math and us parents aren't willing to do that. I think if we would discourage the people at the very top from spending as lavishly as they have been, which is not a moral failure on their part by the way, they just have a lot more money. That's what everybody does, when they get more they spend more. We could just slow down the cascade that has made everybody in the middle have to spend more to meet the standard that's expected of them.</p>
<p>If you have a consumption tax, you'd report your income to the tax authorities, then you'd report your savings. We know how to do that, too, from retirement accounts. Then you take the difference between those two numbers, income minus savings. Knock off a big standard deduction, maybe &pound;20,000 for a family of four, and that's your taxable consumption.</p>
<p>Rates would be very low in the beginning but they would rise steeply as the taxable consumption amount grows. They could rise almost without limit, really. We don't have the same cap that we do in the income tax case. Let's say you're consuming &pound;4 million a year, we'll make the marginal tax rate 100 percent on the next pound you spend.</p>
<p>That means if you spend it, then you pay the vendor a pound, but then you've got to pay the government a pound as the tax on that pound. You're thinking about putting an addition on your mansion? Fine. It's going to cost you &pound;4 million not &pound;2 million. Here's the magic in that tax. If you scale back and build a &pound;1 million pound addition on your mansion, it'll end up costing you &pound;2 million which is what you would have spent in the first place.</p>
<p>Of course you won't get as big an addition, but you won't need as big an addition since others like you will have scaled back too. After a point, it's relative mansion size that matters just as it's relative antler size that matters to the bull elk. There's really a win win for people at the top in a tax system like this, too. Why not move to a place that had a tax like that?</p>
<p>You won't have to waste all your hard earned money on coming of age celebrations for your kids or bigger mansions than you really want just because others like you are expected to entertain in a certain style.</p>
<p><strong>Romesh</strong>: Final question, Rob. Do you think this idea might get more traction in the current climate where everything seems to be up in the air over the past four years? All the agendas about the stagnant economies of the West, the austerity, and then this social reaction that's emerging, this Occupy Wall Street kind of thing.</p>
<p><strong>Robert</strong>: Yeah. I think getting inequality onto the plate for discussion has been an enormously productive thing of the Occupy Wall Street movement. They're not quite sure what to recommend. That's not their expertise and we shouldn't expect them to come forward at this stage with policy proposals. But yes, I think there's really room to move now. We don't want to tax consumption while the economy is still in the doldrums. Any port in the storm. If we can get any extra spending, that's all to the good. We can enact a tax like this and then schedule it for gradual phase in once the economy is back at full employment.</p>
<p>That would actually serve several ends at once. It would commit us to a revenue stream that would help pay down debt. That's important. It would help steer dollars away from consumption spending that isn't really buying much for the people that are spending it. It's mutually offsetting in many of the current contexts. Steer those same dollars into investment or public production of better roads and bridges. That would be a gain.</p>
<p>And there would be a short term benefit which would be by announcing the tax is coming, the people sitting on the cash now thinking maybe to build an addition onto their mansion or stage a big party at some point, &quot;Let's do it now,&quot; they'd say before the tax kicks in. So we'd get an avalanche of stimulus without the government having to spend a nickel.</p>
<p><strong>Romesh</strong>: Sounds good. Big party for everyone. Robert Frank, thank you very much.<br />

Topics:  Taxation

Tags:  competition, Inequality, taxation, Darwin economy

Find out more about The Darwin Economy: Liberty, Competition, and the Common Good here.

Henrietta Johnson Louis Professor of Management and Professor of Economics, Cornell University


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