Sunday, August 14, 2011

The Lottery Economy

Here's how to solve all of the world's economic problems: invent a super-virulent strain of the ebola virus that will kill everyone on earth within a month or two. Voila! No more economic problems. You can't have economic problems without an economy.

What? Not the answer you were looking for? Not surprising. I put forth that extreme position to make this point: underlying any discussion of a solution to a problem are some tacit assumptions, like that you want to cure the disease without killing the patient. Yes, you can get rid of a whole host of problems (cancer, AIDS, hate crimes, athlete's foot) by exterminating humans from the planet, but surely everyone agrees that that is clearly missing the point?

Well, no. Not everyone. There are people who contemplate a planet devoid of humans with varying degrees of seriousness. And actively seeking a world devoid of one's own descendants (a.k.a choosing not to have children) is nowadays not uncommon. And there are a lot of people who argue in all seriousness that things would be better if there were fewer people, even if they stop short of advocating getting rid of them altogether.

Different people have different ideas of what constitutes a good outcome. Some people think that having a big family is the good life, others think it's a yacht and a private jet, and still others think that what really matters in life is getting right with Allah.

What I'm winding up to here is not the usual despair about the intractability of getting people to agree on fundamental issues, but wonder at the remarkable fact that we can afford to have these disagreements. Disagreement is a luxury that most creatures on this planet can't afford. You never see lions arguing about whether it is morally correct to eat wildebeests. They take what they can get or they starve.

It's important to keep things in perspective. Being able to get a banana any day of the year by going to the store and handing someone a piece of paper is not the natural order of things. It is only possible because we humans have built this thing called civilization, on which is layered the amazing system known as the global economy.

I have said in the past that one of the fundamental problems we are having in the U.S. today is that people have lost sight of the distinction between money and wealth. I think the problem actually runs even deeper than that. What people have lost sight of is the relationship between economies, civilizations, and quality metrics.

Civilization at root is based on division of labor. Some people do one kind of work, other people do other kinds of work, and so the overhead involved in learning how to do a particular task and become proficient at it is spread out over a population. Instead of everyone having to learn to do everything, an individual only has to learn to do one thing, and so the whole becomes greater than the sum of its parts.

It's a terrific theory, but it has two problems: first, how do you decide who has to do the dirty work? If everyone decides to be a lawyer and no one is left to fix the plumbing the system breaks down. And second, how do you decide how to distribute the proceeds of the system? And then there is the meta-problem of how to decide who makes the decisions. Obviously, being a decider is preferable to being a decidee (just ask George Bush), which leads to certain conflicts of interest.

In the very earliest civilizations, someone managed to convince everyone else that they should be the decider either by killing all the rivals or convincing people that they were anointed by God (sometimes both). But then we invented trade, which is even more powerful and amazing than division of labor. Division of labor produces dramatic efficiency gains but at the cost of having to solve the problem of decision-making. Trade allows for decentralized decision-making that results in improved outcomes even -- in fact especially -- in the face of different quality metrics. This is an amazing result. It means that you and I can interact in a way that we both agree is mutually beneficial even if we don't agree on what that benefit is! We can have completely different quality metrics and still cooperate to mutually agreed upon mutual benefit. Trade is white magic.

To complete the trifecta we invented money, which makes trade orders of magnitude more efficient. Before money, in order to trade you had to find another person who wanted what you had and who also had what you wanted. It was like dating, with all of its attendant difficulties. (In fact, the reason finding a mate is so troublesome is that it is one of the few kinds of exchange that cannot be facilitated by money.) With the advent of money that problem went away. With money you can buy and sell independently. You still need to find a corresponding seller or buyer depending on which you want to do. But it's a lot easier to find someone who wants to buy a goat and then someone else who wants to sell a pair of shoes than it is to find someone who wants to trade shoes for a goat. (It also solves the problem of how to make change for a goat.)

The upshot of all this is that you can go to the store and buy a banana for the equivalent of about 20 minutes of menial labor. It is truly an amazing thing. Our simian forebears would be incredulous.

Money, alas, is not quite as free of adverse side-effects as trade. The only way to conduct trade is through the provision of mutual benefit (otherwise it isn't trade). Alas, there are two ways to acquire money. One is to produce and sell valuable goods and services. This is the way of Jedi. The other is to game the system. That is the dark side.

There are lots of ways to game the system. You can sell snake oil. You can run a Ponzi scheme. You can acquire a monopoly which allows you to impose tolls.

In the absence of a mechanism to keep people from gaming the system, small disparities in economic power tend to be amplified through positive-feedback effects. If I have enough money I can buy media outlets through which I can influence your thinking. I can give money to government officials so that they will pass laws that unfairly benefit me. I can run my businesses in a way that makes it all but impossible for you to acquire any resources beyond what you need to subsist. The result is the creation of an oligarchy.

This is the problem we have today in the United States. Our country is no longer a democracy, it is a moneyocracy. One dollar, one vote. Which might be acceptable if all those dollars represented the creation of value, but they don't. By and large today, the people making the money are not the ones creating value, they are the ones who are gaming the system. There are, of course, exceptions. But they are a rapidly shrinking minority.

Aside from the fact that the diversion of money to non-productive activity is a drain on the economy, there is an even more insidious and corrosive effect. Those who have acquired money by gaming the system generally live in denial about this. People don't like to think of themselves as parasites, so they invent elaborate stories about how they are producing value by "providing liquidity" or some such bullshit. This begins a process of decoupling decision-making from reality. The end result of this process is a world where the most ridiculous nonsense becomes not just part of the debate but the prevailing view. It begins with investment bankers being in denial about the fact that they are parasites on society. It progresses from there to the belief that the best way to deal with a recession is to cut government spending. It ends with most of the presidential candidates from one of the two major political parties professing to believe in creationism.

Once upon a time we were a country where wealth was more or less correlated with the creation of value. Americans made money building railroads or making steel or inventing computers. There was a strong middle class, so even if you weren't extraordinarily talented you still had a pretty decent shot at a car and a house with a white picket fence if you showed up for work. We had a grip on reality. Science was cool. We invented the Internet and sent men to the moon.

There is still a slow trickle of innovation coming out of the U.S., but the defining themes of this country today are not the latest technological advances but rather shrill ideology about things like terrorism and drugs, epic fiscal irresponsibility, voters who say things like "get government out of my medicare" with a straight face, and political extremism that a few weeks ago very nearly sent us over a cliff.

Above all, we have a tiny minority of people who have won the lottery (myself included) and a huge majority of people who are somewhere between struggling to make ends meet and being on the street. It is no coincidence that gambling is on the rise in the U.S. The entire economy is shifting from merit-based capitalism to a lottery economy. Instead of a pension, you get a 401-K, which may or may not leave you with enough to retire depending on what the stock market does. Instead of a steady job, you get contract work, which may or may not be there next week. Instead of a social safety net, you get your share of a mortgage that you didn't sign up for and have very little hope of ever paying back.

Unless you win the lottery.

If you win the lottery, which nowadays pretty much means being an early employee at a company that goes IPO or making partner at Goldman Sachs, then you don't need a social safety net. You don't need a steady job. You don't need a pension. You get to be one of the people who makes the decisions, buys the politicians, bypasses the security lines at the airport.

But your odds are not good. The top 1% now own about 40% of the nation's wealth. Your odds of being in the top 1% are about 1 in 100. Are you feeling lucky? And do you want to live in a country where that question is the one that decides the fate of your children?

The reason I support raising taxes on rich people is not just because it has to be done to close the budget deficit. There's a much deeper reason than that. Taxing the super-rich provides a vital countervailing force to the natural tendency of money and power to concentrate in the hands of the few people who are most willing to game the system and most able to be in denial about it. The corrosive effects of the phenomenon on the fabric of society are evident everywhere today. Our infrastructure is crumbling. Our people are out of work. The middle class an endangered species. Our government is dysfunctional.

It doesn't have to be this way. We don't have to have a lottery economy. But the first step to recovery from any addiction is always the hardest: admitting to yourself that you have a problem.

[UPDATE: The lead story of the on-line edition of the NYT this morning is "Starved State Budgets Inspire New Look at Web Gambling."]


Dennis Gorelik said...

You are misdiagnosing the problem.
The problem is overspending and stealing (corruption). Not high concentration of power.

To fix these problems we should:
1) Limit functionality of government by significantly cutting spendings.
2) Increase government employees salaries, especially of elected officials and therefore increase competition for these positions.
3) Simplify tax code and close loopholes. That would naturally make richer people to pay more without increasing tax rates.

Ron said...

You have completely missed the point. Yes, overspending and corruption are problems. But these problems have a deeper underlying cause, which is the concentration of power, which in turn has an even deeper underlying cause, which is collective societal Alzheimer's about how economies actually work, and in particular, a lack of understanding of the difference between money and wealth.

You can say "Cut spending, increase salaries, simplify the tax code" until you are blue in the face. It won't happen. And the *reason* it won't happen is because these things are not causes, they are effects. To bring about change you have to address the *cause*. And the cause in this case is that we are practicing cargo-cult capitalism. (Hm, there's a good title for a follow-up post.)

Dennis Gorelik said...

So you are saying that increasing tax rates for the rich would fix corruption problems?
I think quite the opposite would happen: the rich would have even stronger motivation to corrupt the government and increase the number of various loopholes.

I'd like to point to another mistake you are making: you are assuming that dysfunctional government is bad. But it's quite the opposite: dysfunctional government is good.

Ron said...

> So you are saying that increasing tax rates for the rich would fix corruption problems?

Not by itself, no. It's not going to be that easy to put this genie back in its bottle. But it would be a step in the right direction.

> the rich would have even stronger motivation to corrupt the government and increase the number of various loopholes.

But they would have relatively less power and influence, and so would be less likely to succeed.

> you are assuming that dysfunctional government is bad.

I'm not assuming it, it is manifestly true (by my quality metric).

> But it's quite the opposite: dysfunctional government is good.

By your quality metric perhaps. Personally, I like having roads and civil order and clean drinking water coming out of the tap.

BTW, there are plenty of places in the world with governments even more dysfunctional than ours. Somalia for example. If you are such a fan of dysfunctional government, why don't you move there?

Dennis Gorelik said...

> But they would have relatively less power and influence, and so would be less likely to succeed.

Would you say that alcohol prohibition would decrease power of illegal alcohol trading mafia?

> Somalia for example. If you are such a fan of dysfunctional government, why don't you move there?

Somalia's example is too extreme.
I'd say US government does two times more than it should.
Somalian government does ~10 times less than it should.

Ron said...

> Would you say that alcohol prohibition would decrease power of illegal alcohol trading mafia?

Of course not. That's a ridiculous straw man. I've consistently argued that prohibition doesn't work. Taxation is not comparable to prohibition.

> I'd say US government does two times more than it should.

OK, that's not an unreasonable position. But a factor of 2 is not that far off for a system as complex as a government. If you were building a bridge a safety margin of 2x would be considered pretty minimal.

The problem with the government is not that it's 2x bigger than its optimal size (by your quality metric). The problem with the government is that it's doing the wrong things: building weapons instead of infrastructure, prisons instead of schools, bailing out corrupt too-big-to-fail financial institutions instead of leveling the playing field to allow new competitors to challenge the established players. And the reason that government is doing the wrong things is that it has been taken over by money.

Dennis Gorelik said...

1) In it's extreme taxation has the same effect as prohibition (when taxation is 100% of income).
The closer taxation is to 100% - the more prohibition effects it causes.
So raising taxes increases corruption.

2) I agree that problem with the government is that it's doing wrong thing. But the only robust way to prevent government to do wrong things is to cut spending.
Then government naturally scales down to more efficient and less corrupt system.
If there is less money to spend - there is less motivation to steal and more accountability for every dollar spent.

Ron said...

> 1) In it's extreme taxation has the same effect as prohibition (when taxation is 100% of income).

Then you don't understand what prohibition is. Prohibition means if you do X they throw you in prison.

> the only robust way to prevent government to do wrong things is to cut spending

That's also plainly untrue. The government was working pretty well from 1945-75. That didn't happen because we cut spending.

Dennis Gorelik said...

1) I'm well aware about differences between prohibition and taxation.
I'm saying that the effects of prohibition are almost the same as 100% taxation: corruption, revolts, and interruption in supply of goods.

2) Do you imply that % of GDP that US government spent in 1945-75 was as high as today?

Ron said...

> the effects of prohibition are almost the same as 100% taxation

No one said anything about 100% taxation. And the effects are highly non-linear. If you reduce tax rates to 50% you don't get 50% as much corruption as you would at 100%. And you certainly don't get zero corruption at 0%.

> Do you imply that % of GDP that US government spent in 1945-75 was as high as today?

It's pretty close. It has gone from around 30% of GDP between 1945-75 to around 40% today. Yes, it would be good to get it back to 30%. But in the 1920s it was ~10%. That's too low (by my quality metric).

The problem is not that government spending is too high. It is (a little) too high, but that's not the problem. The problem is that we're spending what we're spending on unproductive activities, building bombs and prisons instead of roads and schools, bailing out bankers instead of funding research.

Dennis Gorelik said...

> No one said anything about 100% taxation. And the effects are highly non-linear.

Yes, the effects are highly non-linear.
If taxation is below 20% then corruption stimulation by taxation is insignificant.
At 50% corruption stimulation and economy suppression effects are pretty severe.
At 100% taxation the consequences are quite literally bloody.

US is already suffering from over-taxation. You are suggesting to "fix" it by taxing even more.

If you are fixing things in the wrong direction - guess what would be the result?

That said - the actual problem is not in formal number of tax rate, but in effective taxation which is "government spending per GDP".
If we are now at 40% then it would make sense to return back to 30% in order to achieve reliable prosperity.

As you can see that my focus is on government spending, not as much on tax rate.
So you may ask - why do I oppose to your idea of increasing taxation for the rich (if government spending is the key).

The answer to that is that higher tax rate benefits corrupt businesses and politicians and hurts non-corrupt businesses.

Nate Cull said...

"The government was working pretty well from 1945-75. "

By some measures, yes. But not really by the "making weapons rather than schools" measure. 1947 saw the conversion of the United States economy to a permanent war footing with creation of Eisenhower's "military-industrial complex". Vast sums of government money were poured into creating the worst weapons of mass destruction ever invented, as well as throttling freedom with ideas like "born secret" scientific knowledge. Although this military Keynesianism primed the pump for today's high-tech industries, it also led directly to the corruption of government by huge defence contractors.

We wouldn't have today's blights like private prisons or the Iraq War without the triumph of the permanent war state in 1945. We also maybe wouldn't have the Internet, either, so Mom gives with one hand and takes with the other. But on the whole, I don't think we can say uncritically that the years 1945-1975 were awesome and we should repeat those policies. MAD nearly destroyed the world several times.

Here come the planes. They're American planes. Made in America.

Smoking or non-smoking?

Ben Stewart said...

Completely agree with outr country being a moneyocracy and not a democracy! Like I posted in my blog. The last two presidential elections have been won by the candidate who raised or spent the most money.